Once upon a time, what happened inside the domestic economy of China mattered little to the fate of the West. In 1979, when the country changed gears and embarked upon its current expansion, China represented less than 2 percent of the world's economy. Today it makes up 16 percent, roughly equal to the United States when measured according to currency adjusted purchasing power. The implication is that China matters more to Americans than most of us may realize. And the changes afoot there are clearly sending ripples around the global economic seas.
Chris Hopkins of Barnett & CoMany of the traditional tools applied during the 2007 global recession to boost infrastructure construction are no longer available. Since that time, China's total indebtedness has doubled to 282 percent of GDP and now poses a serious threat, according to a recent McKinsey & Co. paper. Forget the canard about China holding all of our debt; in fact they owe more than we do as a percent of GDP when all household and business obligations are included.
Much of that borrowing financed an oriental version of our bridge to nowhere. Huge vacant housing developments straddle wide but empty highways in dozens of so-called "ghost cities" awaiting future inhabitants. The stimulus fueled a real estate bubble (sound familiar?) that is now deflating. The mass of bad loans sitting on the books is growing, and some of the fleeing housing capital found its way into the casino that is the Chinese stock market. After doubling in less than a year, the Shanghai exchange collapsed in June and has surrendered a third of its value.
Xi Jinping, who assumed leadership in 2012, is engaged in two critically important but monumentally difficult endeavors. First, he is moving to wean China off of its reliance on infrastructure investment and exports as the main economic drivers, shifting emphasis to boosting domestic consumption. Such a transition has consequences for the rest of the world. One has been the end of the great commodities super cycle, as demand for industrial materials like steel, coal, copper and cement has slackened and prices have plummeted. And slower growth in energy demand has conspired with burgeoning North American supply to knock the legs out from under the oil markets. American investors with exposure to commodities are clearly feeling the pain.
Secondly, Mr. Xi is battling to root out rampant corruption in the Communist Party and state-run enterprises. This is a high-stakes game, for failure will inevitably weaken the tenuous coexistence of market forces with political command. Furthermore, Xi is battling resistance from powerful opponents intent on preserving their interests. As part of his strategy, the Chinese leader has adopted a more nationalistic and belligerent tone vis-a-vis his Asian neighbors, which plays well at home but complicates America's defense posture with regard to our commitments to support our allies against Chinese aggression. War-weary Americans may one day be faced with deciding on what if any role our military will play in the South China Sea.
It is true that the U.S. is much less export-dependent than any of our trading partners, and that exports to China comprise just 1 percent of our GDP. But the indirect impacts of a shifting China are manifest through a globally connected economy. China trades with Europe; Europe trades with America, and so on. Meanwhile, capital now flows more easily across borders, the effect of which has recently been to strengthen the Dollar and hurt profits of American companies doing business elsewhere.
The globalization of capitalism has proven to be the greatest force in human history for lifting people out of poverty. But it is often messy during periods of transition such as China's emergence as a major player on the world stage. America continues to hold many advantages, but we are not immune from the effects of China's recalibration.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett and Co. in Chattanooga.