A material slowdown in China will affect other emerging markets despite arguments about decoupling. Even if one believes that the real economies of the emerging markets have decoupled due to domestic consumption drivers - though in China, for instance, consumption accounts for about a third of GDP (versus more than 50 percent in both India and Korea) - it's clear that the financial markets remain interconnected. In fact, if anything, the emergence of exchange-traded funds and other pooled investing products has created greater financial interconnections than ever before.
Further, the mere fact that India, China, Russia, Thailand and other developing countries are pooled into a single asset class known as "emerging markets" connects them via portfolio managers that view them as linked. If Russia were to fall by 20 percent, for instance, and all other markets were flat, emerging-markets managers would find themselves overweight non-Russia markets. Indiscriminate selling might follow as portfolio managers rebalanced, generating the financial contagion all desperately sought to avoid.
In addition, approximately 25 percent of the S&P 500's earnings is directly derived from emerging markets, with a large amount (perhaps around 20 percent), coming indirectly from emerging markets. Unfortunately, this means that multinational corporations may soon find that earnings are harder to grow than previously expected.
While it is not impossible, it seems unlikely that the world is about to descend into a multi-decade debt-deflation spiral. Some areas may not be so vulnerable.
Paradoxically, China probably won't be a severe casualty of a massive deceleration in investment spending. Social stability is on the top of Chinese leaders' minds, particularly as the country goes through a leadership transition. They will deploy all resources at their disposal to prevent social unrest that might emerge from slower economic growth. And even if the country grows GDP at roughly 3 to 5 percent per annum over the next decade, that's impressive growth that will result in a significantly larger middle class: Consumption as a percentage of GDP is destined to rise, creating winners amidst the wreckage and placing the Chinese economy on a more resilient foundation.
Several commodities are not as affected by the China factor as industrial commodities, specifically agricultural and energy commodities. The middle classes of India and China are growing rapidly, even if GDP rates slow in these countries, and accompanying this growth is demand for animal protein and transportation fuels. Families, accustomed to adding some chicken or pork on top of their rice for dinner, are unlikely to cut back to just rice. Likewise, the demand shock to energy is growing as individuals go from riding bikes to mopeds, to motorcycles and cars. Such demand trends are unlikely to reverse. Hence, the globe can anticipate higher prices for food and fuel commodities for the foreseeable future.
Last year, most analysts expected the Chinese economy to eclipse the U.S. economy within 10 years. The combination of a rapid Chinese slowdown and a U.S. renaissance driven by American agriculture and natural gas, i.e, food and fuel, may in fact push the crossover date out by years, if not decades - making analyst credibility perhaps the most visible of casualties.
