FXStreet (Delhi) – Elwin de Groot, Research Analyst at Rabobank, questions that is China going to be the next domino to fall and will it result in global financial contagion? Key Quotes “One of the lessons learned from past crises is that one ought to take the market seriously. Very seriously. From that viewpoint the start to the year is a screaming warning sign. Although we do not take the view that China is about to crash (it rather is shifting towards a lower growth path), regular readers should by now be familiar with the fact that we have been calling for a sharply weaker yuan for quite some time – on the basis that a crisis of confidence is leading to (net) capital outflows from China, which forces the authorities to intervene. A policy that will ultimately fail. The currency and trade channel is also the most obvious route through which negative sentiment is propagated to the rest of the world. A 1.5% decline in the EUR/USD hardly turns heads these days, but a 1.5% decline in the CNY spawns strong selling in global equity and EM FX currencies whilst plunging commodity prices stoke global deflation fears. One reason why the market is watching China so intensely is that all big economic regions have their own issues, so a weaker China means no spender of last resort. Beyond the above-mentioned channels of contagion, however, things are less clear-cut. US and European banks have only limited exposures to China (less than 4%) and so direct comparisons with either the US subprime or the European sovereign debt crisis fall short. But should the ‘core melt’ in China, global policy makers are likely to find themselves pretty much empty handed to respond. That itself is a sufficient reason to be concerned.” For more information, read our latest forex news.