Exactly seven years ago, the fall of Lehman Brothers started a crisis Europe has still to overcome. Meanwhile, China has kept growing regardless at spectacular rates. Yet the sudden devaluation of the Yuan and the Shanghai’s stockmarket turmoil signal troubles ahead for the world’s second largest economy. Despite this, China is unlikely to face a full-blown crisis. Rather, it is affected by a problem quite common across the world: the need to move its economy away from export-led growth towards an increasing reliance on domestic demand. Europe is not dramatically exposed to China, especially compared to emerging markets. But global currency wars and stalling trade are definitely bound to jeopardise Europe’s weak recovery.
Before examining the global context though, let’s focus on China. Compared to high-income countries, the bourse is small relative to the economy. Less than a fifth of China’s household wealth is invested in shares. The stockmarket is thus little indicative of the economy’s health. True, there is no doubt that the Asian giant is slowing down. Yet, in absolute terms, even a GDP growth of “only” 5 percentage points would add more output to the global economy than a rate of 10% did a decade ago. In other words, China is now so big that it is understandable, and not much of an issue, if it grows less in relative terms. The fundamentals remain solid; China’s infrastructure and its innovation potential are unrivalled by the standards of developing countries. However, what last month’s tumble in stocks suggest is that investors are concerned with China’s economic rebalancing away from investment towards consumption. Given the country’s extremely high saving rates and success in developing by exporting, engineering its transition is definitely a hard trick to pull off. Though we can be confident that the factory of the world is also set to become one day the world’s main shopper, the ride to get there might be slower and bumpier than expected. In the short term, this might mean dim prospects for global growth.
Indeed, the problem is not only China’s. Emerging markets are understandably in the spotlight. The Federal Reserve is about to raise interest rates for the first time since the beginning of the financial crisis. This means that the flow of cheap money towards developing countries will stop; actually, investors have already started to repatriate capital to the US. China’s slowing growth adds difficulty to an already complex situation: many emerging markets are dependent on its demand for commodities as well as cheap credit from the US. Brazil, affected by both phenomena, is the example par excellence of troubling times ahead in middle-income countries.
The rich world is not immune from the effects of these developments though. The reason is quite straightforward: the United States is the only country ready to tighten its monetary policy and allow its growth to drive up imports and the dollar. However, the times when the American consumer was enough to pull along the whole world are now over. Europeans have been told times and again in the last five years that the road to growth has to be paved by greater competitiveness and higher exports. Japan’s prime minister Abe too places a great deal of importance on currency devaluation and reliance on foreign demand for Japanese products. And Beijing’s currency devaluation signals that China wants to revive a slowing economy again by exporting. This is the reason why Europe should worry; not because of weak demand from China, which accounts for a small share of European exports, but because it is now clear that it will take a long time before Chinese consumers can sustain global growth.
In a nutshell, all governments – bar Washington and London – want to export their way out, but to whom? Global trade is stalling. If most countries do nothing to boost domestic consumption, foreign demand will not be enough to drive growth. This issue is at the core of the debate on austerity and Berlin’s economic recipe. Germany’s success story cannot be repeated, being the current global context totally different from ten years ago. The Eurozone does need to address the profound imbalances between the North and the South. But somehow it has to revive domestic demand too. In this light, China’s woes will not have a catastrophic impact, but they are a stark reminder of Europe’s precarious situation.