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Ira Kalish, chief global economist for Deloitte Touche Tohmatsu Limited (Deloitte Global), sheds light on China’s economic growing pains and their impact on the U.S. and global economies.

A powerhouse for economic growth during the early 2000s, China has been showing signs of deceleration since 2010. The slowdown across China’s retail, manufacturing, and construction sectors is having a ripple effect on the global economy, and U.S. business leaders and investors are on alert.

During a recent webcast, Dr. Ira Kalish, chief economist for Deloitte Global, discussed the impact of China’s growing pains on its trading partners. He also explained the problems caused by China’s shadow banking system and commented on the environment for business investment in the U.S. Kalish spoke with Deloitte LLP Deputy CEO Tom McGee during the webcast.

The bottom line: While the Chinese economy may be slowing, the U.S. outlook appears brighter and, for perhaps the first time in years, clearer (at least for the foreseeable future).

McGee: How did China’s shadow banking system come about?

Kalish: In China, the banking system is largely state run. The Chinese government establishes the interest rates that banks can pay to depositors, which effectively puts a cap on the amount of lending that takes place. As a result, state-run banks can’t satisfy the country’s huge demand for loans. They’ve gotten around this supply-and-demand issue by funding a shadow banking system. Specifically, the big banks have securitized their loans into “wealth management products,” which they sell to wealthy individuals who get a fairly high return. The banks then put the cash they earn from their wealth management products into off-balance sheet trust companies that, in turn, lend money at relatively high interest rates.

Why has China’s shadow banking system become problematic?

It has caused the supply of credit to balloon in China. Normally, an acceleration of credit leads to economic growth if money is invested well, but that’s not currently the case in China, where credit has expanded dramatically while economic growth has slowed. One problem is that credit has gone to loans that don’t make much economic sense. For example, local governments are borrowing money to build infrastructure, and it’s not clear they’ll be able to pay back a lot of those loans. Another example: Investors are borrowing money to build shopping centers and apartment complexes for which there is little demand. These conditions are likely to set up China for future financial problems. I don’t think it will be a Lehman-style crisis because the Chinese government is unlikely to allow one of the big banks to fail. The government will have to bail out these institutions, and they’ll have to force a cutback in lending. As credit creation diminishes and investment falls in China, economic growth will decline and it could decline quite a bit.

What impact might a substantial slowdown in China have on the global economy?

China’s economic growth has dropped from a high of 14.2 percent in 2007 to about 7.5 percent today. That decline has already had an impact globally, especially in other Asian countries such as South Korea, Taiwan, and Singapore that export a lot of goods to China. It’s also had an impact on commodity-producing countries like Brazil and Australia. Even though the U.S. is a big trading partner with China, the impact of its slowdown on the U.S. economy has so far been modest.

The Chinese government would like to maintain a 7.5 percent growth rate, which would be better for the global economy. If China’s growth were to fall below 7 percent—to, say, 4 or 5 percent—that would be problematic, both for economic and social stability in China and for the U.S. and global economies.

Do you expect U.S. business investment and M&A activity to pick up this year?

Growth of business investment has returned to a historically normal level, and we ought to see a continued increase in the M&A transaction environment. Banks are in much better shape and, therefore, are more willing to extend credit, especially to smaller and midsize businesses. Also, much of the uncertainty that led many companies to continue hoarding cash after the recession has diminished. Congress in February agreed to raise the nation’s borrowing limit, so businesses don’t have to worry about serious fiscal policy disagreements throwing off their capital spending and hiring plans for the year. And while some economic indicators were off at the beginning of 2014, likely due to the bad weather, we have seen improvements in consumer cash flow and the housing market. As a result, I expect to see an uptick in the pace of investment, as well as in the number of M&A transactions. I think there could be disproportionate growth in the most innovative industries, such as information technology and life sciences.

Was hoarding cash a wise strategy for weathering the recession?

Deloitte U.K., a member firm of Deloitte Global, did a study looking at companies that sat on their cash vs. those that invested. They found that companies that strategically deployed their cash experienced much higher returns on their investments, as well as faster profit and revenue growth. Those companies that held onto their cash are beginning to recognize the value of deploying it. That’s another reason I expect U.S. business investment to increase this year.