Are We Recession-Bound? Look to China for the Answer

January 14, 2016
SHIRLEY MUELLER, MD

After a shaky start to 2016, some fear we're at the beginning of another recession. If we are, its origins will be in China.

The market is down. Investors are worried. According to Bloomberg, stockholders have already reclaimed $8.8 billion from world equity markets in 2016. This suggests we might be recession-bound.* According to most authorities, whether we are in a recession or not is contingent on China. This is because this massive country is now powering the world’s growth due to its large economy. There are reasons China might go awry or it could stay afloat. This is why.

On the negative side, China has debt that is 300% of its total economy, more hefty than our own which is roughly equal to our total economy. Although the relationship between debt and economic growth is complicated, some academics indicate there is a negative correlation. If this is true, China’s debt could impact it adversely and secondarily, the rest of the world.

The Shanghai Composite compared to the S&P since 2011 (as of Jan. 11, 2016). The Shanghai Composite is in orange. The S&P is in blue. The Shanghai Composite spiked higher than the S&P in mid-2015 and since has fallen sharply.

On the positive side, though China’s stock market has slumped, thereby already affecting the rest of the world, its market is not reflective of the total cash available in China. Yu Hua wrote in the Opinion Page of The New York Times on May 11, 2014, “Corrupt officials generally do not spend the huge sums they acquire from kickbacks, and are loath to deposit their money in banks for fear it will be discovered. So they hide their money instead. The professor estimates that as much as 50 percent of the surplus money supply may have been taken out of circulation for this reason.” The author is referring to an unnamed professor of literature. If this is the case, there still is plenty of cash In China. We just don’t know about it.

The question is: Where will the corrupt money be spent? Lately, there has been a crackdown in China so public officials and others harboring such money are loath to spend it at home for fear of drawing attention to themselves which could lead to arrest and jail (see box at left). Instead, they squirrel it away or spend it abroad.

A scenario I foresee that could benefit the Chinese economy would be one where political leniency is employed by the government for a period of time allowing corrupt cash to freely enter the Chinese economy. This could revitalize the broken economy.

It is great to be optimistic and hope the latter will happen. I would like to believe that it or something similar will boost China. Still, we know that evidence suggests that making an accurate prediction about what will happen is fruitless.

The best approach for an investor, it appears, is to construct a portfolio with which she can live with the results no matter what happens. Of course, this means the return cannot be optimal because less risk will likely be taken. But, it also means less downside too.

*Recently, recessions have been happening every 7½ years. Since 1929, they have lasted between eight and 18 months.