Global Economy Depends on China Solving its Credit Bubble

Independent analyses by both the University of California macroeconomist James Hamilton and the Bank of England have fingered weak demand as the chief cause of low oil prices. Given that China is driver of incremental demand for most commodities, weak prices must therefore be principally attributed to weakness in the Chinese economy.

But what sort of weakness is this? The thinking splits two ways. Many analysts anticipate a gradual slowdown in China’s underlying growth rate as it migrates from an investment-led to a consumer-led economy. By this view, China is facing a structural re-alignment, with the shift requiring another two to four years. Things are slowing down, but it’s nothing serious.

A darker view sees a credit bubble emanating from years of misguided over-investment in China’s infrastructure, housing and manufacturing. China has created an unsustainable credit bubble, and this will come crashing down, taking the Chinese—and by implication, East Asian—economy with it. This view does not deny the need to restructure the Chinese economy, but anticipates a cyclical downturn, a financial crisis along the lines of 1998. The Chinese economy will not see a “soft landing,” but rather a full-blown crash.

We have proposed the third hypothesis. The collapse of commodity prices from mid-2014 corresponded to an oil supply surge and the failure of China to devalue the yuan in line with the yen, won and Euro. By this line of thinking, China made a simple policy mistake which killed its exports, and with it, the incremental demand for commodity imports. Thus, if China devalues, then all should be well and commodity prices should recover about half their losses since summer 2014. If this is true, China is not in such bad shape. All the country needs is a quick, if painful and politically awkward, devaluation.

via CNBC

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza