As China’s exports tumble for the fourth straight month and the yuan hits a 16-year low, will the country’s slowdown leave the US economy unscathed? Or will the contraction reverberate worldwide, a contagion heralding a lengthy recession?
Current thinking downplays China’s economic threats to the United States. Nobel Prize winner Paul Krugman, for example, asserts that “America has remarkably little financial or trade exposure to China’s problems”. Treasury Secretary Janet Yellen concurs.
This view stresses that US exports to China hardly equal 1 per cent of US gross domestic product. So far this year, Mexico and Canada have beaten China to become America’s biggest trading partners – trade is shifting away from China as supply sources diversify. Direct investment by Americans in mainland China and Hong Kong totals about US$215 billion with portfolio investment adding another US$300 billion – a sliver of US stock markets, valued at over US$46 trillion. Of the US$23 trillion in US banks assets, exposure to China amounts to roughly US$20 billion.
To determine how a slowdown in China could harm the US economy, the bank Wells Fargo simulated a “hard landing” where China’s economy grows annually by just 4.5 per cent over the next three years, having averaged 8.95 per cent since 1989. “Despite the severity of our simulated Chinese growth shock, the effects on real GDP growth in the United States, the Eurozone and Japan are rather modest,” it said. For the US economy, the impact was just 0.1 per cent off its inflation-adjusted growth in 2024 and 0.2 per cent in 2025.
A strong case? To the contrary, no.
Just consider how Apple stocks recently lost nearly US$200 billion of market value in two days after reports that China will ban iPhone use in government agencies and state-owned companies. The US$3 trillion company depends on China, its third largest market, for 18 per cent of its revenue.
An Apple Inc shop in Beijing on September 8. Photo: Bloomberg
The Apple example spotlights a key weakness in Krugman’s thesis: the vulnerabilities that China poses for the US economy come from critical interdependencies whose effect far exceeds the value of the goods or services involved.
Further, the interdependencies are concentrated in sectors with either the greatest growth opportunities or the largest roles in geostrategic ambitions, from national security to sustainable energy development.
Of the 10 S&P 500 companies most exposed to China, 80 per cent are in the information technology sector, eight of those in semiconductors. For some US chip makers, China can account for as much as 70 per cent of their revenue. The Biden administration’s sensitivity to the revenue that US companies derive from China underscores this point. One CEO reportedly questioned the need to build new plants in the US if sales in China shrivel up. This was why recent curbs on US investment were limited to a “small yard”.
When companies lose revenue from China, there’s a domino effect on equity markets. Investors demand higher premiums to risk their capital when returns look dismal. More costly capital hamstrings companies. That slows the economy.
Pharmaceuticals is another sector with lopsided vulnerabilities. The US imported US$6.95 billion worth of pharmaceuticals from China last year, up more than eightfold from US$820 million the year before. In one year, China’s share of US drug imports by value rose from 1 per cent to 9.6 per cent in 2022. Those imports meet critical shortages.
US dependence on China is particularly acute for active pharmaceutical ingredients (APIs), used to produce everything from antibiotics to cancer therapeutics. The US has imported, on average, about 17 per cent of its APIs from China, over the past 10 years.
Another critical dependency: rare earths. China processes 85 per cent of these ores into material that manufacturers can use. When China imposed export controls on gallium and germanium, key to semiconductor manufacturing, the move underscored the country’s near-monopoly position. “We remain entirely vulnerable to that leverage,” US Trade Representative Katherine Tai warned at a recent G20 business meeting.
Another is agriculture. Of US exports to China, about a fifth are agricultural products, including soybeans, by far America’s largest single export to China. While agriculture is one-twentieth of US GDP, the impact is far larger for local economies wholly dependent on farming. When farms have difficulties staying in business, the problem resonates in politics and contributes to fears of economic troubles.
These fears flow into the “risk sentiment channel”, which is probably the most significant means through which China’s woes spill over into the US economy, according to Federal Reserve economists. Krugman’s argument ignores this point. Risk appetites weaken during recessions or abrupt changes in trends anchoring prosperity. These worries feed into the general economy, creating an ever-declining spiral that pulls down equity values, undermines growth and cuts demand.
In a scenario developed in 2019 by eight Federal Reserve economists, if China’s growth falls by 4 percentage points, the global flight to safety would fuel a 7 per cent increase in the dollar’s value and cause equities to fall, with US GDP dropping by more than 1 percentage point. This year, the International Monetary Fund expects China to contribute to 34.9 per cent of global growth.
Finally, the “no worries about China” perspective doesn’t take into account the extent to which China is interwoven into the global economy and the phenomena of synchronicity, where events in one country’s economy – changes in the cost of credit, inflation and equity values – can reverberate rapidly worldwide. Coordinated actions by central banks add to the dynamic, as we’ve seen over the past year with interest rate raises to fight inflation.
History tells us a receding tide grounds all boats. Contrary to Krugman’s contention, the adage that when China sneezes, the world catches a cold, remains true.
James David Spellman, a graduate of Oxford University, is principal of Strategic Communications LLC, a consulting firm based in Washington, DC