I just got to New York yesterday and have been meeting pretty continuously with friends and investors. Not surprisingly, everyone is very interested in hearing about what is going on in China. Last
time I was here, in July, a lot of people asked me about the
“decoupling” thesis, and not everyone was terrible pleased (or in
agreement) when I said I thought the idea was mostly nonsense, based
partly on mistaken premises and partly on wishful thinking
Now, it seems, no one takes the idea of decoupling seriously at all. Everyone is convinced that a sharp slowdown in the US will be disastrous for the rest of the world. This is one idea whose death seems to have come quick and hard. In fact, the most noticeable aspect of my trip here is the sheer gloom and worry about the state of the US and world economy. It has been a while since I have seen so much pessimism and nervousness.
Actually on this trip I found myself taking the unusual but not disagreeable role of downplaying some of the risks and terrors that lurked out there. The sub-prime crisis has certainly been tough, but the resilience of the US financial system has really been impressive during the many crises of the past three or four decades, and the transmission mechanism from financial crisis to economic contraction has, in some way, been sharply weakened in the US.
More
importantly, in my view, the long, globalization cycle we have been
through since the 1990s won’t truly end until we start to see a sharp
reduction in the combined US/Europe trade deficits if, as I believe, it
has largely been Asian and (more recently) OPEC recycling of their huge
current account surpluses that has underpinned the growth in underlying
global liquidity. I am not saying that this
can’t happen – it can and some point must – but so far this has not
happened at anywhere near enough of a scale to convince me that we’ve
reached the end. The main thing to watch, in my opinion, is inflation. If
there is a slowdown, however mild, that is accompanied by a sharp
increase in inflation, this could really spell the beginning of the end.
Talk of rising inflation and a slowing economy brings us straight back to the topic of China. Xinhua yesterday reported that the “U.S. slowdown could be opportunity, not crisis, for China.” They
report that a number of Chinese economists believe that a US slowdown,
by reducing the growth rate of exports, could help rebalance Chinese
growth, towards a healthier mix of investment, exports and consumption
and would help relieve monetary expansion.
To
their credit few Chinese have taken the decoupling thesis very
seriously, but if they expect a US slowdown to help resolve their
domestic problems I think they are missing the point. One
economist mentioned in the article, Zheng Jingping, a researcher with
the National Statistics Bureau, did get focus on the key issue when he
noted that “it was not export growth but the trade surplus that would
be the key issue”. This is exactly right. If
China’s exports decline, and Chinese imports decline also so keeping
the trade surplus high, China will get hit by a double whammy. The
reduction in exports will hurt economic growth but the high trade
surplus will keep China’s furious money expansion going, so continuing
to put upward pressure on investment and industrial production. The “rebalancing” would consist of an even greater share of investment as part of total GDP growth. This would be a worst-case outcome.
Could exports slow while causing a decline in imports? Yes, in fact it is highly likely. Remember that nearly half of Chinese exports are recycled imports, and any slowdown in the very important and lively export sector might indirectly affect Chinese overall consumption by increasing uncertainty. But even if there is a small decline in the trade surplus, that is not enough. In order to halt the money-creating monster that China’s currency regime has become, we need the trade surplus (and hot-money inflows) to decline substantially.
The
problem in China is excessive monetary expansion, caused by the lack of
a domestic monetary policy, and until that is resolved it is wishful
thinking to talk about a healthy rebalancing. Rapid
money growth will continue to fuel excess investment and industrial
production, until it comes to end either after a sharp increase in
unsold inventories forces companies to cut investment or after
persistent and rising inflation forces the government to clamp down
brutally on economic activity.
On
a slightly different topic, there has been a lot of recent downgrading
of expected growth rates for China (so much for decoupling). According
to the New York Times in an article about a recent World Bank report:
The bank said in a quarterly update that it now expected gross domestic product in China to expand at a 9.6 percent rate in 2008, which would be the slowest growth since 2002. In its previous report in September, just as the global credit crunch was intensifying, the bank projected 10.8 percent growth for 2008.
Revising 2008 growth down from 10.8% in September to 9.6% in January is a big jump, and I expect that number will be sharply revised upward or down again. One of the things I have tried to point out about China is that there is a lot of pro-cyclicality embedded into its capital structure, which means that external events, whether adverse or positive will have exaggerated impacts on domestic growth. In spite of a recent report by UBS claiming that the old boom-and-bust of China has given way to smoother change, I continue to think that economic growth is going to be extremely volatile.
This will be reflected in bank stock prices, by the way.
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This article has 2 comments:
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johnthebear
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256 Comments
Feb 10 02:43 PMTo me, that means that FXI returns to the $60-70 range in the coming months, a sharp drop from the current $140 level, and a lot lower than the $220 range enjoyed a few months ago. What goes up too quick, usually falls hard and fast.
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fjd10595
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39 Comments
Mar 14 08:19 AM