What started as a financial crisis in the USA has turned into an economic crisis that effects the entire globe. But, not all of the blame of contagion can be blamed on the USA. In this article, I will outline how China also shares some of the blame for spreading the crisis to emerging markets (especially in Latin America).
First, let me admit my own previous mistake: In a previous posting, I argued back in May ’08 that a slowdown in the US would mean less demand for Chinese products, which in turn would result in less demand for Latin American commodities, which would eventually hurt countries such as Brazil. But, this isnt exactly the way it happened…
While it may be true that orders from China (for Latin American commodities) did fall as we expected them to…it is also true that the fall in orders had less to do with the crisis in the USA, and more to do with internal Chinese market demand (some of which was engineered to fall due to Chinese government policy).
But, investors around the globe punished Latin America anyways. Without really understanding what was happening…investors assumed that falling commodity prices in Latin America was evidence of contagion from the US-based crisis.
You see…when orders from China started slowing, and commodity prices started falling, investors withdrew massive amounts of capital from Latin America. Stock markets fell. Currencies followed suit, and analysts around the globe recited the story that US financial crisis had finally spilled over to the “Latin America”…
But, while this analysis seems good on the surface, it may be lacking in substance. What is missing from this analysis is the role that Chinese policy has played in engineering the Chinese slowdown.
According to Geoff Dyer of the Financial Times, “For all the talk of international crises, the slowdown (in China) actually started at home”.
Why did China slow?
Why is it important to talk about “what caused a Chinese slowdown”? Well, because if you assume that the US slowdown was linked to the global economy through China, then its important to know whether the slowdown in China was a result of linkages with the US, or whether it was in fact caused by internal Chinese policy mistakes.
While the global crisis may have played a minor role, it appears as if Chinese slowdown is more a result of choice than of influence.
Earlier this year, China was facing a very difficult level of inflation as food and energy costs were putting intense pressure on domestic political stability. In response to fears of an overheating economy, China put the breaks on the economy, and attempted to slow down bank lending, the construction industry, and to allow the currency to appreciate. Just a few months ago, the biggest problem in China appeared to be a massive inflow of foreign currency and a resulting bubble in construction and investments.
With the Olympics quickly arriving, the Chinese temporarily asked companies to stop producing and polluting in and around Beijing. In order to slow down the overheating economy, the Chinese put pressure on Banks to slow down lending. In order to ease inflation pressures, the Chinese allowed their currency to appreciate rather drastically vs the Dollar (perhaps in response to US pressure?).
After the Olympics, construction slowed and spending on commodities followed.
Less commodities needed:
With the construction industry temporarily on hold, the financial industry lending less, and with exports challenged due to an appreciated currency, it appeared inevitable that China’s demand for commodities would slow.
Global investors get spooked
The trouble is that China was slowing just at the same moment that the financial crisis was hitting in the USA. And, as a result, investors were looking very carefully to see if the crisis was going to spill over to other emerging nations. While there was much talk of “decoupling“, many analysts were skeptical. History had taught us that “when the US sneezed, Latin America caught a cold”.
Then, in early September we started hearing reports that the Chinese were cutting back purchases of commodities such as steel, and that Brazilian steel producers such as Vale were having trouble passing along price increases. Commodity exporters around the globe started indicating falling demand from Chinese buyers, and as a result, commodity prices fell like a rock. Investors had their proof that the world was in fact “coupled”, and that the financial crisis had inded spilled over to become a global economic crisis. With proof of falling commodity prices on their trading screens, investors around the globe pulled money out of commodity exporting nations (such as Brazil), and currencies tumbled. With falling currency prices, investors really got spooked as bets-gone-wrong caused massive losses at some of the most respected companies.
Mis-information and bad-assumptions
Investors that only see superficial analyst reports were probably misled to believe that falling commodity prices were a direct result of the financial crisis in the USA spilling over to the factories of China, and onto the mines of Latin America. They likely mis-read the signs and assumed that falling commodity prices were a sign to start selling emerging markets for fear that slowing US consumer consumption was in fact causing a chain reaction of falling production in China, which was going to hurt global commodity-producing nations.
The reality is that a big cause of slowing Chinese demand for commodities was due to Chinese internal markets and regulatory decisions that had very little to do with the US financial crisis.
While the links between the US consumer and the Chinese producer may be real, they were not the main driver of global economic slowdown, and should not have been the trigger to ignite a global financial crisis.
Perhaps a better understanding of the Chinese economy and a more thorough understanding of the connections between China and the rest of the world could have helped investors to realize that falling commodity prices were not a direct result of the financial troubles on Wall Street, but were more of an indication of economic engineering in Beijing. With cooler heads and a better understanding of these factors, perhaps we could have avoided the massive sell-off of emerging markets during September and October of 2008.
It is the purpose of GloboTrends to help highlight these global-linkages and to discuss their impacts on global economics and finance. Please join us on our forum for more discussion…
Links from GloboTrends:
- Changes are happening in China
- China
- China and energy markets
- China internet industry
- China market entry strategy
- China trade data
- China’s stockmarket
- Doing business in China
- Private Equity in China
- Real estate market in China
- Rising importance of China
- Venture Capital in China
Further Reading:
