Will the crisis in China sink the U.S. economy?

Sep 02, 2015

Another day and another bit of bad news from China has sent stock markets stateside tumbling.

On Tuesday, it was data showing that activity in China's manufacturing sector during August contracted at the fastest rate in three years. The news sent the S&P 500 falling more than 3%, after stock markets in Europe and Asia posted steep losses as well.

The recent volatility in the U.S. markets is being chalked up to fears that the situation in China is only going to get worse. "Clearly this is showing us we’re not out of the woods by any means," Jonathan Corpina, senior managing partner at Meridian Equity Partners, told The Wall Street Journal.

Analysts are increasingly worried about the situation in China in part because the global economy has grown increasingly interconnected. According to the Treasury Department*, 30% of the jobs created in the U.S. since the Great Recession were export-dependent.

Meanwhile, the share of economic growth coming from emerging markets has increased markedly over the past 20 years. Back in the late 1990s, emerging markets accounted for 20% of global GDP; now it's 40%. And during this decade, China has accounted for a third of global growth, compared to just 17% for the United States. Given this change, Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley Investment Management, has argued that China is now the "critical link" needed to power a prosperous global economy.

There's no doubt that a slowdown in China will seriously crimp global growth, given the role the world's second largest economy has played in recent years. But will the U.S. economy get dragged down with it?

Back in the late 1990s, during the last Asian financial crisis, many economists predicted that the turmoil would slow growth in the United States and Europe but, in fact, just the opposite happened: the late 1990s were some of the best years for growth in American history.

The contagion in emerging Asia didn't spread to developed economies in the West for several reasons, but one major factor was the fact that the crisis was largely about the flight of capital from emerging markets, which had mismanaged their currencies, to the developed world. While many developing countries were hit hard by the Great Recession that started in the U.S. because of their reliance on exporting to the developed world, the Asian financial crisis led to the return of investment capital back to the developed world, which helped boost stock markets, lower interest rates, and power faster growth.

Of course, 2015 isn't 1998. China is a much bigger force in the global economy today than countries like Thailand or South Korea, where the trouble in Asia started a generation ago. But while a slowdown in China might be more meaningful in terms of global growth, there's plenty of reason to be skeptical that it will lead to slower growth in the United States. Exports only account for about 15% of U.S. GDP, while exports to the Pacific Rim account for just 2% of GDP. With figures like these, even a 10% decline in trade to the region would shave just 0.2% from growth in the U.S.

The prospects for the U.S. don't look spectacular. We're living in a world of ho-hum 2% growth. But there are no serious signs of a domestic recession on the horizon. Unemployment continues to trend downward, and commercial and residential investment look bright.

Investors in equity markets, on the other hand, may have reason to worry. By many measures, U.S. stock markets are pricey, and we've been due for a correction for months now. But the stock market follows the beat of a different drummer, with momentum mattering much more, at least in the short term, than economic fundamentals.

*This article originally attributed this statistic, incorrectly, to the economist David Levy

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