Is America at China's Mercy?

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Just how vulnerable is the U.S. economy to troubles in China? It's a question I really started pondering after watching the 6.5 percent drop overnight in Chinese stocks in response to a government tripling of a tax on stock trading. Now Wall Street is sure reacting much better to the decline than it did back in February when the Shanghai Composite index fell 9 percent, sparking a 400-point drop in the Dow Jones industrial average. This time, the Dow industrials were flattish in midday trading.

Paul Hoffmeister, chief economist at Bretton Woods Research, doesn't see much risk to the Chinese economy at this point: "As long as the Chinese apply this sort of 'acupuncture' to the market and avoid imposing growth-killing measures such as introducing a capital gains tax, these negative surprises could turn out to be buying opportunities."

But what if the Chinese do make a policy mistake or some other internal issue slows down the amazing Chinese economic growth machine? What if there is a U.S.-China trade war, not an impossibility given the bipartisan protectionist zeal of the new Congress? China is a country, after all, that holds a trillion bucks in dollar-backed assets and imports some $800 billion worth of goods and services overall every year. Plus, there is the $60 billion in foreign direct investment pouring into the country on an annual basis. To get some handle on all this, I asked several experts to E-mail me their quick takes on what would happen to America if there were a hard landing in China.

Bruce Kasman, chef economist at JP Morgan:

At present, the global economy has a number of engines running, and a specific China event that slows demand there—say to 5 percent or so—would have a very modest impact on global growth. However, to the extent that the source of the Chinese slowing represents broader global themes at work, its effects could be much larger. I would note in this context that we do not think Chinese authorities are setting policies to slow growth at present. While they are working to restrain bank lending and limit the frothiness of their equity market, they maintain stimulative fiscal policies and continue to maintain a broadly accommodative monetary policy stance through their efforts to manage currency appreciation. Will Hutton, author of The Writing on the Wall: Why We Must Embrace China as a Partner or Face It as an Enemy:
Because the country has been so open to imports, has been the single most important stimulus to the Asian and, thus, world economy over the past five years, China's stagnation would trigger a global slowdown, maybe even recession. On the plus side, oil and commodity prices would fall. On the negative side, there would be all the ills of a slowdown, but on top there would be major financial implications. The World Bank estimates that if China's growth rate fell by just 2 percent, up to 60 percent of China's bank loans would become nonperforming—so threatening both China's and, via Hong Kong, Asia's financial system. The flow of saving to finance the U.S.'s deficit would dry up, probably forcing U.S. interest rates up—so worsening the economic slowdown. Kenneth Rogoff, economics professor at Harvard University:
A sharp slowdown in Chinese growth represents the single biggest risk to U.S. and global growth today. China's massive excess savings have been helping to hold down mortgage interest rates everywhere. Trade with China has been a major driver in the revival of U.S. productivity that has helped boost growth and lower inflation. Above all, China's generally peaceful integration into the world economy has been helping lower market volatility, thereby driving up the price for risky assets such as housing and equities. Most investors are far too sanguine about the risk of a China meltdown, forgetting that China is still very much a poor developing country with huge political, social, and financial vulnerabilities.. The immediate impact on the United States would be through a sharp rise in interest rates and market volatility, and a concomitant drop in equity and housing prices. The U.S. may not export a lot of goods to China, but it sure exports a lot of treasury bills and other bonds. Over time, if the meltdown persisted, the U.S. would suffer because globalization, and China in particular, has been a major factor in helping spur innovation and productivity growth. Peter Morici, professor of international business at the University of Maryland:
Not much. If Chinese growth simply slowed because of internal policy changes, the effect on the global economy would be minimal. For example, if China significantly revalued its currency or simply found a way to keep its exports from growing so fast, industrial activity would pick up in other Asian and Latin American economies. China is very different in its effects on the global economy than the United States. China is a huge export machine, powered by massive subsidies and an undervalued currency whose effects equal much more than 10 percent of its gross domestic product. China has a large trade surplus that deprives other developing countries of export markets. Slow the Chinese export machine and other economies would grow faster. Close to home, Mexico would profit, for example. Paul Hoffmeister, chief economist at Bretton Woods Research:

If the reason for a sharp slowdown in China was caused by a China-specific variable, then the impact to U.S. growth, as well as global growth generally, would be small. Remember the Asian crisis in '97-98 when the overly strong dollar [with gold around $300 an ounce] broke the currency pegs in many of the Asian Tiger countries, and their economies were devastated. The U.S. market reeled a few hundred points here and there on the news, but then kept on chugging along.The U.S. economy and stock market began to get really hurt only around 2001, when the dollar deflation finally started to permeate through the U.S. economy, and then Congress overreacted to the fallout (for example, accounting fraud, which came to light during the time, but was not the root cause of the market's and economy's problem) with terrible regulatory responses(for example, Sarbanes-Oxley). Clyde Prestowitz, president of the Economic Strategy Institute:
The U.S. is not that vulnerable to a slowdown in China. We don't export a lot there, and the main problem for us would be any slowdown in Chinese capital flowing into [U.S. Treasury bonds]. But there is also a lot of capital coming out of the Middle East, so I don't see the U.S. as vulnerable to China. But Latin America .and certainly the Asian countries that supply China with raw materials and parts would be hit.

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