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Evan Horowitz | Quick Study

Will the stock crash in China take down the US economy?

China’s stock market is crashing, and it’s pulling down markets all around the world.

Twice this week, stock prices in China fell so far that trading was actually shut down. And the effects have spread quickly; US and European stocks opened lower Thursday, and with the price of oil and other commodities continuing to slide, there’s concern about a full-on global crisis.

The basic problem is that the Chinese economy isn’t what it used to be. Gone are the double-digit growth rates of the last few decades, and with them the hope that China could smoothly transition from a developing country to a mature global economy, with a smaller role for the state and a larger one for consumers.


Whether the United States and the rest of the world can weather a Chinese slowdown without falling back into recession is unclear, but the risk seems to be climbing.

What’s happening in China?

For decades now, economic growth in China has been fiery, often reaching rates above 10 percent. But those heady days of consistent, high-octane growth seem to be over.

In 2015, China’s growth rate hovered around 7 percent, and recent figures from the all-important manufacturing sector suggest that things aren’t about to return to the highs. In fact, things may be even worse than the official numbers suggest; a recent independent analysis found that the true unemployment rate in China may be nearly three times the official rate.

To help bolster the economy, the Chinese government has been letting the value of its currency fall. That’s good for exporters, because it means their goods will suddenly be less expensive in overseas shops.

But it’s a troubling sign for investors, because China was supposed to be moving past the export-first phase of its development and becoming real consumer market, where companies from around the world could sell their goods to a growing Chinese middle class.


Why has this affected global stock prices?

It’s important not to exaggerate the connection between market fluctuations and the real economy. There’s a lot of unpredictability in market movements, and it’s often impossible to tease out the deeper forces.

But the slowdown in China could be feeding broader troubles.

Start with the effects inside of China. The most basic reason stock prices fall is because investors start to think — or fear — that companies are going to perform worse than previously anticipated. So if the Chinese economy is really slowing, that would mean tighter profits for Chinese companies, and smaller returns for stockholders.

As to why a floundering China should prompt sell-offs all around the world, the answer is a little more involved. Some countries have such deep ties with China that they can’t avoid being dragged down by a Chinese recession. Regional trading partners, like Japan, Korea, and Australia, will have the most trouble. But some farther-flung countries, like Brazil, have built huge industries focused on selling commodities and raw materials to China, industries which now seem endangered.

For the United States, however, it’s not clear that a Chinese slowdown will be all that traumatic. True, there are US companies that will have to rethink plans to market to a no-longer-thriving Chinese middle class. But if troubles in China bring lower-cost imports and ever-cheaper gasoline, that could help offset the damage.


Then again, there are economists who worry that a recession in China could trigger a global recession. For instance, if the already-strong dollar is forced up even further, that could widen the trade gap in a way that dampens US job creation and keeps wages from growing.

Why did the Chinese stock market shut down?

Just this week, China implemented a new system of “circuit breakers,” which are designed to prevent panic selling and block downward momentum from getting out of control.

It’s not an unusual practice. Similar triggers exist here in the United States. But the Chinese version was set to kick in much faster, forcing a pause in trading when stocks fall 5 percent and shutting down the market entirely when they drop by 7 percent.

It was a bad sign that the 7 percent shutdown got tripped on the first day, and worse that it happened again 29 minutes into the fourth day.

Following that debacle, the Chinese government has decided to suspend the circuit breakers.

What should I watch for in the days ahead?

The first thing to look for is any gap between US markets and their Chinese counterparts. If Chinese stocks continue down, but US and European shares stabilize, that could be a sign that contagion is likely to be limited.

And moving forward, listen closely to the Federal Reserve. At its last meeting, in December, the Fed raised interest rates for the first time in nearly a decade because the board of governors thought the economy might start growing too fast.


If the situation in China continues to deteriorate, the Fed might be forced to put off any future hikes, or even reverse course. The next Federal Reserve meeting is scheduled for the end of January, providing a first official occasion to assess whether the slowdown in China, combined with the recent rate hike, is shifting the US economy into reverse.

Evan Horowitz digs through data to find information that illuminates the policy issues facing Massachusetts and the United States. He can be reached at evan.horowitz@globe.com. Follow him on Twitter @GlobeHorowitz.

Correction: This story has been updated to correct date references.