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China threatens far more than ‘transient contagion’

Published Tuesday, January 12th, 2016

Is the China effect merely ‘transient contagion’ as some would have us believe? Should we buy the argument that the Chinese stock market is unrepresentative of the real state of the country’s economy, that it is totally detached and the plaything of ill informed, mischievous speculators? That is what a lot of China analysts claim, but can we trust their objectivity? I do not remember them being so vocal when the market was rising. Moreover, the Chinese authorities would surely not take kindly to their stock market being described in such terms. They want it to be seen as a credible market which one day will emulate equity markets in Europe and the USA.

Whichever side you are on the China question there can be no denying that the commodity price collapse risks driving emerging market economies into recession. It is ironic that high oil prices in the past have brought on global recessions and now a price collapse threatens to do the same. The problem is that the negative impact of the price fall is immediate whereas the positive impact is much slower to bear fruit and emerging market economies and the global economy are not strong enough to wait.

Over the last decade emerging market foreign and local currency debt has risen from $5.4 trillion to $24.4 trillion or 90% of GDP according to the International Institute for Fiscal Studies. Within this foreign-denominated debt has risen from $900 million to $4.4 trillion. As local currencies weaken the foreign burden escalates which is why everyone is so concerned about the impact of a Chinese devaluation which would be far more than a ‘transient contagion’. Where China goes with its currency emerging market export competitors are forced to follow. As the burden escalates and defaults loom badly needed capital exits the country at the very moment it is most desperately required. Even local debt becomes a problem as growth weakens and banks run out of funding options to rollover loans.

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Posted by David Hufton