The Economy

China’s Economy: Two Views, Both Bad for Europe

Two economists take opposing stances on the outlook for China’s economy and its currency. Neither’s predictions make for happy reading in Europe.
Andrew SawersNovember 19, 2012

The political leadership may have changed in China but the fundamentals of its economy haven’t – and while two economists take opposing views on the outlook for the Chinese currency, neither scenario is good news for Europe.

Savvas Savouri is partner and chief economist with hedge fund manager Toscafund Asset Management in London. He believes that, at some stage during U.S. President Barack Obama’s second term in office, China will, in effect, “devalue the dollar and abandon its support of the U.S. Treasury market.” Savouri believes that “President Obama was lucky that China chose not to shift its growth paradigm [during his first term],” which would have affected Obama’s chances of re-election. “With its trade-driven model no longer enjoying the voracious export markets it once did, Beijing will serve its best interests by focusing instead on managing robust internal consumption. To do this requires it to severe its monetary links to the United States,” Savouri explains.

Such a move would send the U.S. dollar tumbling – not just against China’s renminbi (RMB) but against the euro as well. The euro zone – and in particular Germany – would find that “exporters would be up against extremely competitive U.S. rivals,” Savouri says.

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It takes two views to make a market, and economist Richard Duncan certainly takes the opposing view. Duncan is widely regarded as the commentator who perhaps came closest to predicting, way back in 2002, the global financial crisis. Thailand-based Duncan, author of The New Depression: The Breakdown of the Paper Money Economy, believes that China’s growth is slowing down sharply but that nothing would be served by dumping U.S. dollars. “That would send [China’s] exports plummeting which would be certain to destroy [its] economy,” he counters.

China’s economy cannot yet rely on domestic consumption. “Eighty percent  of the people earn less than $10 a day,” Duncan says. “The people working in the factories don’t earn enough to buy the things they’re producing in the factories.” Rather, China is increasingly dependent on investment, says Duncan, but that investment is being “misallocated.”

In 2009 China’s growth wobbled in the depths of the global financial crisis, so Chinese officials allowed banks to grow total bank loans by 60% over the next two years. “This resulted in massive misallocation of credit and now they can’t get the money back,” Duncan says. “So they invested more and more but that has just left more excess capacity of everything.”

Long having regarded China as a bubble, Duncan believes that the economy’s growth rate – currently around 7.4% – will slow to “five-point-something” and then eventually “three point something” – “and even that is going to take a whole lot of government borrowing and fiscal stimulus.”

World trade is already slowing down, with the most recent data pointing to a third consecutive monthly slowdown in August. “This new contraction in global trade is hitting corporate profits in the U.S. and Europe as well,” Duncan says. “China will import less from Germany and the euro zone, and that will be bad for their economies.”