China's economy has enjoyed decades of double-digit growth, thanks to its low-cost exports of machinery, equipment, and consumer products. As a result, China is the world's largest economy. In 2019, it contributed $22.5 trillion, or 17.3%, of the world's $130 trillion in gross domestic product (GDP). This size means that any slowdown in China’s economy affects the whole world.
Since 2010, China’s economy has slowed from a 10.6% growth rate to 6.1%. Although this is a dramatic slowdown for China, it’s still blazing-fast compared with developed economies. For example, the U.S. economy has grown around 2% to 3% during that time.
- China has been one of the fastest-growing countries for the last few decades but is slowing its growth due to shifts in domestic consumption.
- A trade war with the U.S. also contributed to China's economic slow-down between 2017 and 2019.
- The issue of U.S. debt with Treasuries could slow, and the value of the dollar could drop.
- If you're invested in China, a diverse portfolio can help you mitigate the risks of a slowdown in China's economic growth.
Causes of China’s Slowdown
There are two main causes of China’s economic slowdown: an intentional shift by Chinese leaders and the U.S./China trade war.
Made in China 2025 Plan
In 2015, Chinese leaders released the “Made in China 2025” plan. It outlined a shift in China’s economic focus from being export-driven to greater domestic consumption. China also aims to become a global technology leader in fields such as robotics, aircraft, and electric vehicles. To do this, Chinese companies were urged to invest abroad to gain more technological expertise. The plan also set goals for companies to produce more components in China and import less. To support this new strategy, it’s believed that China has accepted slower growth.
Many countries are concerned that China’s current economic plan means the global domination of targeted industries.
Other countries are especially worried that the Chinese government might completely “lockout” foreign firms from participating in its economy.
US Launches Trade War
In 2018, the Trump administration initiated a trade war with China. The U.S. raised tariffs on $250 billion worth of Chinese imports. China retaliated with tariffs on $110 billion of U.S. imports.
The trade war reduced trade between the two countries from $635 billion in 2017 to $558 billion in 2019. More than one-fifth of businesses surveyed by the American Chamber of Commerce in China (AmCham) reported a drop in revenue in 2019. Almost 25% of firms reduced spending.
However, the Phase One trade agreement signed in late 2019 aimed to reduce the tariffs on both sides. China agreed to increase its purchases of U.S. imports. These actions should increase trade between the two superpowers.
Implications for the U.S. Economy
The economic relationship between China and the U.S. is extremely symbiotic. A China slowdown will affect the U.S. in three main areas: trade, the U.S. debt, and the value of the U.S. dollar itself.
China and the U.S. are each other's biggest trade partners. U.S. companies exported $106 billion in goods to China in 2019. If China’s economy slows, so will its demand for U.S. exports such as commercial aircraft, automobiles, and food.
IMPORTANT: In 2019, the U.S. imported $452.2 billion of Chinese goods, primarily computers, cell phones, apparel, and toys. U.S. exports to China are far less than imports, creating a $346 billion deficit. As a result, the largest U.S. trade deficit is with China.
Many Chinese imports are from U.S. manufacturers that send raw materials to be assembled at a lower cost.
Once shipped back to the U.S., they are considered imports. For that reason, the trade deficit indirectly benefits many American companies.
Impact on US Treasurys
China’s growth slowdown also could affect America’s ability to issue new debt. China is the second-largest largest holder of U.S. Treasurys. As China's exports to the U.S. decline, its government has fewer dollars on hand to purchase Treasurys. The Chinese government gets these dollars from Chinese companies that receive them as payments for their exports.
Fewer Chinese exports translate to less demand for U.S. debt.
Less demand means the U.S. Treasury will have to promise higher interest rates when auctioning the notes. That puts upward pressure on U.S. interest rates because banks base their mortgage interest rates on the 10-year Treasury yield.
Higher interest rates might also prevent Congress from increasing federal spending. That would then slow U.S. economic growth.
Value of the US Dollar
As China’s demand for U.S. Treasurys falls, so will demand for the dollar. Treasurys are one measurement of the dollar’s value. As a result, the value of the dollar to the yuan could decline.
As the dollar weakens, retail prices for imports will increase. That’s especially true for oil and gasoline. These contracts are priced in dollars. If the dollar weakens, the oil-exporting countries could lower output to raise the price and offset the dollar decline.
At the same time, a weak dollar would help U.S. exporters because their products would cost less in foreign markets.
How to Protect Your Portfolio from China’s Slowdown
As China’s economy slows, it will affect trade, the U.S. debt, and the dollar’s value. How can you protect yourself from all these events? The best way is with a diversified portfolio because not all the assets’ movements correlate with each other. When the value of one rises, the value of the other falls.
A diversified portfolio lowers overall risk because some asset classes will benefit no matter what the economy does.
Risk is also reduced because it's rare for any single event to wipe out an entire portfolio. A diversified portfolio is your best defense against any financial impact, including a slowdown in China’s economy.