The impact of a possible Chinese crash

An enormous accumulation of debt through various stimulus packages is likely to swell further in response to US tariffs. Reuters

The dramatic ascent of the Chinese economy, particularly since 2003, energised commodity markets around the world. Even as growth slows, China’s hunger is still expected to dominate future demand for energy and minerals. But what if the fire in the dragon’s belly were to go out?

The Chinese economy, the world's second largest, dwells in an enormous and complicated labyrinth. Local governments and state-owned enterprises manipulate data to meet central government targets. If a crisis of the magnitude of the 2008 financial credit crunch could surprise policymakers in the much more transparent US and Europe, it is certainly not unthinkable in China.

After more than two decades of almost unbroken annual growth above 8 per cent ended in 2012, 6.6 per cent in 2018 was the lowest since 1990, and the signs are already there that Beijing will set a lower target this year, from 6 to 6.5 per cent. Analysts’ expectations have for years factored in a gradual slowdown. The continuing prospect of a trade war with the US is threatening.

Structurally, China faces a tricky transition as the number of working-age people starts to fall, a hangover from the one-child policy. As it tackles rampant air pollution, it has to move from catching up to being a technological leader and shift from heavy industry and exports towards services and domestic consumption. Instead of promoting private business, state-controlled entities have aggrandised.

But could things get worse? An enormous accumulation of debt, 260 per cent of GDP, via various stimulus packages, is likely to swell further in response to American tariffs.

This has long seemed unproblematic, as the country has little foreign debt, and most lending was by state banks which could be restructured if necessary. It weathered both the 1998 Asian crisis and the 2008 global financial crisis far better than its peers. But now a profusion of provincial banks and shadow financial institutions raises the odds and consequences of a miscalculation.

In such an opaque system, official statistics have to be supplemented. There are various warning signs; this month, Apple said it was surprised by a fall in sales in China, and car purchases last year dropped for the first time in two decades. This may not portend a crash this year, but a serious crisis in the next three to five years is plausible.

So without dwelling on the likelihood or causes of a possible Chinese crash, it is worth pondering the consequences.

The slump does not have to be on par with the Great Recession – it could be simply a mild recession, even a slowdown to 2 per cent growth during an orderly restructuring. The commodity impact would be very different from 2008’s western-centric debacle. Chinese growth is much more dependent on raw materials that are turned into metropolises or exported as machinery, electronics and plastic products.

China is the world’s largest importer of oil, gas, coal, uranium, iron ore, copper, nickel, cobalt and alumina, the second-largest buyer of gold and liquefied natural gas, and the third-largest importer of lithium. Minerals, metals, chemicals and energy make up almost 40 per cent of imports.

BP regards China as by far the biggest source of new gas demand globally to 2040, and the second biggest gainer in oil consumption after India. If its appetite falters, oil and gas prices would fall sharply, and new investment decisions for LNG plants would dry up. Russia and Central Asia, particularly reliant on China as a market for their oil, gas and minerals, would see multibillion dollar pipelines lying idle. Opec would likely work again with Moscow to cut production, but this would only partly soften the impact.

It would be a devastating blow for the more vulnerable petro-states: Libya, Venezuela, Nigeria and Angola. Major mining nations would also be badly hit: Indonesia’s coal, Brazil’s iron ore, South Africa’s gold, platinum and diamonds, Zambia’s copper and Australia’s gold, iron and coal.

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A sharp drop in the value of the renminbi, and attempts by manufacturers to offload surplus stock, would lead to a surge of exports of cheap solar panels and wind turbines. That would be good news for countries looking to install large amounts of renewable energy, but Europe and North America would probably erect “anti-dumping” trade barriers.

America's resurgent oil and LNG industry would also suffer severely, bringing recession to states such as Texas and North Dakota. But the diversified and rather self-sufficient American economy would come out of it better than many others. India might also be relatively unscathed.

Still, there would be no safe haven in such a slump. Big commodity exporters can only partly insulate themselves, by branching out into new markets with less Chinese exposure, diversifying their economies and accumulating fiscal reserves.

The worldwide economic and political ramifications would take years to unfold. President Xi Jinping’s increasingly authoritarian, centralised rule would be discredited; he would be greatly weakened, or be replaced by another leader, likely after a factional power struggle.

China would turn inward, and Mr Xi’s signature Belt and Road initiative would likely be dropped, drying up investment in Central Asia and Pakistan. Important Asian trading partners, such as Japan, South Korea, Taiwan and Vietnam, would also be badly hit.

Beijing has managed its way out of problems before. It may use its control of the banking system to deal gradually with imbalances and make a smooth landing. The economy still has a long way to go before catching up with the sophistication of South Korea or Japan. But those who depend on feeding the Middle Kingdom’s appetite should plan for the day that it is sated.

Robin M. Mills is chief executive of Qamar Energy, and author of The Myth of the Oil Crisis