How China’s Economic Woes Could Impact Australia

Global share prices and oil futures have been in a free fall since the latest round of Chinese economic data was released. The weak reports indicate that China’s GDP growth is likely to slow further in 2016, which will not bode well for the Australian economy.

The first report was the China Caixin Manufacturing PMI, or Purchasing Managers’ Index. It’s taken from a monthly survey of over 400 purchasing managers, asking questions about employment, new orders, prices and inventories.

The reading provides a bird’s eye view of activity in the manufacturing sector and serves as a leading indicator of the strength of the overall economy. When the PMI is below 50.0, the manufacturing economy is contracting, and a value above 50.0 indicates that manufacturing is expanding.

November’s reading was 48.6, but economists expected December’s report to be much rosier, at 49.0. The actual figure came in much lower than anticipated, at 48.2, and marked the tenth month in a row in contraction.

This sent the Chinese share market into a tailspin, losing over 7 percent in the first half hour of the opening trading session. All trading was suspended for the remainder of the day.

Then came the China Caixin Servicing PMI, which is essentially the same report but in the services sector. December’s reading fell to 50.2 from 51.2 in November, the lowest level seen in 17 months.

All up, nearly 22 percent has been wiped off the value of the top 300 Chinese companies since Christmas. That makes the total 41 percent if you go back just seven months to June 2015. Equity markets in the States have had their worst start to a year in more than a century. Our own ASX200 has dropped over 8 percent in two weeks. Even oil futures, which had already been hammered, are down a further 20 percent in the new year.

Amidst the chaos, the Chinese government has responded by devaluing the Yuan, which has further upset currency markets. The immediate goal is to help exporters, but the secondary aim is to address their massive debt problem.

China’s private debt to GDP ratio has been rising faster than any other nation in the world. Given the debt-saturated world we live in, that’s saying a lot.

In light of the economic slowdown that’s brewing, China needs a weaker currency to not only boost demand for their goods, but also to make it easier to pay back their debts.

So how will China’s economic woes, and the worldwide economic fallout, impact Australia? Here are three possible changes we should watch out for:

1. Recession

Canada and Brazil are already in recession. Like Australia, they have been major commodity exporters. Weak iron ore and oil prices have slashed their GDP growth, as the supply gut has grown worldwide and demand from China has slowed down.

So if the Australian economy is so commodity dependent, why haven’t we entered a recession?

Thanks to the RBA’s monetary easing and low interest rates, we’ve avoided the same fate by leveraging up, speculating on property and pouring billions into new housing construction. Our real estate boom has offset our mining bust.

But now our property boom is over, and unfortunately our mining bust probably isn’t. If China keeps slowing down, this will only diminish demand even further for our commodity exports.

Furthermore, if China keeps devaluing the Yuan, fewer Chinese will be able to afford to travel to Australia on holiday. This could hit our tourism industry hard.

What’s left to offset our decline?

2. Lower Interest Rates and a Weaker Aussie Dollar

The only hope remaining is household consumption. If Aussies will just keep spending, perhaps we can keep growing.

But don’t hold your breath. It’s not only China that has a massive debt problem. So do we. Debt equates to interest payments, which means there’s less available at the end of the bills to spend.

Not to mention the fact that the United States, Europe and Japan have all been borrowing at record paces. The entire world is awash in debt. This means that every major economy will want to do what China is doing – devalue its currency.

So together with other central banks of the world, the RBA will likely continue to reduce interest rates and weaken the Aussie dollar. The aim will be to encourage household debt and spending, boost our exports and help our government to borrow and spend, then pay off its debts with weaker dollars.

3. Flat or Falling Home Prices

Don’t expect lower interest rates to translate into rising home prices anytime soon.

APRA has already stepped in to offset the impact of the RBA’s monetary easing on real estate, and you can bet they’ll be quick to do it again. If interest rates go lower, bank capital requirements will likely increase, which means there will be less money available for mortgages. We’ll need wage inflation before regulators let home prices increase.

Furthermore, it’s no secret that Chinese investors have been buying up a significant percentage of new housing in Australia. As the Chinese share market falls, Asian investors may lose capital that they would have otherwise invested in real estate here. We can expect overseas investment to wane.

A weaker Yuan will also not bode well for overseas investment into Australia. Our real estate has been attractive to the Chinese because their currency has been so valuable here. That may not continue to be the case.

By Jason Staggers

Jason was a personal mentor working with Steve McKnight's Property Apprentices. He helped hundreds of investors apply Steve's teachings in the real world and achieve greater results on their journey to financial freedom. Jason now lives in Perth, WA where he leads Neuma Church.