Here’s Where China’s Economic Slide Will Hurt the U.S. Economy

The dramatic 40 percent drop in the Chinese stock market this summer, combined with its broader economic slowdown, have put world markets on edge. The U.S. Federal Reserve is worried; it could put off a long-awaited interest rate hike due, in part, to concerns about Chinese spillover into the American economy. Ahead of a weekend meeting of G-20 finance ministers, the International Monetary Fund warned Friday that China could slow global economic growth.

Fire and brimstone predictions aside, it’s important to note a number of positive economic trends, both in China and the United States, and also to look more closely at where the Chinese slowdown will cause pain in the American economy. Additionally, it’s necessary to point out a key underlying fact: Daily stock market fluctuations do not necessarily tell the complete story of a country’s economic strength. This more sober review shows that while some U.S. sectors will get bitten by China’s bear market, concerns about a broader spillover onto American shores could be inflated.

Any slowdown in China will cause some anguish in the American economy. And sectors like semiconductors, aircraft, and technology are likely to take the hardest hit because Chinese demand for these kinds of products will go down, said Scott Kennedy, a China expert at the Center for Strategic and International Studies. Some of the global market volatility is purely psychological: Beijing for years manipulated the Chinese economy, undervaluing its currency and intervening to stop losses in the equities market. That resulted in Chinese growth while the rest of the world suffered from the Great Recession.

“Our sense is that the Chinese aren’t able to manage their economy like they once did,” Kennedy said. “Their foreign policy may be aggressive [and] their human rights record was nothing to write home about, but at least they could manage their economy.”

China’s benchmark Shanghai Composite Index has fallen 40 percent this year, as retail investors yank money out of the market. The letting in Chinese stocks does show broader weakness in its economy. Exports dropping 8.3 percent year-over-year in July is one such indicator.

That has played into fears — however founded — stateside. For evidence of the disconnect between stocks and the broader economy, look no further than Friday trading on the Dow Jones industrial average. On Friday morning, the Bureau of Labor Statistics announced the unemployment rate in the United States had fallen to 5.1 percent, the lowest level in seven years. This beat expectations, and most would generally consider it a positive development in the economy.

But traders in New York didn’t see it that way. As of 12:58 p.m. ET, the Dow was down 287.92 points, or 1.76 percent. The reason for this, in part, requires some twisted logic: Wall Street is concerned the improved employment picture could compel the Fed to raise interest rates from near zero — something it hasn’t done since 2006 — which would make borrowing money from the government more expensive. But it would also show that the Fed is confident the American economy is strong enough that consumers would pay more to borrow cash. Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, hinted at a rate hike Friday. Right now, the futures traders put the likelihood of a September liftoff at 27 percent; 58 percent believe it will come in December.

Kennedy said the United States should be able to maintain a safe distance from China’s economic slide, even as Beijing is feeling the pain of slow growth acutely. A drop in China’s commodity consumption would damage its regional neighbors, like Australia, a country that sells Chinese citizens things like coal and cattle, Kennedy said, predicting a potential “ripple effect” on the broader global economy.  

However, worries about the Chinese slowdown hammering a broader array of U.S. companies appear to be overblown. China is the second-largest importer of American goods, but the value of these products is just $165 billion, or less than 1 percent of U.S. gross domestic product, according to the New Yorker. Goldman Sachs data shows that a 1 percent drop in China’s growth translates into a paltry 0.06 percent drop in U.S. GDP.

According to Megan Greene, a non-resident fellow at the German Marshall Fund of the United States, there are also encouraging signs for China’s long-term economic prospects. Some of the cash being taken out of the stock market is going into real estate, historically a more stable asset. And China’s economy is still expected to grow by 6.8 percent this year. By contrast, the IMF predicts the U.S. economy will grow by 2.5 percent in 2015.

Chinese growth outpacing that of its American rivals is a continuing trend. The chart below, based on IMF data, tracks U.S. and Chinese GDP from 2010 projected to 2020. Toggle between the United States and China, and it’s obvious that the IMF expects China’s economy to grow much more quickly than America’s.

“People don’t need to be doom and gloom,” Greene, who also is a managing director and chief economist at Manulife Asset Management, told Foreign Policy. “It’s slowing down, but the more important question is how quickly. There may not be the hard landing many are predicting.”

But Kennedy said even a soft landing for the world’s second-largest economy would bring peril — and with it more financial hardship down the line, even if the United States can keep its distance from Beijing.

“It’s like looking at guerrilla warfare from 30,000 feet,” he said. “It looks like it’s a small thing. But if you’re in the middle of that fight, it feels like World War III.”

Photo credit: Spencer Platt/Getty Images