How a Chinese slowdown will hit global growth

Linda Yueh, University of Oxford

As China’s markets fall and drag down global equities, the underlying concern is undoubtedly how much a slowdown in the Chinese economy will affect the rest of the world. Since the 2008 global financial crisis, China has notably emerged as one of the twin engines of world growth.

China has contributed as much to world GDP growth as the US in the past decade and a half, and even more than the world’s biggest economy since the 2008 financial crisis, according to the IMF. Indeed, the IMF projects that China will generate around double what the US contributes to world output until the end of the decade. Together, the US and China are expected to generate as much world output as the rest of the world put together.

IMF/Steven Barnett

Prior to China integrating with the world economy, the US was the biggest and sole engine of global growth as it accounted for nearly a quarter of world GDP, based on market exchange rates. So, it’s the rapid growth of China, which rose from accounting for a mere 2% of world GDP in 1995 to around 15% now, that helped the world economy grow so quickly in the 2000s.

As China slows from the nearly 10% growth rate that it clocked in the first three decades of its reform period, which began in 1979, to what is thought to be a more sustainable 7% or so, the world economy is likely to slow with it. The main areas where the impact will be felt would include not only commodities, but also consumer goods, including luxury goods.

China’s re-balancing of its economy means that consumption (what consumers buy) will become a bigger part of the domestic economy than investment, and services will become a more important driver of growth than manufacturing. As a result, a Chinese slowdown will affect not just commodities and capital goods, but also global consumer demand and thus the profits of multinational companies in America and Europe. Here’s a breakdown of the most affected:

1. Commodities exporters

The countries most affected by a Chinese slowdown are still likely to be those that export a great deal to China, notably commodity exporters such as Australia. As Chinese demand for raw materials and commodities decline, there will be a knock-on effect in terms of their economic growth.

For Australia, China accounts for around one-third of all exports.

For Sub-Saharan Africa, China is the the largest trade partner, accounting for around one-eighth of all trade. But the impact will be concentrated since five countries account for three-quarters of all of Africa’s exports to China: Angola, the Democratic Republic of the Congo, Equatorial Guinea, Republic of Congo, and South Africa.

A Chinese slowdown means fewer of these changing hands.
PughPugh/flickr, CC BY

China has surpassed the US as the most important trading partner for Latin America, which has traditionally been seen as America’s backyard and therefore most susceptible to the economic fortunes of its northern neighbour. But that is no longer the case. Latin American exports to China have risen to account for a record 2% of the GDP of the region.

As China’s growth slows, its imports have fallen by 8% from a year ago, as seen in the latest data for July, following a similarly sizeable 6% drop in June. The slowdown has been felt in the commodity price falls seen throughout the summer that has led to tens of thousands of job losses by oil and coal companies globally, as well as others.

2. Europe

But, it’s not just commodities. Capital goods imports have also fallen, which will affect countries like Germany where exports to China account for around 2% of GDP. Germany itself accounts for the bulk of EU exports to China so the largest country in Europe, which has recovered on the back of exports, will also feel the impact.

Indeed, the European Union is China’s largest trading partner, and China is the second-largest trading partner of the EU after only the US. So, a slowdown in China will affect Europe, which is also felt in the profit warnings issued by European companies such as Burberry and BMW as their sales in China slow.

3. The USA

Exports from the US to China, by contrast, are less than 1% of GDP. That stands in contrast to Japan where exports to China amount to a large 3% of GDP.

But that doesn’t mean that American multinationals will be unaffected. For instance, the world’s most valuable company, Apple, sells more iPhones in China than the US, and its CEO has reassured markets more than once that the Chinese slowdown won’t negatively affect their business.

4. Financial markets

Finally, the Chinese slowdown has been most visibly seen in financial markets. China’s stock market is largely closed to outside investors so does not have a direct impact on global investors. But, despite rebounding from their initial fall, equities markets are certainly reacting to the impact of a Chinese slowdown.

The UK’s FTSE will feel this most acutely, as it has a large portion of commodity stocks and around half are multinational companies, making it one of the most open bourses in the world. No wonder UK stocks experienced their worst one-day fall since the 2008 financial crisis when China’s market tanked.

Undoubtedly it’s unusual for the world’s second-largest economy to be a middle-income country that is not entirely market-driven. Given the importance of China to the world economy, it’s time to get used to monitoring China as well as the US even more closely and becoming accustomed to the greater ups and downs that are likely to be seen in the global economy as a result.

The Conversation

Linda Yueh is Fellow in Economics/Adjunct Professor of Economics at University of Oxford

This article was originally published on The Conversation. Read the original article.

