Over the past year, China has put its mark on the world economy as never before. Not only did its economic slowdown inflict pain on energy and commodity producers; it acted as a serious restraint on growth in the rest of the developing world and held back global economic growth. Equally striking was the way the stock market collapse and mismanaged devaluation in the summer caused the US Federal Reserve to postpone an interest rate rise in September.
No central bank is less prone to responding to external influences when making policy. The Fed’s unexpected sensitivity on this score was a measure of how the world has been changed by China’s rise.
And finally Beijing succeeded in its ambition to have the renminbi included in the International Monetary Fund’s basket of reserve currencies.
In 2016 China will once again be very important in determining the path of the world economy and the direction of capital flows. But this time the story will not be about a slowing economy. As industrial production numbers indicate, measures to stimulate the economy are having an impact. Investment is picking up in response to stronger infrastructure investment, especially from local governments. State-owned enterprises have been investing more heavily.
This represents a return to the old growth model led by investment and exports from which Beijing was trying to escape. When confronted with a slowdown this year that far exceeded their expectations, party officials changed course, no doubt fearing that high unemployment in older industries would lead to social unrest that could pose a threat to the party’s grip on power.
Next year will provide conclusive evidence on whether plans to rebalance the economy towards consumption and continue financial liberalisation have gone out the window. If so, China will pay a higher price later on for perpetuating a costly misallocation of resources.
The rest of the world stands to pay a price. A malign external outcome of an unsustainable growth model is that returns in many industries have been depressed because of the Chinese contribution to global excess capacity. That is an undermentioned factor in the low levels of investment by industry in the US and much of Europe since the financial crisis.
One of the biggest questions relates to currency wars. Chinese industry has been struggling with an uncompetitive exchange rate. That problem has been exacerbated by the renminbi peg to a soaring dollar. The decision this month to switch to a basket of currencies ostensibly helps the transition to a more market-determined exchange rate. It also provides a smokescreen for the People’s Bank to bring about a depreciation of the renminbi. At the same time a sharp fall in producer prices is contributing to a real depreciation of the currency.
An orderly depreciation might be a manageable proposition for the rest of the world, given that the advanced economies suffer from deficient demand. Cheaper imports from China would be a useful spur to increased consumption, coming on top of a decline in the oil price that has boosted consumer incomes.
A more precipitate depreciation, perhaps prompted by further resort to competitive devaluation by Japan, might be another matter, especially if it unleashes a protectionist impulse in the US in a presidential election year. The US tradeable goods sector is small in relation to the overall economy, but US exporters have considerable lobbying power on Capitol Hill. That said, the existence of global supply chains means that protectionist rhetoric may be more muted than in pre-globalisation days.
Should Chinese officials regain their appetite for financial reforms, another kind of shock may be felt elsewhere. A move to full capital account liberalisation would free the vast pool of savings to head for foreign markets. The temptation to diversify into investments in countries with more secure property rights and stable governance would be overwhelming. That would lead to bubbles, especially in the relatively narrow markets of the developing world, but also in rich countries. Worse things can happen to an economy.