Could the Great Fall of China cause the rest of the world to tumble?

On Monday the Chinese stock market plunged 8.5 per cent on a day that was quickly dubbed “The Great Fall of China” while the panic in global markets and ensuing sell-off of shares led to almost £75 billion being wiped off the value of the UK’s largest companies: the worst day for the London stock market since the depths of the Great Recession in 2009, and just four months after the FTSE hit an all-time high above 7100.

Although global stock markets largely recovered their losses over the following days, the downturn in the world’s second largest economy – which accounts for 15 per cent of the world economy and is the UK’s six largest export market – prompted Chancellor George Osborne to warn that the UK is “not immune” from the crisis, which he said was a “cause for real concern”.

While concern has been growing for months about China’s slowing economy and over-inflated stock market, the spark for the current market turmoil was a decision earlier this month by China’s central bank to devalue the currency for three days in a row – which quickly led other emerging market currencies in Indonesia, Malaysia, Brazil and Russia to follow suit.

Time to man the lifeboats? Not necessarily. Ironically, in the short-term the downturn in the Chinese economy could actually make UK consumers feel better off. The falling price of oil – which has more than halved from a peak of $115 a barrel last year to around $45 now partly because of slumping demand in China, the world’s largest importer of crude oil – could soon lead to a litre of petrol dropping below one pound.

The devaluation of the renminbi (or yuan) now makes it more expensive to buy fuel in China, so demand is set to fall further still piling yet more downward pressure on oil prices. Lower oil prices also lead to cheaper groceries as it costs less to transport goods to shops.

But, although a fall in the price of oil is good news for those filling up their cars on station forecourts it is bad news for Scotland’s oil sector, which has already shed thousands of jobs over the last year as oil companies put on hold or cancel projects.

Just last week North Sea operator Maersk Oil warned that up to 200 jobs are at risk as it plans to close production at the Janice floating production unit 150 miles south-east of Aberdeen.

Investment in other sectors of the UK economy is also set to drop, as the falling value of the renminbi makes overseas investments by China less attractive. Recent Chinese investments in the UK include the nuclear energy industry, the financial and property sectors and in the makers of Weetabix.

With Chinese investment in the UK’s infrastructure over the next ten years estimated, last year, at £100bn, jobs and growth could be threatened if any of that expected investment into the UK dries up.

Meanwhile anyone who invests in shares through an ISA or their pension will, following last week’s events, be a loser.

Guy Foster, head of research at investment management firm Brewin Dolphin warns that anyone with savings in a “tracker fund” – a so-called “passively” managed portfolio that mirrors the components of a market index such as the FTSE100 – is likely to have been hit by the Chinese downturn.

Those with actively managed investment portfolios will be less affected as fund managers are likely to have divested themselves of hard-hit energy and mining stocks.

“The long-term impact on pensions will depend on whether the market stays down or rebounds,” Foster says. “Certainly those approaching retirement will be impacted by the current extremely low annuity rates although those who have bought an annuity will be insulated.”

Foster also warns that because the prospect of an interest rate rise by the Bank of England has now receded, this will affect the income with anyone with cash savings, although borrowers will be glad to see low interest rates remain at their current record low levels.

“We have to be extremely cautious but there was clearly some irrationality in the market last week but it was not over nothing: it is a reflection of the fact that the world is increasingly uncertain,” he said.

Savers can, though, take heart from the fact that, over the long-term, stock market investments generally outperform the alternatives. During the 20th century, for example, global stock markets returned an average of 10.4% a year.

And, given time, stock markets have historically made up their losses. The US market crash of 1987 – when stocks fell by 23 per cent followed by a 25 per cent drop the following day – eventually led to a recovery, although it was not until eleven years later that shares had recouped their losses.

Andrew Milligan head of global strategy at Edinburgh-based Standard Life Investments told the Sunday Herald that fears of a “hard landing” for the Chinese economy are overstated.

“We are a long, long way from previous crises such as the 1997/98 crisis in Russia,” he said. “All the signs are that the world economy is doing reasonably well although there are worries about China.

“The events of the last week are unlikely to have an immediate effect on consumer spending in UK as people tend to change spending patterns based on their own financial positions, rather than because of something they have heard about in Shanghai.”

Milligan believes that if Chinese growth were to slow to 3-4 per cent a year that would be a cause for concern but so long as growth continues to hover around 5 or 6 per cent (still at least twice the level of growth in the UK and the US), China will continue to contribute the global growth.

“We have to remember that this is still a country in transition from a communist to a capitalist system,” he said.

“Our view is that the Chinese economy may slow further but that’s a long way from saying that it is going to be suffering a recession. We will probably never see 10 per cent growth rates again but even at 5 or 6 per cent China is still an impetus to the world economy.”

Milligan also points to the fact that, unlike central banks in the West, China has plenty of tools at its disposal if the situation were to worsen. These include cutting interest rates a lot further (Chinese interest rates are currently around 4 per cent); easing liquidity to allow banks to lend more and running a larger public sector deficit.

Richard Murphy, the tax expert recruited by Labour leadership contender Jeremy Corbyn to draft his economic policy, told the Sunday Herald that if the stock market jitters of the last couple of weeks were “not just a mispricing of Chinese stock market which is being corrected they might be an indication of something much deeper.”

“We face a great number of unknowns and uncertainty,” he said. “China appears to be reducing its demand for external goods and services. It might be having a financial crisis but at the moment we don’t know what the long-term consequences are going to be.”

Murphy contrasts the situation in China – where the government is trying to rebalance the economy away from manufacturing by encouraging more consumer spending and spending less on infrastructure investment – with the mirror image situation in the UK where “less consumption and more investment is needed”.

If the global economy continues to deteriorate this could lead to stagnating earnings in the UK and deflation taking hold of the economy, Murphy believes.

The expected reduction of Chinese money coming into UK economy will impact growth while lower oil prices will lead to a fall in government receipts. All of that, says Murphy, will make it harder than ever for the government to achieve its target of eliminating the national deficit by 2020.

“The road ahead is not nearly as smooth as George Osborne believes,” he said. “The likelihood of deflation has now moved from possible to more than likely. The government needs to step into the gaps that the private sector is not going to fill because of the economic uncertainty and we are going to have to think about more unconventional measures.”

By “unconventional measures” Murphy includes his proposal of “people’s quantitative easing” to stimulate the economy and boost employment by printing money to invest in infrastructure projects, such as new schools, hospitals and roads.

People’s QE is a central tenet of “Corbynomics” and differs from the QE undertaken by the Bank of England between 2009-12 when newly-created money was used to prop up the country’s collapsing banking system.

As for Scotland, Murphy believes that the Scottish Government needs to persuade Westminster to invest in infrastructure projects and green energy technology. “Scotland needs to create a new industrial base for the post oil-economy,” he said.

For the last three decades the economies of Western countries have been bolstered by – and during the financial crisis came to rely on – China’s breakneck growth. Even at 5 or 6 per cent today that still contributes more to world output than the 14.2 per cent growth recorded in 2007. But now that that expansion is slowing, countries around the world will increasingly have to find other innovative ways to grow their economies.