Stock Market Update

With the 24-hour news cycle, all of you are probably aware of the ongoing correction in stocks (meaning down over 10%), and increased volatility, as the summer draws to a close. What’s going on? Weakness in China has led it to decouple its currency, the Yuan, from the U.S. Dollar. It also has allowed its currency to depreciate compared to the U.S. Dollar and other currencies to help its export sectors. You can see from the first chart how strong the Chinese currency has been over the last decade. Evidently, it has become too strong and weakened its export-focused economy too much for the leaders’ likings. In all likelihood it will manage its currency even lower in the year to come. But, Chinese leaders will pull out all the stops to keep the economy growing to absorb a growing workforce. So weakness shouldn’t be extrapolated to a major economic contraction in our view. We think the Federal Reserve will also delay hiking interest rates in September and this should cheer investors in the coming days.Real-Yuan

Let’s keep things in perspective. The second chart shows how subdued volatility has been over the last couple of years. It also shows that it has been a few years, in fact four years, without a meaningful correction in stocks. We were due for a correction in stocks. Where do stocks bottom? We really don’t know and no one else does either. So far, the Dow Jones Industrials are down about 10% for the year while the S&P 500 is down about 7%, both excluding dividends. Another thing to remember, while 500 points on the Dow seems like a big number and would have been a market crash in 1987 (meaning down over 20%), today it is about 3%. Short-term results like this are well within the range of what should be expected from time to time.

What is our strategy? First, we have been at this long enough to know panicking will cost you money in the long runsp500. Second, this pullback has made some companies we have on our target list more attractive in our opinion. So, we plan to stay focused on buying high quality companies at a discount to their intrinsic value rather than trying to time the market.

We encourage you to keep in mind, as long-term investors patience is your best friend. As always, your situation is unique and you may have liquidity needs of which we are not aware. Please do not hesitate to contact us if you have any questions or would like to meet to go over your portfolio.

Are You Financially Retirement Ready?

We are frequently asked, “How much do I need to retire?” It is difficult to answer without a lot of buts and ifs and detailed spreadsheets.  So while nothing can substitute for a financial assessment by one of our Wealth Managers, you can use our Retirement Cash Flow Estimator (RCF) to help you gauge your retirement readiness (see graph).  The RCF Estimator uses the life expectancy data for females.[1]  It is an estimate of the present value of a $1 financial annuity ending at age 95 and beginning at the age you select in the graph.  We adjust the $1 annual annuity to account for inflation, mortality, and the time value of money using a recent yield curve for investment grade bonds.[2] Thus, you should think of the RCF value as what the average retiree can expect.

RCF EstimatorThere are two ways to use the RCF value.  One, divide your portfolio value (excluding your primary home equity[3]) by the RCF value nearest your age to estimate the real cash flow (it will increase by the expected inflation rate over your retirement period) the average person can expect in retirement.  For example, say you are 65 and your current portfolio value is $1,000,000.  You would divide the portfolio value by 20.01 from the graph and get $49,975.  This is an estimate of the real pre-tax cash flow a $1,000,000 portfolio would produce through age 95 for the average investor.  At age 95, the portfolio of the average retiree would be drawn down to zero.  If your retirement budget is equal to or greater than the $49,975, you probably need to save more (i.e., work longer) or find ways to cut your retirement budget.

The other way to use the RCF Estimator is to multiply the RCF value by your estimated retirement budget to determine the size of the portfolio the average retiree needs to cover retirement expenses. If your current portfolio value is well above the amount calculated above, you may be financially ready for retirement.  Now you can take the next step and meet with one of our Wealth Managers to perform a detailed financial assessment.

This should be used as a rough guide or starting point to your estimated cash flow in retirement.  It is not a guarantee of any kind nor does it reflect fees and taxes.  As it represents what the average retiree can expect, your results are likely to be different.


[1] U.S. Department of Health and Human Services, National Vital Statistics Reports, 2010. Using mortality data for females results in more conservative estimate of potential cash flow from your portfolio.
[2] Thank you to BlackRock, Inc. for inspiration and similar calculations.  We encourage you to also use BlackRock’s CORI™ estimator at
[3] We recommend leaving out your home equity and consider that a margin of safety in retirement.

Yuan is Too Strong

Scott Grannis of Calafia Beach Pundit blog has an excellent piece on China’s currency move which you can read by clicking the link.  Below we show his chart of the real value of the Yuan to keep the longer term in perspective.  He writes, “Over the past 20 years, China has strengthened its peg vis-a-vis the dollar considerably, from 8.4 yuan to the dollar to now 6.3. As the chart (below) shows, the real value of the yuan against all other currencies has doubled in the past 20 years. So it’s fair to say the yuan has been an incredibly strong currency for the past two decades. That it should drop 2% against the dollar is hardly noteworthy. Maybe it was just too strong, and now it’s a little bit less than ‘too strong.'”


