Twenty five years ago, a sudden collapse in Japanese stock prices was followed just months later by a US recession. Could the same thing happen today, with respect to China?
Listening to Larry Summers, Ray Dalio, Bill Dudley and the IMF this past week or so, you could be forgiven for thinking that the US economy is in mortal danger as a result of the recent gyrations (mostly downwards) in China’s stock market. Mr. Dudley may have been restricted in what he could say about the next move in US monetary policy, but Professor Summers and Mr. Dalio weren’t: according to them, the next move in Fed policy could well be an easing, never mind the tightening in policy that most people are currently expecting sometime between now and year-end.
Perhaps they were thinking about what happened to US growth twenty-five years ago, when it was a sudden collapse of stock prices in Japan that was followed just months later by a US recession.
It was Christmas 1989 when the Japanese stock market peaked. Back then, Japan was within spitting distance of overtaking the US as the world’s biggest economy. Japan had been quite the economic miracle in the preceding forty years, after the disaster of World War II. Those in the know gave a lot of credit to Japan for the intense co-ordination that went on between government, industry and labour. There was the all-powerful Ministry of Finance (‘the MOF’), the Ministry of International Trade & Industry (MITI) and the Keidanren (Employers’ Federation). And there were the wise amakudari, the government mandarins who rounded out their careers in public service by moving to industry and overseeing government relations there. At first, of course, it was impossible to know just how much Japan’s stock market problems might jeopardise the economy’s medium-term health. Perhaps a slowdown in its previously rapid growth rate was only to be expected now that it had come to the end of its long ‘catch-up’ phase.
A year later, though, it wasn’t the Japanese economy that was in recession, but the US economy. And within another two years, virtually every other major industrial economy had seen a downturn, too. Was that crash in Japan’s stock market to blame?
Happily, it wasn’t. Because also in the news in 1990 was Iraq’s invasion of Kuwait (in early August) and the upward spike in oil prices that it caused, and also Germany’s formal reunification following the fall of the Berlin Wall in late-1989. Also as far as the US and Germany were concerned, their domestic monetary policies had become increasingly restrictive in the preceding years, which is a far cry indeed from the easy monetary policies of today.
On the other hand, China today does a lot more importing than Japan did in the late-1980s: slightly more than twice as much, according to the World Bank statistics I’ve looked at. If the past relationship between Chinese imports and commodity prices is anything to go by, Chinese imports could still have a further 30-40% to fall in the coming year (see chart). In addition, while the direct economic links between China and the US/Europe don’t look big enough to upend the latter’s growth, the indirect linkages (via countries such as South Korea) are likely to be more significant than they were twenty-five years ago. Actually, it’s probably Europe rather than the US that is more exposed to China at present given extant patterns of world trade. It might help explain why it was the European Central Bank downgrading its economic forecasts yesterday, with senior Fed officials apparently a lot more laid-back.
All things told, though, I remain relatively relaxed about the economic impact of this latest China stock price crash, particularly on the US economy. If I were Fed Chairwoman Janet Yellen, it certainly wouldn’t be enough to get me to change my vote to raised interest rates slightly at the next Federal Open Market Committee meeting.