At the start of 2016, the financial markets went into a frenzy when China's Shanghai Stock Exchange Composite Index plunged 7% in one day. The stock markets in Europe, Asia and the United States quickly followed suit with steep declines. In the following days, while traders focused on China's financial markets, economists were looking at the underlying problem – China's slowing economy.
When the Chinese government suspended trading, two critical economic indicators came to light that revealed that China's economy may be slowing faster than most economists had thought: the decline in China's manufacturing sector appeared to be accelerating, and the continued devaluation of its currency was an indication that there was no end in sight to the economic decline.
China's double-digit, credit-fueled, investment-driven economic growth could only be sustained for so long. The consumption-fueled economic growth China counted on just wasn't materializing. Economists wondered whether the Chinese downturn would cause the world to feel a gentle ripple, or would it be engulfed in a giant tidal wave? Some factors – much more than others – contributed to the effect the world felt from China's economic downturn.
Lower Oil Prices
Depressed oil prices, which were affecting the economies of Russia, the OPEC countries and the U.S., were a result of oversupply. China's falling demand for oil greatly contributed to that oversupply. The economies of countries that have depended on China's unquenchable thirst for oil were contracting with no immediate sign of relief. The issue seemed to be multiplied by the general oil prices that year, which were falling in tandem with Chinese need for crude.
Falling Commodity Prices
Oil is a commodity, but it is just one of many that are losing value as a result of falling demand. China is the world's largest consumer of iron ore, lead, steel, copper and other investment commodities. A slowdown in China's economic growth reduced its demand for all commodities, which hurt commodity-exporting countries such as Australia, Brazil, Peru, Indonesia and South Africa – all major exporters to China. The ensuing sharp decline in commodity prices threatened the global economy with deflationary pressure which was felt worldwide through the financial markets.
Reduction in Trade
China might not have been the world’s economic engine, but in 2016 was very much becoming a trade engine. In 2013, China became the world’s leading trade nation. Its demand for imports fell 10% in 2015. Countries that were dependent on trade with China felt the impact on falling demand, which spilled over to countries that were not dependent on Chinese trade.
The Corporate Domino Effect
Even for countries for which trade with China is a small blip on their gross national products (GDPs), the domino effect of falling demand hit individual companies that had direct or indirect exposure to China. Some companies that sold products in China, such as Apple and Microsoft, were more directly exposed.
Other companies were indirectly exposed, but with a potentially more severe impact. For example, John Deere sells farm equipment to countries in South America that were relying heavily on agricultural exports to China. When China's demand for imports decreased, the demand for farm equipment decreased along with it.
What People Expected
Economists were more concerned with the weakening underpinnings of an economy built largely on the credit market and government investment. Without intervention by Chinese consumers to fuel the economy, the environment for sustainable growth just wouldn't be able to exist.
The larger concern was the possibility of a faltering Chinese economy leading to a loss of confidence in the global markets. If confidence disappeared, it could lead to a global financial crisis that would dwarf the one in 2008. Many economists believed China would be able to implement some policies and controls that will stabilize the economy enough to stop its decline and continue to build a consumer-driven foundation for future growth. As of Oct. 2020, it seemed that they were right.