We are pleased to welcome once again Dr. Robert Wescott, President of Keybridge Research and a long-time adviser to Pioneer, as a guest contributor. Dr. Wescott attended our recent Macro Advisory Forum, chaired by Giordano Lombardo, CEO and Group CIO, discussing how geopolitical risks could shape the investment landscape.
In the second of this series of blogs, Dr. Wescott looks at how China’s slowdown could impact the US or Europe.
There are certainly severe pain points for companies that have heavy exposure to China due to how rapidly demand may tail off. Dr. Wescott cited the example of a US firm in construction and mining sector that sold more excavators in China in a single month (March 2011) than it sold in the whole year 2015. Looking at overall US exposure to China’s slowdown, he said 7.4% of US exports go to China and they represent about 0.9% of US GDP. US exports to China were down about 5% in 2015, but Dr. Wescott said that if this doubled to a 10% decline in 2016, it could directly take about 0.1% off US economic growth.
However, he said it is also necessary to consider the knock-on effects on trade with other emerging market countries that suffer from slower Chinese growth. Approximately one third of US exports go to emerging markets other than China, representing about 4.2% of GDP. If US exports to these markets fell by 5% (due to Chinese spillover effects) that would take another 0.2% off US growth. Thus, the cumulative effect of a direct loss of business to China plus loss of exports to other emerging markets hurt by China’s slowdown could therefore take about 0.3% off US GDP growth, according to Dr. Wescott. The impact of a slowdown in China might be slightly worse for Europe—maybe 0.4%—because of slightly more trade exposure to China.
On a positive note, however, there are reasons to believe other economic forces could counterbalance the negative impact from China on the US economy. The US residential investment sector should add around half point of GDP growth this year. Also federal, state, and local government spending are all starting to show revivals after five years of budget cuts and sequestration—which together could add another 0.6% to US GDP growth in 2016. All this suggests that the negative impact from China’s slowdown should not cause an outright recession in the US economy. However, there are other indirect downside risks to consider as well. Dr. Wescott was particularly worried about the negative wealth effects that a decline in China could have on the US equity markets. Citing a normal wealth effect of 3-4%, he said that if the US equity markets remained a trillion dollars below trend because of concerns about China, that this could take another 0.2 or 0.3% points of GDP growth, for a total negative impact of 0.5% in 2016. Again, this would be more than a rounding error, but probably not enough to cause a US recession.