Keep your eyes on China. One of the themes I keep reiterating in these pages is that our world is more interconnected than many investors think. While it is certainly important to be aware of how the American economy is performing, we cannot forget that we are part of the global economy.
While the U.S. is still a large player in the global economy, we are not alone at the top. Over the past decade, the Chinese economy has grown to rival our own in size, and its effects can be felt everywhere. The Chinese economy has been a huge driver for many parts of the global economy, including commodity prices and the materials sector.
However, recent attempts by leaders in that nation to shift the Chinese economy away from a production- and export-oriented nation into one that is driven more by domestic demand is causing significant problems.
The latest gross domestic product (GDP) data for the second quarter indicated that the Chinese economy grew at a 7.5% rate, according to the National Bureau of Statistics in Beijing. That was much lower than the forecast conducted by Bloomberg, of which the median estimate was for 7.7% growth in the Chinese economy. (Source: “China growth slows to 7.5% as 2013 target under threat,” Bloomberg, July 15, 2013, accessed July 16, 2013.)
Whether we like it or not, the global economy is heavily dependent on the Chinese economy. For much of the past decade, many companies, including U.S. firms, have deliberately focused their attention on the rapidly rising Chinese economy.
With the slowdown being worse than expected, I believe that this is only the beginning and the Chinese economy will continue slowing for a considerable period of time. Because many parts of the global economy are also slowing—including the eurozone, which is a large trade partner with the Chinese economy—China’s leaders can no longer rely on exporting their way to growth.
To be perfectly frank, I believe the headline GDP number showing the growth of the Chinese economy is manufactured, so the trend is more important than the actual data point. Whether it is 7.5% or 7.7%, the trend is clear: the Chinese economy is slowing.
And what’s more worrisome to me is that there is the possibility for serious financial and economic problems in China. If the Chinese economy falls below a certain rate, which is unclear at the moment, there will be serious ramifications for the global economy.
For example, the largest producer of steel and iron announced that income for the first half of 2013 would drop by 70%–90%. Another company in China, one of the largest shipyards, is looking to the government for financial help.
I think there are many companies within the Chinese economy that are massively over-leveraged and could be susceptible to serious financial problems—problems that could spread out to and infect the global economy.
I think we could be facing a long period of time in which the Chinese economy suffers as growth continues to slow and companies face financial pressure. That could mean bankruptcies, which means government bailouts to prevent massive layoffs. If bailouts were to occur, social unrest might grow, which is the last thing Chinese leaders want.
Because China is such a large player within the global economy, we must pay attention to that nation. Already we are seeing American firms such as Caterpillar Inc. (NYSE/CAT) report a significant drop in sales within the Chinese economy.
I think companies that focus on selling basic materials and goods used for construction could suffer over the next couple of years within the Chinese economy. If a full-blown financial crisis were to erupt in China, it would seriously impact the global economy—causing an even larger drag on growth.
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