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China is a Mirror

This stock market sell off is being blamed on news that China’s economy is weakening, but it is important to note that China’s news is a mirror on what is going on in the rest of the world including the U.S.  China is an industrial powerhouse built on exports and the global economies are just not buying Chinese exports like they used to. Furthermore, raw material economies like Brazil and Australia depend on China to import huge quantities of their raw materials to manufacture finished goods which China then sells to the world. So when China doesn’t sell to the developed world, it doesn’t buy from the raw material economies.

Many attribute this to what changed in 2008. They call it ‘peak debt’. The pillar of aggregate demand (the middle class) maxed out on the money/credit they could or would borrow and spend. So demand for Chinese goods began to falter and the demand for raw materials began to taper off. This effect was delayed as the Chinese government injected stimulus to support their economy;  building even more capacity hoping demand for their exports would return. It didn’t.

Compounding this was the cure the developed world’s central banks undertook only made the problem worse. To reinvigorate economic activity or ‘aggregate demand’ they dropped interest rates to 0% (Quantitative Easing, or Zero Interest Rate Policy). Corporations worldwide used these low interest rates to expand even more capacity to meet the expanding aggregate demand they thought would soon appear.  But it didn’t happen. The American and European middle class was under pressure and not willing or able to continue  their  borrow-and-spend splurge. The expected resurgence in demand for Chinese exports never happened.

China’s economy is cooling because the world’s economies cannot increasingly import their exports. Without the world’s need for China’s exports, they have less need for the raw materials to manufacture those exports. Hence, a concurrent collapse in commodities prices, and not just oil, but iron ore, copper, zinc, etc. This lack of demand for exports from raw material economies then boomerangs back on less demand for Chinese exports, and so on.

It is not just China’s economy that is weakening, it is worldwide.