China Is Crashing. Don't Freak, America
China’s stock market is having its second crash this year, which isn't very surprising. Last month, when the Chinese government intervened to support the market, almost everyone realized that it still had further to fall. Given that China’s stocks are still up a lot over the past year, there may be more bloodshed to come.
And yet every time there’s a big market meltdown somewhere in the world, people freak out. Is this the start of the next global recession? Will U.S. markets catch the disease and crater as well? Although that's always a possibility, these dangers probably are not as serious as many people think. Here are some reasons why you shouldn’t worry.
The first is that in the U.S., stocks almost always bounce back. Though U.S. markets have plunged by about 10 percent from their highs in the past week, the decline shows some signs of running out of steam and it's possible they might start rising again. The really important reversion, however, happens over larger time spans. When stocks are expensive and price-to-earnings multiples are high, they tend to post returns that are lower than historical averages. When stocks are cheap, they tend to return more.
U.S. stocks have been looking somewhat expensive in the past few years, so we should expect to see below-average returns. The recent China-driven selloff just makes stocks cheaper, meaning their expected future returns have gone up a bit. In other words, my Bloomberg View colleague Megan McArdle has it exactly right -- don’t try to time the market. Sit back and see what happens during the next decade, not the next week.
More fundamentally, China’s stock market crash -- and the accompanying economic slowdown that is already well underway there -- doesn't spell disaster for the U.S. economy.
Just as an aside, that may not be the case for commodity-driven economies such as Russia or Brazil -- China’s slump is a big worry. China’s industrialization, driven heavily by capital investment, pushed up the prices of their products, and generated huge export booms. But lower resource prices are actually a boon to resource importers such as the U.S., Europe and Japan. That will cushion some of the impact of a Chinese slowdown.
A second reason not to worry too much is that the U.S. has an enormous bilateral trade deficit with China. The U.S. imports about three times as much from China as it exports to China. In other words, U.S. trade with China is mostly one-way -- China sells the U.S. goods and services, the U.S. gives China IOUs. That means that a Chinese slump will do little harm to U.S. businesses, because so few of them are dependent on selling to China.
But what about U.S. businesses that had big plans to expand into the Chinese market? Unfortunately, those plans already were in trouble well before the Chinese stock market crash. And anyway, China’s government has spent years making life difficult for U.S. companies, guided by policies intended to support domestic champions instead of promoting free commerce. Tech companies have, predictably, borne the brunt of this. Chinese support for indigenous companies over foreign competitors is likely to intensify as China becomes less dependent on the foreign direct investment of Western and Japanese multinationals. So the Chinese market was probably never as attractive as many investors and corporate managers assumed.
How about U.S. consumers? Should they be worried that China will stop making and exporting cheap products? Quite the contrary. China’s slowdown and market crash is already inducing capital flight, meaning that investors are moving their money out of yuan-denominated assets. That puts pressure on the Chinese currency, which the Chinese government is only too happy to see weaken in order to keep exports humming. In other words, Americans will keep getting a flood of inexpensive Chinese goods, only this time it will be the natural result of an economic slump instead of artificial currency manipulation by the Chinese government.
Nor will financial contagion be likely, at least for the U.S. Although U.K. banks are heavily exposed to China, those in the U.S. are relatively safe and there probably is little risk of anything approaching a repeat of the 2008 financial crisis.
So there are many theoretical reasons not to worry very much about the Chinese market crash and slowdown. There are historical reasons as well. In 1989 and 1990, Japan experienced a titanic crash in both its real estate and stock markets, followed by a decade-long economic slump. During that period the U.S. economy zoomed ahead, while U.S. stock markets went on a record tear. Contagion from what was then the world’s second-largest economy just wasn't that severe.
In other words, keep things in perspective. Another Asian bubble has burst, but it’s not going to be the U.S. that's on the hook.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
To contact the author on this story:
Noah Smith at firstname.lastname@example.org
To contact the editor on this story:
James Greiff at email@example.com