FBR - The chinese economic tidal wave on western shores

The chinese economic tidal wave on western shores

Federico Ortolá

Publicado el
18 de Abril de 2016
The progressive opening up of China is causing an ever-increasing exposure to foreign cultural influences.

There is an old Chinese proverb which says, “The fluttering of a butterfly´s wings can cause a tidal wave on the other side of the world,” and this is truer than ever in the world economy.  We have been more connected through the financial markets than in recent years.  As a result, a Chinese dragon’s wings beat, not a butterfly’s, when, last August, the Chinese devalued the Yuan letting loose a worldwide economic tidal wave shaking even the remotest financial markets.  

The peak time, with its consequent media effect, had us up to our necks with worry facing the prospect of some days wondering at which point the crisis in China would affect the long- awaited announced recovery of the Spanish economy.  Some reflection on the Chinese giant and our connections to that economy can help us to discern with more objectivity at which point this crisis will damage us.

“The fluttering of a butterfly´s wings can cause a tidal wave on the other side of the world.”

The Chinese media called 24 August “Black Monday”.  Once the Chinese stock markets reached their peak last June, they have been losing value exponentially, exceeding the burst of the famous digital bubble, also known as the dot-com crash.

China’s economy since it decided on the course of State Capitalism, i.e. become a market economy directed from the centre of power, has had successive years sustained and spectacular growth.  Around 2007 GDP growth levels were extremely high at a rate of 14%, and, in recent years, there has been a sustained rhythm holding at 7%, which we would have been desirable in Europe.

When the 2007 crisis hit, Chinese exports suffered a slowdown, which the authorities offset by promoting domestic consumption.  In economics, any measure has a multitude of consequences and the increase in domestic consumption led to a reduction in the ability of the people to save, making it difficult to find the funding sources that would have sustained growth of this magnitude.  After maintaining such a strong marathon pace, the economy tired and has begun to slow down. 

In order not to reduce growth, the authorities devalued the currency; the immediate effect of which is decidedly to favour exports.  It is a valid measure in the short term to sustain the rhythm of economic growth and was immediately interpreted as such by the large economic centres.  What many overlooked is that State Capitalism, as it matures, needs long-term access to alternative sources of funding, if you want to maintain the rhythm.  For that to exist, it is necessary to relinquish state control and to expose the economy competitively through a flexible exchange rate on the international currency markets.  Although traumatic, it seems to me that this crisis is pointing to this necessary step which China should undertake if it wishes to continue growing.

The fact is that not having undertaken this transition earlier has left more wounded than anticipated and, in part, can be explained by the Chinese centralist mentality and control. 

It seems to me that we will still be facing a few ups and downs, although not as great, until the Yuan settles down over time on the foreign exchange markets through a flexible exchange rate.  The great fear with all these moves is that China will unleash a new financial crisis such as that in Asia in the 1990s, which has had, and continues to have, high costs for some economies such as the Japanese.

The rich western economies are not as exposed as it may seem at first sight to the fluctuations in China.  The stock markets are reflecting the China effect with greater virulence than may be reflected in the total economy.   Publicly listed companies are the largest and have greater weight in international trade, so their fluctuations are more pronounced.  De Guindos pointed out that “The Spanish exposure to the Chinese crisis is irrelevant” reassuring the markets that Spanish exports to China are than 2% of total exports.   In Europe, the economy with the highest level of exports to China is Germany.  In 2014, exports from the USA to China accounted for less than 1% of its GDP.  In this sense we can remain calm, but that does not mean to say that we are invulnerable.  We cannot ignore the fact that everything in economics can have a domino effect, but, it seems to me, there is enough room for manoeuvre and reaction. 

“The Spanish exposure to the Chinese crisis is irrelevant; we export less than 2%” De Guindos

Those who are decidedly feeling this crisis and seeing it reflected in their currencies are the emerging countries and those countries whose economic driving force rests on raw materials and high export levels to China.  In addition, rich countries such as Australia, which in recent years has been an important exporter to China, have been affected more famously and this crisis means that they will have to adjust. 

Are we facing a genuine and deep crisis in China?  I think not.  Clearly, there is a lot of mismatch and there will be quite a few ups and downs and changes over the coming years, but that is leading to China’s move to state capitalism which, rightly speaking, is now a market economy.  They may need to polish up many aspects, e.g. the way they provide information which is not always transparent, and often doubtful, concealing state interests, although the same market dynamics are pushing them to be clearer and more explicit.  For example, China is dealing with an enormous debt level, but they do not have precise data on the subject and some people estimate that it could be around 250% of GDP.  It seems clear that they will be unable to sustain recent growth levels, but will continue to grow in the future.  

The maximum risk centred on a huge flight of capital has been substantial and it is entering a Japanese-style recession, but it will never be the same since China has its own characteristics.  On 25 August last, in order to inject money into the system, the Chinese Central Bank reduced interest rates and bank minimum reserves, i.e. the deposits that the bank must keep as reserves.

It is a clear signal that the authorities are ready to facilitate the availability of money to sustain investment and growth.  For China, if that could bring about  a strong economic recovery in Europe and the USA it would bring with it the much-heralded rise of the money-rate of interest in the USA and the return of much western capital which fled in search of better returns to Asian markets highly interwoven with the Chinese giant. 

The burning issue is that the gradual opening up of China continually leading to greater exposure to foreign cultural influences, and this in a country whose operational maxim is  a unitary centralized nationalism , can cause a cultural change which, logically, will have social and economic consequences, but this will happen over some years.  

8% of US exports go to China, meaning 0.7% of its GDP is dependent on this.  In Spain, these figures are much lower.  Levels of dependency are low to unleash a crisis in the West.  It seems to me that the beating of the Chinese dragon’s wings will not bring a tidal wave of disaster to the West, and to Spain, but Chinese proverbs reflect the wisdom of the ages and if “The fluttering of a butterfly´s wings can cause a tidal wave on the other side of the world,” we must be aware of any new signs that appear on the horizon.

Federico Ortolá
Sobre Federico Ortolá: Licenciado en Ciencias Económicas y Empresariales especialidad en Administración de Empresas - Universidades de Valencia y Murcia, Doctor en Filosofía del Derecho - PUSC (Roma, Italia), Máster en Educación – C.U. Villanueva, Universidad Co...
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