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September 2 - Beware an Asian Contagion

You’ve probably seen the bad news regarding China’s flagging economy: slowing growth, devaluation of the currency, lackluster consumer demand, and a stock market in freefall despite (or because of?) government efforts to bolster its strength.

The recent turmoil in stock markets throughout the world has stemmed from events in China. Yet it’s important to cull through the various reactions to see which are probably long-term issues and which are probably short-term reactions (read as: overreactions).

Because China is the second largest economy in the world and such a substantial importer of raw materials, Asian markets and emerging markets around the world seem likely to be hard hit for the foreseeable future. Japan’s economy, for instance, is already contracting (0.4% last quarter) and other Asian economies that rely on exports to China are likewise in trouble. Emerging markets such as Brazil and Russia are already feeling the pain as oil and other natural resources are generating far less revenue.

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The U.S. economy is in better shape overall, but not in such solid shape as to make up for loss of demand from China. If you’re concerned about the U.S. stock market, other factors should be higher on your list of worries; for instance, a pending decision by the Federal Reserve to raise interest rates.

A strong dollar can mean an equity crisis in the making. As equities in emerging markets are slumping hard - down 22%-45% in places like Brazil, Russia, Indonesia, Turkey, Mexico, and South Korea - bond prices in the U.S. have risen nearly 9%. When the Fed raises interest rates, it is realistic to expect a sudden U.S. market contraction long in the making.

The Eurozone countries’ stock markets fluctuated greatly the last couple of weeks like their counterparts across the world. But compared to the negative impact of China’s slowdown on Asian and emerging markets, the fallout here seems to be less severe. The primary cause for concern in Europe continues to be almost non-existent growth (0.3% in the second quarter of this year following 0.4% in the first). Unemployment in countries like Spain is still sky-high despite slightly better growth, and the economies of France and Italy are actually getting worse. Unless the Eurozone countries decide to try a different path than the austerity route of the past few years, the problem seems unlikely to abate.

The question is how much Chinese economic problems will affect the rest of the world. When Asian, European, and American markets plummeted last week after China's market fell, that was a sign that the effect could be great. When China's market continued to spiral downward on August 25-26 and the other indices recovered nicely, that was a sign the effect could be mitigated.

The stakes are huge. The three-day global sell-off that followed China's market collapse totaled $3 billion in lost value.

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So ask yourself, Where is my money safe?

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References


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