China's changes will help developed world

The global turbulence triggered by China’s stock market crash should not obscure a greater truth: policy shifts in Beijing are positive for developed economies. Investors should look to buy US equities, in particular on the dip.

The sharp structural slowdown in China, long predicted but wilfully ignored until now, is a catastrophe for exporters of natural resources and deflationary for most emerging markets, with the exception of Mexico and India. China and most other emerging economies are likely to see continued demand deflation in the next 12-18 months and further nominal currency depreciation. We believe the renminbi could fall another 5-10 per cent.

But this is ultimately good news for developed markets. Wasteful investment in China, now being wound down, has been depressing global returns for a decade. Tumbling commodity prices, by transferring income from producers to consumers, act as a tax cut for rich-country households. This is exactly what is needed in a world lacking genuine consumer demand.

These divergent trends fuse together in our “deflationary boom” outlook for the world. Our analysis suggests both the deflation and the boom still have further to run, with investors likely to keep lurching between the positive and negative aspects of this pattern of growth.

The global economy thus remains in a precarious position. Much will depend, of course, on the timing and the path of the Federal Reserve’s tightening. US domestic data still justify an initial rate rise in the next few months. But the biggest uncertainty surrounds China.
Despite botched attempts to prop up share prices and a confusing mini-depreciation of the renminbi, the leadership in Beijing seems to be on the right policy route.

But China’s resolve will not truly be tested until economic weakness finally spreads to the labour market over the next 12-18 months. And even if Beijing sticks to reform, it could easily fail to pull off the transition from investment-led to consumption-powered growth. Investment is the most volatile component of output and in China accounts for a whopping 46 per cent of GDP, so the possibility of a self-fulfilling investment-led collapse is real.

A lot hinges, too, on how others respond to China’s slowdown. If Beijing sticks to the path of reform, it can pull its economy out of the doldrums after a few years of economic and financial distress. But it needs the rest of the word to accept the transformation it is attempting and what it entails.

The US must welcome China into the global financial system and allow it to take its rightful place in global monetary institutions. Whether the renminbi is added to the currencies that make up the International Monetary Fund’s special drawing right unit will be a litmus test.

If it is rejected, Beijing may well redouble efforts to establish an alternative financial system centred on the renminbi, not the dollar. The US must also accept that China’s embrace of a greater role for market forces — a central aim of US international economic policy — will involve a stronger dollar.

The key economy to watch in trying to assess the global response is Japan. “Abenomics”, the economic programme of Prime Minister Shinzo Abe, is turning into a policy disaster. It has done little to stimulate domestic demand and the Bank of Japan will be under political pressure to launch yet another round of quantitative easing. This would open a new front in the currency war and make it difficult for China and the US not to respond. After China’s depreciation, Japan is the remaining piece of the puzzle that could surprise global markets.

A full-blown currency war and the eventual protectionism it would spark is the main danger for the global economy and risk assets. At present, though, this is not our main scenario.

Recent events have understandably dented confidence in China, but investors should not let their anxieties blind them to the bigger picture: important changes are under way. Beijing’s apparent determination to clean up past excesses and to liberalise and rebalance its economy is light at the end of the tunnel. As such, false alarms about the end of the US cycle and fears that the Fed is making a policy mistake should provide buyable dips in US equities.

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Rhythm Media Group is a multi-media company, operating a US-based Chinese daily newspaper, The China Press, and the paper's website - (which has mobile-app version), as well as a Beijing-based English website The group boasts 15 branch offices across the US, and a number of cultural centers focusing on culture-related business in the North America, Chinese mainland, Hong Kong and Taiwan.

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