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Aug 26, 2015 | 20:49 GMT

Conversation: China's Slowdown Reaches Around the World

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Mark Fleming-Williams: Hello, my name is Mark Fleming-Williams and today I'm joined by John Minnich to discuss the global economy. John it's been an interesting week, month, well seven years in the global economy. Obviously there has been a lot going and it seems to be stemming a large part from China. So as the East Asia analyst, potentially you can give us a quick rundown of the latest events coming out of China.

John Minnich: Sure. So there are two main recent events that we've been watching in China. The first, which has been running for the last eight weeks or so, is the stock market decline. And that is more or less the product of we had over the course of 2014 and into 2015 Chinese stock prices rise some 130 percent on average and in mid-June they began to fall, and since then they've tumbled 40 percent. So that's been one event we've been watching. The second was the Chinese government's decision in early August to reset the way that the yuan exchange rate works with the dollar, the yuan pegged to the dollar. And that has had the practical effect of devaluing the yuan somewhat over the course of the last 3-4 weeks. So those are the two recent events we're been watching and they’ve sent jitters through the global markets and they've had their impact. But its important to remember that these, both are part of a much longer running process, which is the Chinese slowdown, the slowdown of the economy. And that itself is part of a longer process, which is China's transition form an export- and investment-led economic growth model to one that they hope eventually will be grounded in domestic consumption. And the heart of that process has been the winding down of this investment and construction boom in China.

Mark: Absolutely, and this is where the global economy comes in because obviously China is massive and is now hugely influential as the second largest economy in the world. And so as a result these emerging markets, the rest of the emerging markets, which have been piggy-backing off China's success to an extent, and to the extent that the commodities that they sell have been largely going into this Chinese engine. So as that's been slowing down, then we've seen an awful lot of these emerging markets, which have grown very far and now really struggling. So we've seen their currencies, the currencies fall over the last 3-4 years as the commodities market hit its peek in 2011.

John: Right and now we're in this uncomfortable position in emerging markets where on the one hand they are reeling from the effects of China's economic slowdown, the way that that's hit iron ore prices, coal prices, across the board commodity prices are down. At the same time, emerging markets are being hit by anticipation of an interest rate hike from the U.S. Federal Reserve. So how is that going to play into this process of, you know, hitting at both directions, what is that going to mean for the global economy?

Mark: I mean, yeah, as you say it's a nightmare for the emerging markets, it's all happening at once, a perfect storm. But the interesting development is that this Chinese currency change, which you mentioned, actually makes it likely that the Chinese yuan is going to start heading downwards. It's only gone down 2-3 percent so far. It's probably going to continue heading downwards, which means that the U.S. now finds itself alone with a strong currency, and if it does raise rates as the market expected it to in December, then it could see its exports really hit. I mean America is not as reliant on its exports as many other countries in the world, but still, being alone with a strong currency could hurt it. So suddenly the markets have now, the expectations have pushed back from September, could be December, could be October, but it could even go into next year. So these Chinese are having huge effects around the word.

John: So we have on the one hand a weakening China with a depreciating currency. At the same time, we have a strengthening United States with, on the whole, a strengthening dollar as well and the anticipation of the Federal Reserve rate hike, which may not come in the next 3 months but is sort of an eventuality that the everyone is anticipating. What about the rest of the developed world caught in between? So we have on the one hand Japan and Europe, both of which have been struggling with many years of economic stagnation and both of which are trying to ignite their economies, push themselves out of that stagnation with their own formulations of quantitative easing. So what does what's happening in China, especially with the yuan, and what's happening in the U.S. played back on the decision-making process in Tokyo, in Berlin and in Brussels?

Mark: Well it probably creates more problems basically for the Europeans and the Japanese. As you say, they are quite tied. They've both got these aging populations and they're both facing a similar kind of slowing high debt kind of economies. And so both have been pursuing these quantitative easing strategies, which a large part of it, though they can't say it because it looks like a currency war, but a large part of it is to weaken their currencies. But now what we're seeing are these Chinese and emerging market currencies falling naturally, and the U.S. perhaps delaying their rate rise, which will mean that the strengthening will happen and happen more slowly. So suddenly these European an these Japanese central banks that have been buying bonds like crazy, suddenly despite their best efforts are seeing their currencies begin to float upward anyway. So the big political question comes as to do they redouble their efforts, do they double up on QE, which japan has already done. I mean Japan specifically is in this big political experiment, which doesn't seem to be working. They're trying to raise exports. They're trying to raise inflation. These things aren't really happening that much. So the question comes, they already own a large quantity of the bonds already available in the market. How much can they double up if they want to? So yeah, all of these moves out of China, they are affecting the calculus in every single governments around the world at the moment.

John: And I think the most important thing to remember is that there is the story of the real economy in China and then there is the story of things like the stock market. And the stock market is not insignificant in context of the broader question of where China's economy is going. But it's also not that significant. It's important to set it aside, to understand what it means for the rest of the Chinese economy. And the reality is that, for instance in the last couple of months, we've actually seen parts of the housing sector improve in China. So we've seen home prices and home sales rise in roughly half of the cities surveyed by the Chinese government, and what this reminds us is that China is a massive, very big economy undergoing a very significant transformation that will have profound effects on the global economy. It's important though not to get caught in the headlines of the up and down day-to-day movements of stock prices in China and to remember this underlying transition process that's going on.

Mark: Indeed. We'll be keeping a close eye on China going forward. Thank you very much for joining us and for more information on this and any other topics, please visit stratfor.com. 

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