The Next Crisis

A Critique of the Article “Four Things That Could Go Wrong Now.” Wall Street Journal 10 Aug. 2015, R1. Print.

The Wall Street Journal, and other publications like Barron’s, periodically advises its readers to prepare for the next financial crisis. These articles are largely aimed towards the retail investor and can be found in the “Journal Report” or “Investing in Funds & ETFs” section of the Journal.

Where They Get it Right:

The Journal rightly brings to the reader’s attention the need to prepare for negative market events: The ability of the tech sector to bring down the market again; The Chinese stock market decline and the potential for failure of the Greek Bailout; Past and future missteps by the Federal Reserve and central bankers around the world; The inevitable bursting of the bond bubble (whose existence we can debate for hours another time…). The Wall Street Journal hits the nail on the head when it comes to the idea of being ready, being cautious, and safeguarding your portfolio from global financial upheavals.

Where They Get it Wrong:

First, let’s be honest. If you are young and have a long time horizon, time itself is the best safeguard. Not panicking through market downturns and dollar cost averaging over a lengthy career smooths volatility and lessens buy high sell low behavior. But time is not on all investors’ side and being proactive is important. Let’s look at some recent advice from the Wall Street Journal:

Risk: Overheated tech stocks come back down to earth.

WSJ Solution: Don’t over-allocate to the tech sector (okay, this is sound advice), buy long-term put contracts, and place stop-loss orders on tech stocks.

Our Take: Buying long-term puts can cost upwards of 2.5%, a hefty fee to protect against an event that isn’t a given. Puts, which give the holder the right, but not the obligation, to sell a security at a set price, appreciate if the underlying security depreciates in value. If the underlying security appreciates, the puts expire worthless.

With stop-loss orders a sell-decision is triggered by a loss of a pre-determined amount set by the investor. Selling a stock simply because it has declined in price may result in selling a good company just because it has a bad day, or worse, because the sector has a bad day. The decision to sell a stock should be based on the valuation of that stock, or because the long-term ability to keep competitors at bay, and margins high, has been eroded.

Risk: The Chinese stock market continues to decline and the Greek Bailout fails.

WSJ Solution: Buy call options on the volatility index known as the VIX and shorting ETFs that track large sectors of the Chinese economy.

Our Take: As with the put contracts, call options are not cheap and are difficult to understand for the average retail investor. As for betting against the Chinese stock market and economy, you will not be betting against a free-market economy. The Chinese government is working hard, even devaluing its currency, to fight the downfall. The saying goes “Don’t fight the Fed.” I’m guessing fighting the Chinese government could have similar, if not worse, consequences.

Risk: Central bankers make matters worse either through what they’ve already done or by raising rates too soon.

WSJ Solution: Buy long-term bonds and gold.

Our Take: While I’ll reserve discussion of gold for another conversation, buying long-term bonds as a hedge against the missteps of central bankers implies investors have a lot of time to let the bonds mature and aren’t likely to need access to liquidity. The Wall Street Journal correctly states that longer bonds react more to inflation expectations than to the whims and policies of central bankers…they also experience much wider swings in price and react to economic growth expectations. Long-term bonds are further out on the risk curve and should not be used as a bet against the Fed.

Risk: The Big Bond Selloff.

WSJ Solution: Avoid getting caught in a liquidity trap during a selloff by buying mortgages and, you guessed it, make more bearish bets in the form of put contracts on investments like high yield corporate bond ETFs. The idea is to shift into bonds that are less frequently found in funds and ETFs to limit exposure to a rush in selling and fund redemptions.

Our Take: The Journal alleges that mortgages are safer today than they were during the financial collapse. Even if this is true, due to higher lending standards, it takes due diligence to understand what makes up all the tranches of mortgage debt. Further, mortgage bonds can and often are called early due to the ability of homeowners to pre-pay, reducing the predictability of these securities.

Once again, options contracts can be expensive and are hard to understand for most investors. Also, to quote John Maynard Keynes, “Markets can stay irrational longer than you can remain solvent.” You may be convinced that the day of reckoning for high yield bonds is upon us, and buy put contract after put contract on a high-yield ETF, only to watch as the bonds increase in value for years while you watch expensive puts expire worthless.

