Bad news from China sends the markets down as the world nervously braces for an explanation from the historically secretive country. The markets are spooked. First from China’s currency devaluation followed by its decision to ease interest rates. So why does one nation’s economic problems have the world markets on edge?
Their decisions have a big impact on commodity prices, precious metals and global industry. Here’s why:
1. China is the world’s second-largest economy.
China has been moving from an export economy to one based on consumer spending. An economic slowdown by Chinese consumers affects many nations that export products and services to China. And nations that don’t export to China could still be affected if the Chinese cut back on tourism and foreign real estate investments.
2. China has an insatiable demand for oil.
Lower Chinese economic growth could depress oil prices as China levels off their need for oil. The good news is that lower oil prices means cheaper gas for motorists. But lower gas prices affect shareholder’s returns on worldwide oil industry stocks.
And as China’s demand for oil slows down, other natural resource prices in steel and iron also drop, affecting a wide variety of companies and industries. Australia, in the midst of an economic boom from sale of coal and iron ore to China may be one of the hardest hit. More than a quarter of their natural resource exports go to China. Other nations that could be hard hit include Russia, Korea and Brazil.
3. A downward spiral for gold
The Chinese have been big investors in gold and gold jewelry. As consumer demand continues to taper off, major jewelry companies like Tiffany and Cartier will take an earnings hit. But worse, investors holding on to gold as a safe investment are unlikely to see a decent return any time soon.
3. Delayed interest rate rises
Central bankers in the US and Europe have been issuing warnings for months that as growth strengthens they are preparing to push interest rates up by the end of the year in order to reverse the emergency cuts made during the global credit crunch. But if the cheaper Chinese yuan cuts the price of imports, this will undermine inflation (which is already at zero in parts of Europe) by delaying an interest rate rise.
While lower borrowing costs help consumers in debt, the markets are afraid of a stagnant Chinese economy leading to deflation. Brief periods of falling prices in one or two commodities is good for the American consumer, but persistently falling prices affect employee wages, spending, and overall company growth. And if the markets are in store for a downturn due to China’s problems, there’s not much governments can do about it since interest rates are already at near zero.
5. Even more austerity for Greece
If the Chinese devaluation does bring a wave of deflation to the world economy, countries holding the most debt (like Greece) are in trouble. Wages and profits fall during deflation, but debt remains fixed, making it more expensive to pay off.
Greece is already in a deflationary period after repeated government cuts in wages and benefits in an attempt to balance the troubled nation’s books. If it worsens, their massive debts worth more than 170 percent of the size of the economy will be nearly impossible to pay off.