The world's stock markets are spiralling downwards. The U.S. equity market fell 10 percent last month. Investor terminology calls this a "correction" not a crash. But prospects don't look good.
Big investors, banks and financial institutions are worried that China's economy is imploding and they expect a significant devaluation of the yuan. This would hurt other emerging economies and drag the rest of world, including the advanced capitalist economies into a global slump.
The economists at many investment banks, previously confident of economic recovery and lauding the great emerging market "miracle," are now in despair. For example, analysts at the Royal Bank of Scotland (RBS) just told clients to "sell everything" as stock markets could fall more than a fifth, while oil and other commodity prices could drop to a tenth of where they were just a year ago. RBS noticed a "nasty cocktail" of commodity price deflation, recession in emerging economies, capital flight by China's rich and by investors from other emerging economies, and the prospect of higher dollar debt servicing costs as the U.S. Federal Reserve raises interest rates this year.
Capitalism is an unplanned economic system that automatically experiences booms and slumps. The outlook of its sales staff is predisposed to wild mood swings - like those of a manic-depressive. They commonly alternate between exaggerated optimism and deep pessimism.
The doom-mongers concentrate on China. RBS analysts say that "China has set off a major correction and it is going to snowball… the epicentre of global stress is China, where debt-driven expansion has reached saturation. The country now faces a surge in capital flight and needs a 'dramatically lower' currency." Albert Edwards at Societe Generale, who predicted a deflationary slump during the last five years of global economic recovery, now says the Chinese crisis will lead to a global slump. "The western manufacturing sector will choke under this imported deflationary tourniquet."
Is China really to blame? There is no question that the Chinese economy faces numerous problems. Growth has slowed to under 7 percent on official estimates in 2015. When the Great Recession broke in 2008, the Chinese government reacted to falling export demand by launching a huge government-spending program focused on infrastructure. This succeeded. Interest rates were slashed and local authorities were allowed to borrow to spend on housing and other projects. However, Chinese non-financial debt rose from about 100 percent to about 250 percent of GDP. Total social financing, a broad measure of monthly credit creation, is now growing at nearly three times the rate of officially recorded money GDP growth.
There are some who argue that China must open up to more foreign and private capital. They say that China should privatize the big state owned companies and banks, end capital controls, and allow the Chinese yuan to become a freely fluctuating currency. Indeed, just before the Chinese stock market and currency fall began, the Chinese yuan was included in the IMF's international reserve currency basket. Therefore, the yuan is increasingly subject to the laws of the international currency markets and the capitalist law of value.
Higher debt, slower growth and an overvalued currency - now subject to speculation - produced China's stock market crash. Now rich Chinese and foreign investors are trying to get their money out of China or to convert savings into dollars - held abroad. China's wealthy class are moving about $100bn a month out of China. As Chinese dollar reserves are about $3.3trn and around half of that is needed to cover imports, if capital flight continues at the current rate, Chinese dollar reserves will be exhausted in about 18 months. Clearly such economic sabotage must be stopped.
The extent that China has opened its economy made it susceptible to currency and financial speculation. Although a weaker yuan boosted exports, it also encouraged rich individuals and Chinese companies to buy more dollars, legally and illegally. Last year the authorities propped up the stock market with extra credit and state-owned banks bought stocks. However, this fuelled even more debt. This policy was then reversed, provoking a stock market crash and credit squeeze.
Many Western economists predict that China will suffer a "hard landing" or economic slump, capitalist-style, and this will add to already diving emerging economies and drive the world into slump. But China is not a capitalist economy. State ownership remains dominant in the commanding heights of heavy industry, energy, telecommunications, financial services and investment. But China has opened its economy to the pressures of capitalism, particularly in trade and capital flows, and so it is more vulnerable to crises. Some Chinese economists agree with the World Bank and others who want to "liberalize" the financial sector and make China a respected part of the international financial "community." Events show that this is poor counsel.
Yes, the world is slowing down, and a long period of below-trend growth is still operating. Last week, the World Bank revealed that developing economies grew just 3.7 percent in 2015, the slowest since 2001 and two percentage points below the average 6.3 percent growth during the boom years between 2000 and 2008.
The IMF chief Christine Lagarde reckons that developing countries face "new reality" of lower growth. "Growth rates are down, and cyclical and structural forces have undermined the traditional growth paradigm. On current forecasts, the emerging world will converge to advanced-economy income levels at less than two-thirds the pace we had predicted just a decade ago. This is cause for concern." A 1 percent slowdown in emerging markets would cause already weak growth in advanced countries to slow by about 0.2 percentage points, Ms Lagarde said.
But is the slowdown in China and the slumps in major emerging economies the cause of the world's economic problems? This argument is partly based on the claim that emerging economies are driving the world economy. According to IMF figures, emerging economies make up 57 percent of world GDP, outstripping the advanced capital countries. But this is a wild exaggeration because the IMF calculation uses purchasing power parity (PPP). This measures what you can spend or invest in local currency in any country. It exaggerates the national output of emerging economies. In the real world trade and investment GDP is measured in dollars.
In dollar terms, emerging economies produce only 40 percent of world GDP. True, that share has doubled since 2002, but the top seven major capitalist economies have a greater share than all the emerging economies, with 46 percent. And in the last two years, that share has stabilized.
While China's share of world dollar GDP has rocketed from just 4 percent in 2002 to 15 percent now, it is still much smaller than the share of world GDP for the U.S. which has fallen from 32 percent in 2002 to 24 percent now. This shows the tremendous expansion of the Chinese economy. It also shows that the U.S. remains the pivotal economy for any global capitalist crisis particularly because it dominates the world's financial and technology sectors. For example, in 1998, emerging economies experienced a major economic and financial crisis that did not lead to a global slump. However, in 2008, the U.S. had a biggest slump in its post 1945 economic history and this led to a global recession, the Great Recession. This weighting still applies.
The fate of the U.S. economy is not determined whether by the level of interest rates is "too high" or "too low." It is the level of corporate profits and investment that is decisive. Investment drives employment and incomes and this shapes economic growth.
A growing body of evidence shows that the profitability of capital, and corporate profits generally, lead business investment with a lag of 12-18 months, upwards and downwards. Currently global corporate profits (a weighted average of U.S., U.K., Germany, Japan and China) have turned negative, and U.S. corporate profits are also falling (on a year on year basis). This suggests that business investment, which has been expanding at about a 5 percent rate in the U.S., will start to drop too within a year or so. If that happens, the U.S. will likely head into recession. So, it won't be China or other emerging economies that will cause the new world economic crisis.
