How The 2008 U.S. Recession Will Hit China
The current U.S. recession, which I believe began in December 2007, will slow China's growth rate materially. A globally integrated China cannot escape global economic and financial market movements. China, now worried that its economy is too hot, will soon worry that it is not hot enough.
The U.S. subprime mess has now spread throughout the credit markets in the U.S., and indeed to the world. The Fed is on the case, slashing interest rates--with more to come and economists are marking down their forecasts. Financial market volatility is stunning and fear is replacing greed in the minds of many investors worldwide.
It is useful to remember that this is the first time in the modern era in which China's economy has become sufficiently involved (trade and capital flows) with other economies that troubles in the U.S., Europe and Japan would affect China. Welcome, Beijing, to the rough-and-tumble of the globally competitive marketplace.
China's real gross domestic product growth rate is likely to slow from 11.4% in 2007 to the 8% to 9% range in 2008, the slowest rate in seven years. This will slow the rise in real per-capita incomes for Chinese citizens from about 10% annually to about 8%. Too bad. For most of the years of my career I would have been happy with an 8% uptick.
While much media ink is being devoted to the deteriorating U.S. situation, most Chinese won't perceive much difference between an 8% or 10% rise. But even absorbing this jolt will still likely leave China as the fastest-growing economy in the world in 2008--a familiar ranking.
Why the hit to China? It sells 48% of its exports to the U.S., Japan and Europe. I believe all three are likely to be in or near recession in the next few months, with growth around 1%, maybe less, for 2008. In years 2005 to 2007, 32% of China's GDP growth came from its positive net exports. It should not be surprising that a slowdown in these countries will take a bite out of China's growth.
Consumer spending in China is also likely to slow a bit as the reality of slower growth and greater caution yields a spending pause. Additionally, capital spending is likely to slow as foreign investors will pull back from their new Chinese commitments. As a partial offset to the slower private-sector capital spending, watch for Beijing to ramp up the capital spending made by the various governmental entities. Chinese business people and individual investors all are subject to the same kinds of psychological pressures that we in the West understand.
The slowdown likely will, by midyear, cause China to stop its current program of monetary policy tightening and substantial currency appreciation. Beijing has been raising interest rates and reserve requirements and also tightening up on bank loan quotas as well in the effort to slow growth. Nothing has worked very well. During the last few months the rate of appreciation of the Chinese Yuan has accelerated. With exports slowing, China is not going to encourage a greater slowdown with a rising currency.
But soon we see Beijing's No. 1 concern morphing to economic growth that is too slow, not too hot. So, rather than tightening, we expect China to start to ease policy during the second quarter this year. We would also expect the path of gradual currency appreciation to end by midyear. This 180 degree flip-flop on policy will get the attention of the West as well as of domestic business people and investors.
On the inflation side, watch for China to use nonmarket price controls more aggressively in the coming months. I remain convinced that China is making the wrong bet by continuing to use administrative price controls rather than market forces to keep inflation in check. But it is important to remember that China has racked up the fastest growth in the world for the last quarter-century doing it its own way. It doesn't feel like the West has much to offer in terms of economic policy. The last thing China wants is slower economic growth and higher inflation at the same time.
China has worked hard, and relatively successfully, to become a full-fledged player in the global economic and financial community. But officials in Beijing, for which control is everything, are beginning to worry about the slower growth that many China experts anticipate. This is a not-so-subtle reminder that China's larger global role exposes the country to the global economy like never before.
Donald H. Straszheim is vice chairman of Roth Capital Partners in Los Angeles, former global chief economist at Merrill Lynch, a visiting scholar at the University of California-L.A. Anderson School of Management and a longtime China specialist. He previously served as president of the Milken Institute and joined Roth in 2006 to spearhead the firm's China initiatives.
