The Independent Market Observer

Thinking About a Global Slowdown: What Are the Biggest Threats?

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Sep 24, 2015 2:25:00 PM

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global slowdownAlthough growth in the U.S. continues at a reasonable rate, there are undeniable signs of a more global slowdown, especially in China. Even though we are doing reasonably well, the slowdown in the rest of the world does affect us. For example, here in the U.S., we see signs of slowdown in the industrial and manufacturing areas, and the recent drawdown in financial markets certainly owed more to events in China than in the U.S.

While the U.S. is largely a closed economy, the emerging effects here mean that we are now at a point where we should be thinking about what might happen—and what that will mean to us as investors. What are the biggest threats?

Let’s start with China

Chinese growth has slowed significantly from the 9 percent to 10 percent that had been typical for the past couple of decades down to a target level of around 7 percent. And there is concern that even this lower level of growth will not be attainable.

This is a reasonable concern. Much of the growth in China in previous years came from exports and infrastructure investment, both of which have largely topped out. Growth was also largely stoked by fiscal stimulus, which has gradually lost its effectiveness and actually failed the last time China tried it. Lower growth in China is very probable in the near term—and probably inevitable in the medium and longer terms.

What will lower Chinese growth actually mean for the world economy, though? To start, consider that even at lower growth rates, the Chinese economy is so much larger now that even a much lower growth rate contributes as much to the economy on an absolute basis. Using round numbers:

  • If your base is 20, at a 20-percent growth rate you grow by 4.
  • If your base is 100, a 4-percent growth rate also gives growth of 4.

China now has that much higher base and can contribute just as much to world growth even with a lower growth rate.

The problem is that much of the world economy has been built around a Chinese growth rate, not a level of growth. This is particularly apparent when you look at the commodity producers, who have been scaling up production to match continually increasing Chinese demand. Since that demand hasn’t materialized, we now have massive oversupply in many commodities, and the consequent price drops are doing real damage to the economies that depend on them.

Declining commodity prices and production

This is the source of much of the angst in the world economy: declines in commodity prices and production. The oil sector is a good example of this. Even here in the U.S., we are seeing declines in oil and gas employment and investment as prices continue to drop. Boom economies such as Texas and North Dakota are suffering from this. The energy companies and stocks have gotten hit hard as well. This is a big source of the declines we’ve seen in the world stock markets.

And yet, bringing it back to the U.S., declines in commodity prices, especially energy, have typically resulted, after short-term turmoil, in higher growth and stock markets. The reason is that lower input costs allow consumers to spend more and companies to make more money with lower costs. U.S. companies and consumers have actually benefited from lower commodity prices in the past.

Looking at the big picture

Other countries will continue to have problems, especially the commodity producers, but as the U.S. economy exports only about 10 percent of its GDP, any damage from slowdowns elsewhere in the world should be limited and offset by the benefits of lower commodity prices. Looked at another way, the most globally exposed sector of the U.S. economy is industrial and manufacturing, and that only accounts for about one-eighth of the economy. Services, which are largely domestic, account for the remainder and are doing just fine on domestic demand.

Bottom line: A global slowdown does appear likely, but the U.S. should be largely isolated from it. Although the headlines will continue to be scary, any real effects here should be offset by the benefits we get from lower commodity prices, among other factors. It’s one more thing to pay attention to but not panic over.

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