China's economic woes may spread beyond its borders
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World financial markets are being roiled by the apparent bursting of the Chinese credit market bubble. This is understandable, since China is now the world's second-largest economy and, over the past decade, was its main engine of economic growth. However, in setting U.S. monetary policy, it would be a mistake for the Federal Reserve to premise its policy on the assumption that it is the Chinese economy alone that has a major debt problem. Both the emerging market economies and those in the European periphery have built up major debt vulnerabilities during the prolonged period of easy global money. This makes it all too likely that they too will be dangerously exposed to a sustained setback in the Chinese economic growth machine.

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The present sputtering of the Chinese economy and the bursting of its property and equity market bubbles should have come as no surprise to observers of that economy. Analysts had long been warning of the dangers of the excessive Chinese credit expansion that followed in the wake of the Chinese authorities' efforts to stimulate the Chinese economy following the 2008-2009 global economic recession. In particular, it was widely observed that China's domestic credit expansion between 2008 and 2014 exceeded 90 percent of its gross domestic product (GDP), which made it practically the fastest rate of credit expansion on record. This expansion was also approximately double the credit expansion that preceded both the U.S. housing market bust in 2008 and the Japanese property and equity market bust in 1989.

A major problem for the global economic outlook is that the bursting of the Chinese credit market bubble is all too likely to highly damage a number of other major emerging market economies like Brazil, Turkey and Russia, which until now have also been important sources of global economic growth. It will do so in part by depressing global commodity prices and by reducing export growth prospects for the many countries with which it trades. Equally importantly, it will do so by contributing to a steep decline in those countries' currencies, which will in turn increase the burden of those countries’ externally denominated debt. In that context, the Bank for International Settlements has for long been warning that a major risk to the global economy is that over the past six years the emerging market corporate sector has increased its U.S. dollar borrowing by more than $3 trillion.

An equally troubling aspect of a Chinese economic slowdown is that it is all too likely to again expose the debt problems of Europe's troubled economic periphery. For a start, a less settled global economic and financial environment is going to make it all the more difficult to resolve Greece's present political and economic crisis. More importantly yet, it runs the risk of having financial markets again focus on the unsustainable sovereign debt positions of a number of European economies. Far from reducing their debt burdens during the time of ample global liquidity, countries like Ireland, Italy and Portugal have all allowed their public debt to GDP ratios to rise above 125 percent. If past is prologue to the future, as global economic growth slows, this could be setting Europe up for yet another round of its sovereign debt crisis.

When the Federal Reserve Open Market Committee meets next week, one has to hope that it will give ample weight to global considerations in setting domestic interest rate policy. For it is all too likely that China's economic woes will continue to spread well beyond its borders and to expose the considerable debt vulnerabilities of both the emerging market economies and those in the European economic periphery. At the very least, those considerations should dissuade the Federal Reserve from any early start to an interest rate hiking cycle at such a delicate stage for the global economy.

Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.