Conclusion: The Wall Street Journal correctly points out that investors should be careful with their wealth today. However, major risk events have always existed with financial markets, with some coming to fruition and others passing by harmlessly. Rarely is there a good time to pursue an expensive and unpredictable investment strategy, particularly one that is challenging to understand. Investing is not easy but it can always be made more difficult. We take pride in our processes of due diligence to reduce volatility in our client portfolios and are always happy to discuss why we agree or disagree with various nuggets of investing “wisdom.”

Why the falling price of gold may be cause for optimism




Johan Rewilak, University of Huddersfield

Gold prices have tumbled to a five-year low. As a tradeable commodity, the price of gold is largely linked to supply and demand. While supply remains fairly fixed, demand is shaped by the state of the global economy and investor perceptions of gold’s value as an asset – this is in turn shaped by the strength of the US dollar.

The intrinsic value of gold has long made this precious metal a useful resource in the absence of legal or reliable money. The ease at which gold may substitute for currency means that during turbulent economic times gold is a valuable asset to hold.

The love affair with gold as a financial instrument can be traced back for centuries. A more recent example which offers lessons in the relationship between the commodity’s value and the US dollar is the Bretton Woods System, the monetary order which governed international currency relations between 1944 and 1971. With the growth of international trade after World War II, many countries were happy to hold US dollars in reserve, given they were convertible into gold at a rate of US$35 an ounce. And, with the US owning three-quarters of all gold reserves at the time, a US dollar was as good as gold.

An inverse relationship

The demise of the Bretton system was inherently a liquidity problem. As the growth of international trade outpaced that of US gold mining activities, the demand for international reserves (US dollars) outpaced US gold reserves. In essence, gold was not mined fast enough, making it a scarce resource – and so its true value exceeded US$35 per ounce. Effectively, the failure of Bretton Woods was a simple supply-and-demand problem, where the demand for US reserves (or, crudely, gold) was far greater than its supply, leading to what should have been, a higher price of gold.

History tells us that, in general, there is an inverse relationship with the US dollar and gold. As the dollar strengthens, the price of gold falls, and vice versa. In the example above, it was effectively a weakening dollar (which at the time was overvalued) that should have raised the price of gold.

Moving forward into the 21st century, a boom in commodities such as oil and iron led to an increase in prices including those of precious metals such as gold. Despite the sharp slump coinciding with the financial crisis of 2007, metals in particular witnessed high price increases in the subsequent years.

Gold hit an all-time price high in September 2011 (more than US$1,900 an ounce, and silver was priced at US$49 an ounce in April 2011. While platinum peaked in March 2008, in May 2011 it was priced at just under US$1,880 an ounce, a five-year high. The falling prices we are now seeing in gold and other metals too has some speculating this is the end of the commodity bubble – though this certainly a very pessimistic take on the matter.

EPA/Shawn Thew

US Federal Reserve chair, Janet Yellen, has said interest rates are likely to rise in the near future.

Light at the end of the tunnel

Ever the optimist, I would like to think that the falling prices in commodities (including gold) is because we are beginning to see light at the end of tunnel of what has been the largest financial crisis since the Great Depression. It is a well-known fact that when the financial system collapses and the economy becomes increasingly turbulent the demand for commodities, including gold rises. Look no further than the Bolivian hyperinflation where tin-ore became the commodity of choice (and when needed was exchanged for US dollars) to tackle a peso that was losing value by the hour. With short-term interest rates cut close to zero and quantitative easing reducing longer-term rates, present-day investors have avoided losing out on interest payments by holding gold.

But, with a mooted rise in interest rates in the near future and signs of economic recovery in spite of the eurozone crisis, it is inevitable that investors are looking to substitute back from commodities to other financial instruments. With interest rates unmoved at present, it could be that investors are pulling out while the price is high, which is contributing to the current falling price of gold. The data further shows that the US dollar is gaining strength vis-à-vis the euro and if interest rates do rise, then this may continue. Again this links back to the inverse relationship between the US dollar and the price of gold.

Will the price of gold keep falling in the future? While this is a possibility, I would exercise extreme caution. The economic recovery in the US has been uneven at best, so more swings are possible – and other forces should not be ignored. Although the current cracks in the eurozone have been papered over, the longer-term problems associated with the region are far from resolved.

Not only that, but with the demand for commodities (gold included) likely to increase in emerging markets when their economies recover, there is every possibility gold prices may start to rise again. Whereas most of the above has focused on the demand for gold, ultimately the mines that supply this resource will also have an important role to play.

The ConversationJohan Rewilak is Lecturer in Economics at University of Huddersfield.

This article was originally published on The Conversation.
Read the original article.