China does matter: How two developments could undermine the global economy

Recent Chinese economic developments leave little doubt China will be front and center in this year’s US presidential election campaign.

Among the more notable of these developments have been a private capital flight of more than US$100 billion in December 2015 alone, and the Chinese government’s decision to allow its currency to depreciate in response to a weakening recovery. This is bound to lead the US election to focus on a vexing question : whether or not China has been a persistent currency manipulator in an effort to steal an unfair competitive advantage over US exporters.

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China is also likely to be a matter of keen election interest in 2016 for reasons beyond the fact that it is the world’s second largest economy and a major trading power. This is because a slowing Chinese economy and a weakening Chinese currency have the potential to destabilize global financial markets. That in turn could put the US economic recovery in jeopardy.

There are two basic channels by which China can undermine the global economy. First, a slowing Chinese economy will keep international commodity prices at or below their currently very depressed levels. Were that to occur, there would be a deepening in the current difficulties of the major emerging market exporting countries like Brazil, Indonesia, Russia and South Africa. This would be important for the global economy since the emerging market economies (including China) are now estimated by the IMF to account for around half of the world economy measured on a purchasing power parity basis. Also important, these countries’ corporate sectors might find it difficult to repay the US$ 3 ¼ trillion in US dollar denominated debt that they have taken over the past few years.

The second reason for concern is that a weakening of Chinese currency could raise the risks of a global currency war that would destabilize global financial markets. As China allows its currency to weaken further, one has to expect that other Asian countries — and most notably Japan — will take action to weaken their currencies for fear of losing competitive advantage to China. The same is likely to be true of the European Central Bank, which has been engaged over the past year in efforts to secure a weaker Euro to fend off the risk of European deflation.

All of which is bound to make China one of the key issues in this year’s US elections.

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