Napoleon described China as a sleeping giant which, when roused from slumber, would shake the world. The great awakening began in the mid-1980s when Deng Xiaoping slowly opened up the Chinese economy, embraced free market economics and described the policy change as "socialism with Chinese characteristics". Now, with its greatly enhanced status as the world's second largest economy, what happens in China clearly matters to the rest of the world, as the turmoil on international stock markets has so clearly demonstrated.
Share price volatility, evident in China and abroad, reflect investors fears for the future health of the world economy, as the Chinese authorities – uncharacteristically – struggle to stabilise the currency (the yuan) and to deflate a stock market bubble. The failure of these official interventions has, in turn, raised international concerns about the real state of the Chinese economy – as its national statistics are unreliable – and, in particular, about what slower growth means for China’s appetite for foreign goods and services.
The economic slowdown in China is happening just as the US, the world's major growth engine, is staging a modest but steady economic recovery. This has put the US central bank, the Federal Reserve, under pressure to raise interest rates soon. However, the imminent prospect of higher US rates, which has seen the dollar appreciate in value, has had adverse consequences for many of the world's emerging market economies; notably, those in Latin America and Asia. Many commodity producing countries borrowed heavily in dollars at low interest rates, to finance exports to a Chinese economy which needed them to sustain its own export-led growth programme.
China’s switch to achieve a more balanced economic policy, relying less on exports and more on domestic consumption, has contributed to the country’s economic slowdown, as that transition has begun. Moreover, it has contributed to a sharp drop in commodity prices, with adverse consequences for developing economies as their exports to China slump, their currencies fall, and leaves corporate borrowers exposed to currency risk on their dollar denominated debt.
The increased divergence between the performance of the world’s two largest economies remains a worrying backdrop: the US where growth is modest and an interest rate rise seems imminent, and China where growth is stalling, but where interest rate cuts have done little to raise economic activity. China’s remarkable economic performance since the mid-1980s has greatly benefited the world. The success or failure of its major policy shift, in moving from an export-led to a more consumption-driven economy, represents a major challenge for China and, in a globalised world, has consequences for everyone else.