For stock markets, October is by tradition the cruellest month. This time around, they’ve not been able to wait that long. A sharp slowdown in Chinese growth, combined with a seemingly incompetent response to it – first with desperate attempts to prop up China’s over-inflated stock market, and then a surprise devaluation in the renminbi – has prompted the worst sell-off in global stock markets since 2008/9. While it may yet be no more than a summer squall, soon calmed by central bank reassurance, the panic has served to remind us of the fragility of Britain’s economic recovery, and how vulnerable a highly indebted world economy is to continued crisis and setback.
Paradoxically, the immediate impact of the Chinese slowdown could be mildly stimulative for the UK, in that it is fuelling a further collapse in energy and commodity prices. This will increase the amount of disposable income households have to spend, thereby helping to sustain Britain’s consumer-led recovery. Turmoil in financial markets may also further delay the point at which the Bank of England feels obliged to start raising interest rates.
We should, nevertheless, be careful to avoid schadenfreude, pleasing though it may be to some Western observers to see the Chinese economic success story somewhat derailed. China is being forced to learn the hard way what traditional practitioners of market-based economics have known all along – that you cannot buck the markets and that economic development never proceeds in a straight line. The belief that China’s own peculiar form of authoritarian, state-sponsored capitalism could somehow defy the usual laws of economics always did look deluded.
What’s more, the prescribed transition China is attempting to make from an export/investment-heavy economy to one more dependent on domestic consumption is proving exceptionally problematic. The one seems to be slowing much more quickly than the other can grow.
Unable to stomach any pronounced setback, and the threat this might pose to Communist Party legitimacy, China has met every economic mishap by simply inflating another bubble. In the wake of the Western financial crisis, China unleashed a fiscal stimulus of unprecedented size and duration; when this began to fade, it encouraged a massive expansion of credit, much of which went into the housing market. And when this started to cool, it recklessly sponsored a stock market boom. Many investors came to believe that their money was in some way underwritten by the state.
All this may seem of little relevance to the UK. Britain has enjoyed some success in exporting to Chinese growth markets, particularly high-end cars and other luxury goods. But it is not nearly as exposed as some of its European counterparts, particularly Germany. Where the UK is affected is in North Sea oil, and the predominance of big energy and mining companies in its stock markets, all of which have been badly hit by the Chinese-led collapse in commodity prices.
China is also a much larger proportion of the global economy than it used to be, and capable of inflicting far more damage on global sentiment and confidence. At the very least, its slowdown threatens to spark a rolling series of debt and currency crises in emerging markets. Internationally, policymakers must therefore strive to avoid a renewed outbreak of “currency wars”, under which countries attempt to steal demand from each other through competitive devaluation.
In Britain, the Chancellor, George Osborne, was hoping for at least another couple of years of relatively benign economic conditions to help take the edge off his deficit reduction programme. It’s not clear that China is going to oblige him. Small wonder that stock markets are panicking.
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