4 reasons why China's problems could harm U.S.
Until recently, China was considered the economic dragon that was breathing fire into the world's markets. In 2016, that dragon may exhale more fumes than flames.
American investors received a rude 2016 awakening when U.S. shares plunged on Monday following a rout in the Chinese markets that erased nearly $600 billion of that country's stock market valuations. The Dow Jones industrials index ended the first trading day of the year down by 275 points, its worst yearly start since 2008.
The fallout comes after China's stock market saw a dazzling start to 2015, with stocks more than doubling in the 12 months prior to June. While some may want to write off Monday's downturn as a tough day in the market, over the past year serious cracks have been emerging in China's foundation. Those range from a slowdown in manufacturing to a labor shortage, thanks to the country's decades-old one-child policy, which has resulted in a rapidly aging population.
Given that China is now the world's second-biggest economy, its slowdown could have multiple impacts on American investors, corporations and consumers.
"China's GDP growth rate is falling," Carl B. Weinberg, chief economist at High Frequency Economics, said in a note. "That does not mean GDP is falling -- rather, the economy is growing, but at a slower pace."
If China reports weaker-than-expected GDP on Jan. 19, that could spark continued price depression in commodities, Weinberg noted. Over the past four years, oil and coal -- which depend on China as a prime consumer -- have seen their prices decline by 75 percent and 55 percent, respectively.
On top of a slower-growing economy, Chinese equities may be set for a bear market this year. Bank of America Merrill Lynch analyst David Cui forecasts the Shanghai Composite index will slide almost 30 percent this year.
What might any of this mean for the U.S.? Here are four things worth worrying about:
Slower economic growth. China became second only to the U.S. in economic size, thanks to GDP growth of almost 10 percent annually between 1996 to 2000, according to World Bank data. Since then growth has averaged close to 8 percent per year, but the country is now entering a phase of slower expansion. For instance, UBS economists forecast 2016 GDP growth at 6.2 percent.
That suggests "a very strong hit to North Asia" and other world economies, although Europe and the U.S. will be slightly more insulated, the analysts noted. However, if the slowdown is even worse than predictions, the Federal Reserve may need to pare down the number of interest rate hikes it makes this year as a way to offset the impact to the U.S. economy, the UBS team noted.
Because about 40 percent of revenue generated by companies in the S&P 500 stem from overseas sales, China's slowing economy is already hurting American companies ranging from Caterpillar (CAT) to United Technologies (UTX).
Financial risks. After last year's roller-coaster ride in the Chinese stock market, national officials took a hard look at the leverage some investors were employing. As a result, regulators in November raised margin requirements to 100 percent from 50 percent, which means a Chinese investor can now borrow only $1 from a broker for each dollar invested. Before, that ratio was $2 of leverage for every dollar invested.
China's central government has made financial regulation a priority for 2016. In the long run that may be a good tactic, but short-term risks could emerge, said Brian Jackson, China economist at IHS Global Insight in a research note published last month. Leverage and risky loans have become an increasing headache for Chinese officials and banks.
"Financial risk is clearly a key issue for China's leaders," Jackson noted. "In the near term they may increase the cost of financing ... This will amount to making nontraditional financing less competitive, potentially favoring the state banking system."
That financial risk can also become a problem for other world markets, as Europe and Wall Street found out once again on Jan. 4.
A sliding currency. After China devalued the yuan last year, the currency weakened against the U.S. dollar. While that's a positive change for Americans who are buying goods made in China, there's a distinct downside for U.S. corporations that sell their goods there.
Apple (AAPL), for instance, was cited by The Wall Street Journal as likely to be "one of the biggest losers" after China made the surprise devaluation in August, given that the company relies on Chinese consumers to buy lots of its iPhones and other products. While Apple made no mention of China in its fiscal fourth-quarter earnings statement, the company may have more to say when it reports first-quarter results on Jan. 26.
Labor shortages. With a rapidly aging society, China faces labor shortages, especially as it transitions from a manufacturing-based economy into one more like the U.S. and other developed economies, where service businesses are the major economic component.
Part of the issue is the country's decades-old one-child policy, which was created in the 1970s to slow rapid population growth. But now, after years of fast-paced economic expansion, the country lacks enough workers in some industries. That's leading to rapidly rising wages, which may make China's manufacturers less competitive against other emerging markets.
That could make Chinese-made products more expensive for American consumers, while also raising the cost of business for U.S. companies with outsourced operations in China.
One way or another, China's woes are increasingly becoming America's problems as well.