July 10, 2013 | By Scott Minerd
The macroeconomic outlook for China continues to deteriorate. Premier Li Keqiang’s program to hold banks accountable for their reckless lending practices is having a number of unintended consequences, including an elevated risk of a financial crisis over the next six months. Importantly, the line of reasoning being followed by Chinese monetary authorities is exactly that which the U.S. government adhered to in 2008 when it decided not to prevent the collapse of Lehman Brothers. I view the probability of a parallel outcome in China as around 10 percent right now. Although it is not the base case scenario, the possibility of an unintended financial crisis in China is gravely concerning given the severity of the potential consequences.
Chinese officials have shown that they are willing to tolerate a lower growth rate than originally anticipated as they attempt to reduce the moral hazard in the financial system. This, combined with instability in Japan as Abenomics continues, puts all of Asia in a precarious situation. If the bad news becomes worse and volatility rises further, there will inevitably be greater knock-on effects for the global economy and markets. We could see a return to safe-haven U.S. Treasury buying, which would push down interest rates in the United States.
China’s economic growth will likely continue to slow in the near-term, given the chaos in the banking system and the potential squeeze of credit to the real economy. Economic growth in other emerging markets is likely to be severely hit if demand from China falters. Measuring by export exposure to China, Asia-Pacific countries and those driven by commodity exports are most vulnerable to a slowdown in China. By comparison, the direct impact on most advanced economies appears to be moderate, as their exports to China account for a much smaller share of GDP.
Source: Haver Analytics, Guggenheim Investments. Data is annual trade data as of 12/31/2012.
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