But economic activities could slow significantly, as a result of the financial crisis and economic recession in the U.S. China’s real export growth already moderated to below 10% in recent months from around 25% a year ago. As a result, industrial production also decelerated sharply. Available leading indicators, such purchasing managers’ index, point to risks of economic contraction in the months ahead. Advocates of the “decoupling” thesis would argue that China is a large economy and therefore it should be much better positioned to withstand external shocks. That is certainly true if we compare China with Hong Kong and Singapore. But exports are about 36% of China’s GDP and contributed 3-4 percentage points to China’s GDP growth in recent years. The current economic downturn in China has been initially triggered by weakening of exports.
Alongside the export sector, real estate market probably contained greatest economic and financial risks in China. Housing prices already started to decline significantly in Shenzhen, Guangzhou, Beijing and may soon spread to the rest of the country. During the past years, residential investment accounted for about 25% of China’s fixed asset investment and the housing market accounted for roughly one-third of China’s total bank credit. Therefore, a reversal of the housing market trend could further slow China’s economic growth and at the same time increase fragility of the Chinese financial system.
During the third quarter, China’s macroeconomic policies experienced a roller-coaster ride. In July, PBOC still tightened credit controls in order to prevent further escalation of inflation. In August, the balance of policy concerns began to shift toward growth from inflation and therefore tightening measures slowed. In September, PBOC took steps to ease monetary controls. Clearly, the main reason behind the macroeconomic policy turnaround was the shift economic risks. But sudden escalation of U.S. financial crisis in mid-September definitely accelerated the change of China’s policy bias. At the moment, it isn’t clear when and where will the U.S. financial crisis end. China will most likely adopt further monetary and fiscal measures to support economic growth.
The financial crisis will likely force economic changes in the U.S. — the external account deficits likely will shrink and global liquidity conditions could tighten. Interestingly, these will also force changes in the Chinese economy. For much of the past decade, China was the mirror image of the U.S. – China’s growing external surplus facilitated America’s rising external deficits, U.S. consumption growth supported China’s export expansion. Therefore, China is both insulated from the U.S. financial crisis yet also has to be a part of the post-crisis U.S. economic adjustment.
On a positive note, the U.S. financial crisis could also provide a golden opportunity for China’s sovereign wealth fund (SWF) to play a more active role in the global financial markets and at the same time to lay the foundation for longer term development. The crisis, especially the drying of liquidity conditions, makes the Chinese reserves more scarce resource. Meanwhile, the crisis also lowered the negative noises surrounding SWFs. What is surprising, this time round, is that the Japanese institutions, especially Nomura and Mitsubishi, have been much more active than their Chinese counterparts. This was probably because the Chinese leaders have been attacked for previous loss-making investment in Blackstone and Morgan Stanley.
The current financial crisis could also pronounce the beginning of the end of the American economic dominance. Since the mid-15th Century, Portugal, Spain, France, Holland and England each dominated the world economy by roughly 100 years each. If the same rule still exists, then the time for the American rule of the world economy, which began in the 1920s, is also about to end. The historical responsibility of the world economic leadership may fall back onto China’s shoulders again. But China still faces a long march in terms of improving governance quality, financial regulation, and capacity for innovation .