But the most immediate and transparent threat to markets is already evident in the funk in emerging market equity, local currency bond, and currency markets, as well as in global commodity markets. Predictably, China is centre stage.
It has already figured prominently in the economic forecasting industry’s downgrades, but there is a still a way to go. Analysts and investors have not yet embraced fully the idea that the China problem is not about a cyclical and easily countered economic detour, but about the implications of what a fundamental transformation of the country’s economic model means for China’s GDP growth and supply chains, and for global commodity markets and industries.
One way or another, the model is going to change. The role of physical capital formation will fade as the economy rebalances. Physical labour input has been more or less exploited, and the credit intensity of GDP growth has to be brought down. China’s top leaders understand this, but changing the model to one based on efficiency, innovation and a greater role for markets at the expense of the state, is easier said than politically done.
Even if they succeeded, making the change could only be done in the context of slower, sustainable growth, and policies designed to absorb or address overcapacity in heavy and commodity-intensive industries, and a rise in debt service problems, defaults, and non-performing loans.
This comprises an unequivocally deflationary risk for global markets, which is likely to challenge risk appetite again and push up the US dollar, especially against emerging market currencies, including even the renminbi.
In China, the GDP deflator (a measure of the level of prices of all new, domestically produced, goods and services in an economy) has already slumped to a reported annual rate of 0.5 per cent in the June quarter, from around 7 per cent just two years ago. The combination of overcapacity in several industries and weaker growth could generate further downward pressure on Chinese goods prices at home and abroad.
Industrial and mining commodity exporters face a daunting time as the share of property investment in GDP falls from a lofty 15 per cent. The income and wealth effects on sectors from steel and cement to white and luxury goods could affect up to 35-40 per cent of the economy. Against this backdrop, concerns about tapering are little more than the proverbial rounding error.