In the best of times, an economic cardiac arrest in China, the world’s second-largest economy, would not be good for the global economy. But these are far from the best of times. This makes it all the more difficult to understand both the financial markets’ and world economic policymakers’ complacency about the real risk of a coronavirus-induced global economic recession in the months immediately ahead.
By now there should be little doubt that China is experiencing the equivalent of an economic cardiac arrest.
The number of those infected with the coronavirus is already some ten times higher than was the case with the 2003 SARS epidemic. At the same time, in an effort to bring the epidemic under control, around 150 million Chinese residents remain under lockdown. That is preventing Chinese factories from returning to normal production schedules, causing havoc in the Chinese transportation system and inducing Chinese consumers to scale back on their purchases.
Already China’s economic problems are reverberating throughout the global economy. As underlined by Apple and Hyundai’s recent earnings warnings, global supply chains, reliant on in-time Chinese parts deliveries, are being seriously disrupted. At the same time, commodity export-dependent emerging market economies are being dealt a body blow by a Chinese induced decline in international commodity prices, while those economies reliant on Chinese tourism are being severely impacted by a generalized suspension of international flights to China.
The world economy is hardly in a good state to withstand a Chinese economic shock. Already before the start of the coronavirus epidemic, Japan, Germany and the United Kingdom, the world’s third, fourth and sixth largest economies, respectively, were all on the cusp of economic recessions. Meanwhile, large emerging market economies like Brazil, China, India and Mexico were all experiencing marked economic slowdowns.
The coronavirus threat to the world economy is also coming at a time that the global economy is suffering from serious financial market vulnerabilities. A decade of ultra-easy monetary policy by the world’s major central banks has left the world drowning in debt. This is underlined by the fact that global debt to GDP levels today are higher than they were on the eve of the 2008 global economic and financial market crisis. More troubling yet, global equity market valuations appear to be stretched, global credit risk has been seriously mispriced and global credit has been grossly misallocated.
The financial markets and global economic policymakers seem to be expecting that the coronavirus epidemic will soon be contained notwithstanding disturbing reports of its significant spread to other Asian countries like Japan, South Korea and Singapore. They also seem to be expecting that as was the case with the 2003 SARS epidemic, the Chinese economy will bounce back quickly and leave little lasting impact on the global economy.
Even if the optimists prove to be right that the epidemic will soon be contained, they are mistaken in thinking that China’s economic slowdown over the past month will not have longer run effects on the Chinese and global economies.
For a start, one would think that foreign companies will scale back on their Chinese investment and will relocate some of their Chinese operations elsewhere in an effort to reduce that country’s importance in their supply chains. There is also reason to think that the global tourist industry will take long to recover and that international commodity prices will continue to be weighed down by the unwanted inventory build-up induced by the Chinese economy’s abrupt first quarter slowdown.
Worse yet, judging by the sharp decline of emerging market currencies since the start of the year, there is the real risk that the large capital flows that have buoyed the emerging market economies over the past five years will be reversed. This could occur as corporate defaults increase in the wake of China’s first quarter economic meltdown, low international commodity prices and real trouble to the global tourist industry. One would think that a marked capital flow reversal would be the last thing that a socially and politically challenged Latin America now needs.
In 2008, financial markets and global policymakers were caught by surprise by the way in which trouble in the U.S. subprime mortgage market triggered the worst global economic recession in the post-war period. Judging by their seeming complacency about China’s economic cardiac arrest, one has to wonder how much, if anything, they learned from their 2008-2009 near-death experience.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.