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| No global economic crisis yet, but the ingredients are there | No global economic crisis yet, but the ingredients are there |
| (about 3 hours later) | |
| Another day, another financial spasm. In London, New York, Shanghai and Frankfurt the story was the same: shares dumped and the oil price crashing to its lowest level since 2003 on fears that China is heading into a recession that will drag the rest of the world economy down with it. | |
| Despite the fresh sell-off in financial markets on Wednesday, this is far from a done deal. For the doomsday scenario to materialise, China would need to have a hard landing, rather than simply a bumpy one, the rest of the world would have to be ripe for its own crisis, and there would need to be a transmission mechanism for delivering a problem centred on east Asia to the rest of the global economy. | Despite the fresh sell-off in financial markets on Wednesday, this is far from a done deal. For the doomsday scenario to materialise, China would need to have a hard landing, rather than simply a bumpy one, the rest of the world would have to be ripe for its own crisis, and there would need to be a transmission mechanism for delivering a problem centred on east Asia to the rest of the global economy. |
| For the time being, the theory that the events of the past three weeks herald another 2008-style crisis is just that: a hypothesis. But make no mistake, if the conditions for a recession are right, it would move around the world like a pandemic. | For the time being, the theory that the events of the past three weeks herald another 2008-style crisis is just that: a hypothesis. But make no mistake, if the conditions for a recession are right, it would move around the world like a pandemic. |
| Related: Beware the great 2016 financial crisis, warns leading City pessimist | Related: Beware the great 2016 financial crisis, warns leading City pessimist |
| That, after all, is the essence of globalisation. Economies are far more integrated than they were half a century ago, when capital controls, trade barriers and extensive public ownership shielded national economies. Today, changes in political philosophy and technology mean there are far fewer impediments to the free movement of goods – and virtually none at all to the free movement of money. | That, after all, is the essence of globalisation. Economies are far more integrated than they were half a century ago, when capital controls, trade barriers and extensive public ownership shielded national economies. Today, changes in political philosophy and technology mean there are far fewer impediments to the free movement of goods – and virtually none at all to the free movement of money. |
| So, when one country runs into problems there is always the risk of contagion. That was true of Thailand in 1997, when the collapse of its currency, the baht, quickly had a domino effect across south-east Asia. | So, when one country runs into problems there is always the risk of contagion. That was true of Thailand in 1997, when the collapse of its currency, the baht, quickly had a domino effect across south-east Asia. |
| It was true also of what appeared to be a local difficulty in a much bigger economy. Ben Bernanke, then chairman of the US Federal Reserve, was dismissive in 2006 of the notion that problems with sub-prime mortgages posed a threat to the American, let alone the global, economy. How wrong he was. | It was true also of what appeared to be a local difficulty in a much bigger economy. Ben Bernanke, then chairman of the US Federal Reserve, was dismissive in 2006 of the notion that problems with sub-prime mortgages posed a threat to the American, let alone the global, economy. How wrong he was. |
| Britain’s direct exposure to China is relatively modest. It is not in the top five overseas markets for UK companies, and only 4% of UK goods and services go there. If China’s economy hits the wall, some jobs would be at risk but it would not be nearly as serious as a recession in the United States or the eurozone. The US has more at stake, but even so exports to China account for only 1% of GDP. | Britain’s direct exposure to China is relatively modest. It is not in the top five overseas markets for UK companies, and only 4% of UK goods and services go there. If China’s economy hits the wall, some jobs would be at risk but it would not be nearly as serious as a recession in the United States or the eurozone. The US has more at stake, but even so exports to China account for only 1% of GDP. |
| Britain’s banks are, however, a different story. UK banks – HSBC and Standard Chartered in particular – have lent lots of money to China to the extent that they have more at risk than any other country, should the loans turn sour. China has a mountain of bad debts. | Britain’s banks are, however, a different story. UK banks – HSBC and Standard Chartered in particular – have lent lots of money to China to the extent that they have more at risk than any other country, should the loans turn sour. China has a mountain of bad debts. |
| So how would the crisis manifest itself? One way, according to Nariman Behravesh, chief economist at analysts IHS, would be if China stopped trying to support its currency, the yuan. The result, he says, would be a devaluation of 15-20% that would make China’s exports cheaper but those of every other country more expensive. | So how would the crisis manifest itself? One way, according to Nariman Behravesh, chief economist at analysts IHS, would be if China stopped trying to support its currency, the yuan. The result, he says, would be a devaluation of 15-20% that would make China’s exports cheaper but those of every other country more expensive. |
| This would be the opening salvo in a full-blown currency war. Other countries would retaliate and the US would impose trade sanctions on Chinese goods. Deflationary pressure would intensify as Asian countries dumped their excess production on the rest of the world. | This would be the opening salvo in a full-blown currency war. Other countries would retaliate and the US would impose trade sanctions on Chinese goods. Deflationary pressure would intensify as Asian countries dumped their excess production on the rest of the world. |
| The UK steel industry has already had a taste of this. China is producing more steel than it needs for its own economic growth and is selling it at cut-price rates. British producers have found it impossible to compete. | The UK steel industry has already had a taste of this. China is producing more steel than it needs for its own economic growth and is selling it at cut-price rates. British producers have found it impossible to compete. |
| Related: China economy grows at slowest pace in 25 years, latest GDP figures show | Related: China economy grows at slowest pace in 25 years, latest GDP figures show |
| That, though, would only be the start of the mayhem. Many countries in the emerging world have borrowed heavily in dollars. China itself has $1tn of dollar-denominated debt. If the yuan and other emerging market currencies are devalued, then the value of these dollar debts will rise, putting severe strain on all the affected economies and unbearable strain on the most vulnerable. | That, though, would only be the start of the mayhem. Many countries in the emerging world have borrowed heavily in dollars. China itself has $1tn of dollar-denominated debt. If the yuan and other emerging market currencies are devalued, then the value of these dollar debts will rise, putting severe strain on all the affected economies and unbearable strain on the most vulnerable. |
| Zhu Min, deputy managing director of the International Monetary Fund, sketched out in Davos on Wednesday what would happen next. Quite simply, every investor would stampede for the exit at the same time. Liquidity in the global economy would dry up, he said, noting: “That scares everybody.” | Zhu Min, deputy managing director of the International Monetary Fund, sketched out in Davos on Wednesday what would happen next. Quite simply, every investor would stampede for the exit at the same time. Liquidity in the global economy would dry up, he said, noting: “That scares everybody.” |
| It certainly does. Around the concrete bunker hosting the World Economic Forum, the masters of the universe were quietly checking the latest from the financial markets on their smartphones and tablets. A few eyebrows were raised when the Dow’s fall reached 500 points. | It certainly does. Around the concrete bunker hosting the World Economic Forum, the masters of the universe were quietly checking the latest from the financial markets on their smartphones and tablets. A few eyebrows were raised when the Dow’s fall reached 500 points. |
| Chief executives of multinational corporations should not, of course, need to be reminded of global interconnectedness. If they did, Nobel prize-winning scientists were on hand in Davos for a tutorial on chaos theory. | Chief executives of multinational corporations should not, of course, need to be reminded of global interconnectedness. If they did, Nobel prize-winning scientists were on hand in Davos for a tutorial on chaos theory. |
| One of its ideas is that seemingly tiny events can have big impacts, so that a beating of a butterfly’s wing could lead to a hurricane on the other side of the world. China is a very big butterfly. | One of its ideas is that seemingly tiny events can have big impacts, so that a beating of a butterfly’s wing could lead to a hurricane on the other side of the world. China is a very big butterfly. |