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The Western World Must Be Ready To React Should The Chinese Sprint Turn Into A Fosbury Flop

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Will there be a post-Olympic flop? The Chinese economy has been lifted by huge spending on infrastructure, with the games costing something like $30bn (around £15bn), but also by a surge in current spending. Sure, some factories have been shut in the run-up to try to reduce pollution, and some non-games capital spending has been cut back, but there can be little doubt that hosting the Olympics has given a boost to an already-booming economy.

Just as the millennium signalled a turning point – a huge surge in activity beforehand and an economic hangover afterwards – might the Olympics do the same? Already, just ahead of the opening ceremony, commodity prices have started to decline, showing in July the sharpest monthly drop in 28 years. Since Chinese growth has been the principal driver of demand for raw materials, it is at least plausible that the markets are calling the end of the cycle. Are commodities to this cycle what dot-com shares were to the last one?

Well, not quite. The bursting of the dot-com bubble led to the most serious fall in share prices since the 1970s and triggered the early 2000s downturn, but any fall in commodity prices would help soften the present slowdown. It would reflect a fall in economic activity rather than provoke one. But while the parallel is superficial, it is worth looking at events in China because what happens there will have a profound influence on what happens here and elsewhere in the developed world.

The evidence is mixed. On the one hand consumer demand has been shooting ahead and is still doing so. While consumption is not as important to the Chinese economy as it would be in the developed world – some 40 per cent of GDP rather than a typical 65 per cent – the fact remains that Chinese consumers are currently adding more incremental demand to the world than the US and probably more than the US and Europe combined.

Goldman Sachs has done some calculations which suggest that the monthly increase in Chinese retail sales is running at about $30bn above the level at the start of last year, and there is no sign of that slackening. There has been a surge in inflation, worse actually in China than in the developed world, but the Goldman Sachs economics team notes that this is already falling and will fall further. You can see the numbers on the surge in retail sales and inflation in the graphs.

The basic point is that Chinese consumers have taken over from those in the US as the main drivers of additional demand in the world economy. Yes, there may be recession or near recession in the US, Europe and Japan, and the news on that front continues to be confused. But as a whole, the world economy keeps growing.

So why are commodity prices falling? It could just be that they went too high in the first place, moving beyond their long-term equilibrium. It could be that the reaction in the West is so dramatic that we are offsetting demand from China. But it could be because the markets sense that China's demand will slacken in the months ahead.

One indicator came out last week supporting this last view. It was the purchasing managers' index, out on Friday, which fell below the 50 per cent margin. This means that among the businesses questioned, more than half were experiencing or expected a fall in output. That may just be a freak result and I would not take it too seriously. Output at the moment is running up about 15 per cent year-on-year. But what I would say is that some slowing of Chinese growth is likely to occur in the next couple of years and we will notice the effects of it, just as we have noticed the effects of the long Chinese boom.

That leads to a more general point. All eyes will be on China over the next month. It will be the first time for most of us in the West that we will have to contemplate a world where China takes over from the US as the largest economy. That tipping point is probably still 25 years away, but long before that the shift of power will shape our perception of global economics. Some aspects of Chinese behaviour will be quite disturbing. Issues such as freedom of information and minority rights are already out in front. But the two big economic issues that will make us feel uncomfortable will be attitudes to the environment and to international investment.

On the environment the most obvious at the moment, pollution, will be the most pressing. Longer-term matters such as carbon intensity and climate change will grind away over the next couple of decades, but right now the issue is whether pollution and environmental degradation has already become a drag on economic performance. We cannot measure how serious it is because it is hard to gauge to what extent it is actually cutting the standard of living through higher-than-necessary food prices and damage to health.

Once the Olympics it will be interesting to see what happens to the Chinese economy, they certainly need to address the pollution problem if they don't they may lose Beijing to the sea.

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  • 401 Brexit, House prices and Summer 2020

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