What Does The Chinese Fallout Mean For Apple?

This morning, Apple (NASDAQ:AAPL) suffered from a stark drop when the stock market opened. Its shares tanked 10 percent to $95.17 compared to Friday’s closing price. Shortly after, Apple bounced back. As of this writing, Apple is back to $105.48 down only 0.2 percent compared to Friday’s closing price.

It’s an incredible recovery, but it doesn’t mean that the Chinese fallout won’t affect Apple eventually. Now that China is more important than Europe for Apple, the company needs to pay attention to some long term risks.

But first, let’s recap what’s happening in China. The Chinese government has been lying about its growth numbers for years. Every year, the Government sets a target for the GDP. And miraculously, at the end of every year, the Government reports that it managed to beat its GDP target with an impressive growth rate of 7 to 10 percent. Economic growth is too important for the Chinese Government to rely on statisticians.

Traders in New York know that, the IMF knows that, the Fed knows that, everybody knows that. And that’s exactly why stock markets already freaked out after the three-day devaluation of the yuan a couple of weeks ago. We don’t know exactly how well China is doing. Every little sign that says that the Chinese economy isn’t doing as well as expected leads to big market movements.

So is there any way to know China’s actual economic growth? You can look at steel production numbers for example. As China needs to import most of its iron to produce steel, it can’t lie on these numbers. Steel production has been down 1.3 percent since January. Electricity production is another good indicator. It was up 7.7 percent in 2013, meaning that the country was producing more goods. It’s been up only 1 percent since January 2015.

And yet, growth is key to China’s current situation. When China became a socialist market economy, the population and the Government sealed a tacit agreement. As long as the standard of living would improve, people wouldn’t interfere with the Government. And it has worked incredibly well so far thanks to low salaries, a huge domestic market and some very smart moves to attract foreign companies.

But China’s real growth rate is way below 7 percent. Unemployment combined with an aging population is going to become a serious issue as there is no safety net. We are not there yet, but if the standard of living decreases in China, it could mark the beginning of an important transition period.

First, if China doesn’t manage to stop the current economic slowdown, iPhone sales could drop in China. As unemployment grows, people who still have a job would have to give a bigger part of their pay to their families (again, no safety net in China). Buying an iPhone over a Xiaomi or Huawei phone would become a waste.

Second, workers could ask for a minimum wage, better contracts, etc. This could hurt tech companies producing in China, drastically increasing production costs, starting with Apple. Third, China could devalue its currency even further in order to boost exports. While it would help Chinese companies, U.S.-based companies still report their earnings in USD. It means that Apple would have to sell cheaper iPhones, or make the iPhone more expensive in China compared to other Chinese phones. It would be a serious dilemma as there’s no right answer.

There are many other potential options. The government could decide to heavily tax or ban iPhones to help Chinese makers. A big political crisis could slow down the economy for years.

Of course these are all long term issues as China is still growing. But there have been many concerns over the past few years about a potential meltdown. Today is a sign that we might be closer to a flat growth rate in China than expected. As Apple CEO Tim Cook noted in an email sent to Jim Cramer, Apple is still growing in China. But growing in a grim market is a lot more difficult, and that will be Apple’s next challenge.