'Chinese Spillovers'

Paul Krugman:

Chinese Spillovers: China is clearly in economic trouble. But how worried should we be about spillovers from China’s woes to the rest of the world economy? I have in general been telling people “not very”, although it’s a bigger issue for Japan and Korea. But Citi’s Willem Buiter suggests that it could be a quite big deal, leading to a global recession. ... So could he be right?

Let me start with the case for not worrying too much, which comes down to the fact that China’s economy, while big, is still a small fraction of the global economy...

One possibility is ... that a Chinese slump could, via its impact on commodity prices, do a lot more harm to some other emerging markets than the above analysis suggests. I’m still working on this, although so far I don’t seem to be finding much there.

Another possibility is an international version of the financial accelerator. As Buiter points out, many emerging markets seem to be vulnerable thanks to private-sector foreign currency debt (which was so deadly in 1997-98). ...

Maybe, also, we could see some version of the financial contagion so obvious in the 1990s. Troubles in Brazil might make investors leery of other emerging markets, driving up interest spreads and forcing fiscal austerity that worsens the downturn. Or for matter, to the extent that the same hedge funds have been buying assets in a number of emerging nations, losses in one place could force them to liquidate assets elsewhere, causing a sort of global debt deflation. That was a popular story in the 1990s...

Overall, I’m not convinced of the Buiter thesis; China still seems to me not big enough to bring down the rest of the world. But I’m not rock-solid in that conviction, largely because we’ve seen so much contagion in the past. Stay tuned.