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Why Fears of a China Slowdown Sank the Dow Today

By Travis Hoium - Mar 13, 2014 at 3:30PM

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The Dow Jones Industrial Average is down nearly 240 points today and the biggest reason is fear of a Chinese slowdown. Here's why China is important and why you should keep an eye on it long term.

It's amazing how fast the market can sell off on little more than fear, but that's the case today as the Dow Jones Industrial Average ( ^DJI 0.00% ) dropped 237 points in late trading. The New York Times reported that Russian forces are conducting new military operations near the Ukraine boarder, which brings up fear that conflict could erupt if a looming Crimean vote to leave Ukraine for Russia passes.  

But the bigger fear was out of China where data shows a slowdown in industrial output growth and property sales. Industrial output grew 8.6% in the first two months of the year, which was well below the 9.7% growth in December. Worse yet, property sales fell 3.7% in the period versus a 26.3% increase last year.  

In the short term, this can cause stocks to fall because China has been the growth leader coming into and out of the recession. But longer term, there's worry that massive lending to businesses with little ability to pay the money back will lead to asset bubbles and a collapse in China if easy monetary policy and stimulus continues too long. So a slowdown may be a good sign for long-term investors, especially if that means business coming back to the U.S.

Similarities to the U.S. housing crash
The bubble fear from investors isn't dissimilar to the U.S. housing crash that brought the global economy to its knees in 2008. Low interest rates and lax lending standards led people without the financial ability to afford homes to buy real estate, pushing up prices. When "flipping" homes became popular speculators piled in and prices soared even more. Since construction and the industries that supply it are huge job generators the economy boomed as the bubble grew.

When the economy slowed banks realized they were lending to people who couldn't make their mortgage payments; lending came to a halt, killing employment and initiating a downward spiral for the economy.

Many economists fear the same thing will happen in China, not only in real estate but also for the hundreds of billions in loans given to businesses that operate with razor thin margins. If China slows down and they experience waning demand or can't fully utilize equipment, the result could be bankruptcies, banks pulling back on lending, and a hard economic fall in China.

The hope is that China's new leadership will help slow economic growth without leading to a crash, in what's dubbed a soft landing. Then China's economy could grow at a more sustainable rate of 4%-8% instead of double-digits seen over most of the past decade.

With so much uncertainty as to how much China's economy will grow, and if or when a slowdown will take place, it doesn't take much to cause a sell-off -- the data that came out today was enough to do it. I think China is the single biggest risk to the global economy, and investors would be wise to not only watch what's going on there but also to limit exposure to potential problems. The U.S. economy isn't a growth engine, but it's much safer than investing in China, especially if there is a collapse.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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