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Slower boat from China

globe dollar

By Bob Landaas

The stock market in the United States has stabilized recently after the most extreme price swings since the financial crisis. China sparked a worldwide sell-off in the markets by devaluing its currency, heightening concerns about the country’s financial problems.

On Aug. 11, in a very bold move, the Chinese government devalued its currency. It cheapened the currency by 4% and then again by another 2%. Within a two-week period, all the Chinese goods that come into the United States got 6% cheaper.

By cheapening the currency, China is trying to sell more exports, but what it did was create concern and confusion over just how weak its economy really is. It also launched a race to the bottom for all the countries that compete with China for exports. Countries in Asia and the old Baltic region have seen their currencies plummet.

The devaluation is a sign that the Chinese economy is slowing more than the government has officially acknowledged. Attempts by the Chinese government to stabilize the country’s financial markets have been met with skepticism, with many leading economists questioning the decision making of the Chinese leadership.

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The good news is that the U.S. economy still appears to be strengthening. The government now says gross domestic product grew 3.7% in the second quarter, up from a previous estimate of 2.3%. Other recent reports show an increase in U.S. consumer confidence, robust new-home sales and an encouraging gain in durable goods orders.

Market turbulence should force investors to reconsider their assumptions for things like revenue growth and earnings growth. The recent recovery in stock prices in the United States suggests that the U.S. economy is unlikely to be significantly harmed by the turmoil in China.

The primary impact will be felt in the emerging world. Many emerging economies, until recently, have been thriving because the growth in China has boosted demand for their raw materials. The slowdown in China has caused a huge drop in commodities prices and along with that a setback for countries that provide those raw materials.

Furthermore, the U.S. dollar has been gaining strength against just about all emerging market currencies. Loans made in dollars have become more expensive to pay back in local currencies, putting additional burdens on emerging countries.

We are witnessing a big disparity between the world’s two largest economies. While China appears to have lost economic momentum, the United State continues to grow. The U.S. growth may be modest, but it is the envy of the developed world – twice as fast as Europe and three to four times as fast as Japan.

Selected industries in the United States will be hurt by the slowdown in China – car manufacturers, construction equipment manufacturers. While other sectors – the service sector, consumer non-durables – could see no change.

History shows us that the United States successfully decoupled from Asia during the Asian financial crisis that began in 1997. The U.S. economy continued to grow in spite of the problems in Asia, and most investors did okay.

Short term, China’s problems are a significant issue. We can talk about whether the stock market needed a correction, but what has really happened is an acknowledgment globally that the Chinese economy is clearly weaker than we thought and that many emerging market economies will grow at a much slower rate because of the slowdown in China.

While unnerving to most investors, the recent market turmoil should serve to reinforce the importance of properly balanced portfolios. Be thankful that you have a portion of your money in bonds, which is going to tide you over until the stock market ultimately gets back on track.

Bob Landaas is president of Landaas & Company.

(initially posted Aug. 27, 2015)

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