China might be half a world away, but as the world’s second largest economy, its economic uncertainty can create waves that ripple across the United States. Growth of China’s real Gross Domestic Product (GDP), a measure of its economic output adjusted for changing prices, has slowed to its weakest rate in 25 years—from a high of 14.3 percent in 1992 to 6.9 percent in 2015.
Although the economy is still growing, this downward trend has caused concerns. On top of that, the value of the Chinese yuan against the U.S. dollar has weakened sharply in recent months, from 6.40 yuan per dollar in August 2015, when China’s central bank said there was “no basis for further depreciation,” to its current rate of 6.56.
Bill Adams, PNC senior international economist, and Bill Stone, chief investment strategist for PNC Asset Management, explain how China’s economy affects the United States and why our own stock market ups and downs are influenced less by China than many people think.
Adams: China’s economic slowdown is concentrated in a few key sectors: Manufacturing, construction, and housing. These industries generated most of China’s demand for imported commodities like energy and metal ores, and their slowdown has an outsized effect on the global balance of supply and demand for commodities. As a result, the economies that supplied China’s commodity imports, like Brazil and South Africa, are in even worse shape than China. And China’s depreciating currency amplifies the effect, since it cuts the purchasing power of Chinese buyers and puts even more downward pressure on global commodity prices.
Stone: The Chinese markets are different compared to the U.S. in that they’re more like casinos, with large fluctuations and lots of uncertainty around the rules. It remains very difficult to accurately predict how policymakers might change the rules of the game in China. Investors deal better with knowing about specific bad news rather than uncertainty, and that’s what we’re seeing play out now.
Adams: American exports to China account for only about 1 percent of our economy, so the direct effect of slower-growing Chinese demand on the U.S. economy will be small. The indirect effects are larger, though, because the currencies of America’s two largest export markets – Mexico and Canada – tend to weaken when the Chinese economy slows and pushes global commodity prices lower. The strong U.S. dollar relative to the currencies of most U.S. trading partners not only makes it harder for American manufacturers to sell to foreign customers overseas, it also makes it harder for U.S. manufacturers to compete against foreign imports here in the United States. China’s weakness is an important part of why the dollar is so strong.
Stone: Some people have this feeling that the Chinese economy is slowing dramatically and that will put the global economy at risk—but we think that overstates the case. As Bill said, our exports to China account for only 1 percent of the U.S. economy, so even if they fell 10 percent, that would only knock a tenth off of our GDP.
Many people view oil prices as a crucial indicator of the strength of the U.S. and global economy. When oil prices go up, that means the global economy is better, and when oil goes down, supposedly that's a reflection of a much weaker economy. But our view is that lower oil prices are a positive for the U.S., Japan, China and other economies, including Europe, as net consumers of oil. We think that lower oil prices will be a positive for U.S. stocks over time.
Adams: The flip side of the headwinds U.S manufacturers face from a weak yuan is that the weaker yuan – or phrased another way, the stronger dollar – in effect gives a tax cut to U.S. consumers. A strong dollar cuts prices of gasoline and other consumer goods, and leaves consumers with more disposable income to spend once their gas tanks are full and houses are heated.
Stone: Also notable, if not also reassuring, is that China’s stock market is very disconnected from their real economy. In other words, historically, a poorly performing stock market in China has had no appreciable impact on their economic growth.
Stone: The fluctuations in the U.S. markets resulting from concerns about China might be uncomfortable in the short term, but they do not predict long-term trends. We see market corrections every 8-9 months that then rebound.
Although it’s painful to watch this market volatility in the U.S. and China, it’s beneficial to keep long-term opportunities in mind. I encourage clients to work with financial advisors on an asset allocation that can get them through these bumps.
History tells us that, over the long term, stocks tend to outperform bonds and cash and produce attractive returns.
China’s annual GDP growth has slowed gradually during the past five years:
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