China (officially People's Republic of China), ruled by a communist government, has experienced an abnormal growth rate in Gross Domestic Product (GDP) over the past decades. Data from recent quarters, however, signal an economic growth slowdown of the Asian giant. What impact would this advent have on the US economy and global economy? In order to answer this question one needs to clarify the economic position of China in the world economy and its relation to the US economy.

The Chinese Economy: How Big and How Small

China, the most populous country in the world, is the second largest economy ranked just below the US with a nominal GDP of $10.36 trillion as of 2014. However, this high GDP does not necessarily indicate the wealth of the country. The country ranked 80 for GDP per capita which was only $7,589 as of 2014. Many global manufacturing companies are attracted by low labor costs and cheap supply materials in China, locating their manufacturing units in this country. This allows companies to produce goods very cheaply; therefore it is not surprising that almost everything we use in our daily lives has the label "made in China." (For more, see: US Vs. China: Battle To Be the Largest Economy in the World.)

Connection to the US Economy

China is the third largest export partner (the first and the second being Canada and Mexico respectively) of the US, with export goods and services valued at $123.67 billion as of 2014. This makes up about 5.3% of the total exports of the U.S. China is also the U.S.'s largest import partner whose imports were valued at $466.75 billion as of 2014 or about 16.4% of the total import of the U.S. Thus, the trade balance of the U.S. vis-à-vis China is negative, and this deficit is financed partly by the capital flow from China. That is to say, China is also the largest creditor of the U.S. holding the largest part of the US Treasury securities with an amount of $1,270.3 billion as of May 2015. This is about one-fifth of the total US treasury securities ($6134.8 billion as of May 2015) outstanding. (For more, read also: The Reasons Why China Buys US Treasury Bonds.)

All of these statistics show the importance of the Chinese economy and gives a clue on how any developments in China, be they negative or positive, can influence the world’s largest economy and the world economy overall.

Since 2010, the economic growth rate of China started to decline gradually. The GDP growth rate dropped from 9.3% in 2011 to 7.4% in 2014 (see the graph below). According to the International Monetary Fund (IMF) GDP growth forecast numbers, the downtrend in the growth rate will continue until 2018 after which the gradual recovery will follow.

China GDP growth rate

Concerns raised include the possibility that the slowdown in the economy of China will have negative impacts on the markets that are closely related to this economy, one of them being the U.S. A decrease in the level of consumer spending will affect US exports negatively, and if the U.S. is not successful in shifting to other markets, then based on the GDP formula a decrease in the US GDP at least in the short run can be expected.

GDP = Consumption + Investment + Government expenditure + (Export - Import)

With exports decreasing and imports being less affected from these negative developments, the deficit in the US balance of trade with China will widen further in the short run. According to The Organization for Economic Cooperation and Development (OECD), a 2% point decline in Chinese domestic demand growth will cause a decrease in the US GDP growth rate by about 0.3% points in 2015 and 2016. The graph below shows that the slowdown will have a wide coverage, being highest in the Japanese economy which is closely related to the Chinese economy. Overall, the world economic growth will decline by 0.5–0.6% points.

The impact of a China slowdown The Economist

Another way that developments in China can evolve unfavorably to the US economy is through the selling off of Treasury securities. The Chinese government may want to sell of part of these securities to use the proceeds for economic stimulus. Potential massive selling of the U.S. Treasury securities creates a threat to the U.S. economy, as a large supply may dump the price down and drive the yields up for at least the short term. Unexpected increases in interest rates may increase down pressure on GDP growth through lower valuations of investments. (For more, see: What Happens to the Economy If China Deleverages.)

Effect on the Unemployment Rate

U.S. companies that generate an important portion of their revenues from China are likely to be negatively affected from lower domestic demand in China. This is bad news for both shareholders and employees of such companies. When concerns arise about cost cutting to remain profitable, layoffs are usually one of the first options to consider, which increases unemployment rate.

Not Everything Is Bad

A Chinese economic slowdown does not have only negative effects on the U.S. economy. One of the major factors why oil prices decreased from high levels was pessimistic expectations about the GDP growth rate in China, the biggest oil importer with about 7.4 million barrels per day as of April 2015. One of the biggest winners from low oil prices is the U.S. as the second biggest oil importer with about 7.2 million barrels as of April 2015. Lower oil prices positively affect trade balance deficit as the country’s cost to import oil decreases.

The Bottom Line

China, with its giant economy, has a very large impact on the world economies, especially those of which are related to China. A decrease in domestic demand in China will most likely adversely impact the world economy and slowdown global economic growth. The U.S. is one of the countries that is likely to be affected from the slowdown of the Chinese economy, largely due to the expected decrease in the export of goods and services to China, which constitutes about 5.3% of the total exports of the US. However, the negative effects from the economic slowdown are partially offset by lower oil prices.

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.