Will China Slow Global Growth?
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Will China Slow Global Growth?
Or will the Fed reverse course to save the world economy? (no paywall)
Happy Labor Day with deepest thanks to our loyal subscribers and valued readers who make our work possible. To celebrate, we are sharing our August 19th Hale China Report with paywall removed. Our next report will be published this weekend.
China Beige Book’s survey released today supports our recent call that China’s economy has bottomed out, buttressed by a series of policy moves designed to stimulate the economy:
“Consumer spending bounced back in August after a tepid July, per @ChinaBeigeBook’s survey…All five categories—apparel, automotive, food, furniture and appliances and luxury—saw a marked increase in sales this month, versus July, the report said.” @shehzadhqazi - CNBC
(August 19, 2023) After a bad week in global markets widely attributed to a slowdown in China, it might seem contrarian to say that the negative take on China’s economy is overdone. I could be early making this call, but in my experience the difference between being too late and too early is approximately 15 minutes in China.
In January I wrote that China’s economy would not rebound as quickly as everyone thought. Now a persistent Chinese downturn with possible global contagion has become the mantra. So it was with a sense of relief that I saw pushback from Nick Lardy, the highly respected economist who follows China’s financial sector at the Peterson Institute for International Economics:
A new consensus has emerged among many economists, journalists, and other analysts regarding the current slowdown in the Chinese economy. Their contention is that China's stumbles in spring 2023 portend a far more serious long-term problem derived from flawed, insular, and Communist Party-controlled policymaking in response to COVID and its aftermath, with likely adverse consequences for the global economy.
That widely popular assessment is likely premature and, at least in part, perhaps simply wrong.
Lardy’s convincing reasoning is that we are interpreting the data using the wrong comparative timeframes, and that post-Covid he sees no evidence that China is entering an era of prolonged cyclical decline.
For example, nominal household savings are up, which is cited as evidence that there is a reluctance on the part of consumers to spend. But wages are also up compared to income during the lockdowns last year, so as a percentage of income, savings are actually slowing, not rising in China. This underlines the need to be very, very careful with data comparisons from 2020-2022. You can read the rest of his article “How Serious is China’s Economic Slowdown” here where he deals with demographics and all of the usual reasons people say we are past peak China.
US Contagion?
As we look forward to Jackson Hole Symposium next week, I am beginning to wonder if instead of China dampening the US and the world economy, that the transmission mechanism is actually running in the opposite direction, and that the Fed’s very rapid interest rate increases are the root cause of deceleration in China as well as the rest of the world. Japan has held on to its low rates, and posted a surprise 6% GDP increase.
Japan and China are the two major foreign holders of US debt, and marked to market they have must have lost money on holdings which have also been downgraded by credit agencies. Another US debt ceiling crisis is looming. Both the yuan and the yen are under pressure, although per Brad Setser at the CFR, the connection between currencies and US treasuries is not clear. However, higher interest rates on (strong) dollar-denominated debt in the rest of the world that ballooned during Covid is not stimulative to global growth under any economic theory I know.
While the consensus is that the US economy will have a soft landing, the Conference Board’s index of Leading Economic Indicators for the US has fallen for the past 16 months, which exactly mirrors this new era of Federal Reserve interest rate hikes.
“The US LEI—which tracks where the economy is heading—fell for the sixteenth consecutive month in July, signaling the outlook remains highly uncertain” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board…
The leading index continues to suggest that economic activity is likely to decelerate and descend into mild contraction in the months ahead. The Conference Board now forecasts a short and shallow recession in the Q4 2023 to Q1 2024 timespan - LEI for the US Fell Again in July, August 17, 2023
If this proves correct, the US will also weigh down global momentum.
China Contagion?
Regardless of the cause of China’s current economic weakness, the question is what the read-through will be to the global economy. Jonathan Cheng of the Wall Street Journal writes:
The risk for the global economy is that a prolonged spell of soggy demand in China holds back growth everywhere else. Already, U.S. companies have warned of disappointing sales in China and a gloomier outlook in what had long been a dependable market.
Although some prefer trade or the balance of payments as an indicator of global economic activity, let’s look at real GDP. Global GDP for 2022 was $100,562.01B, a 3.8% increase from 2021. As of spring this year, the IMF was predicting 3% growth for 2023, and that China will contribute about a third of that increase, far more than any other country- two times greater than India. China would thus would be responsible for about a one trillion dollar increase in global GDP. In the unlikely event that China did not increase its real GDP at all, and experienced zero growth, the global economy would still grow by 2% this year.
Of course, this scenario does not account for the knock-on effects of Chinese stagnation in other countries in its region, particularly since Asia overall is expected to add 70%. China falling somewhat short of its growth target does not seem like a real reason for markets to fall disproportionately. And any slack in Chinese production for example, could be taken up in Vietnam or Mexico. This applies whether you measure growth using GDP or trade.
What should China do?
To avoid any slowdown, many economists are wondering why China just doesn’t hand out stimulus money directly to consumers, following US policy. Here is why:
Americans have $700B in savings accounts and $7 trillion in 401k savings, totaling $7.7 trillion. On a per capita basis Americans have about $2000 in cash and $20,000 in non-liquid savings, while Chinese per capita have about $16K in cash savings accounts. When the US government handed out stimulus payments of $1400 that increased the average American’s savings by over 170%, which was impactful. Many were not working at the time, but in China there are no longer any Covid restrictions.
The wealth effect is what matters. The fall in the value of Chinese household investments in real estate, markets and investment vehicles is making Chinese consumers cautious. It is not lack of cash. Still, I think savings are also falling because of an increase in costs of critical services such as healthcare that are losing local government support.
What can the US do?
If the Conference Board and others are right, there is no reason to raise rates in September or going forward. At Jackson Hole, I wonder if the new governor of the PBOC will attend, and whether the other central bankers gathered in the shadow of the Grand Tetons will stage a verbal intervention and tell Jay Powell to stay neutral. Currencies around the world are softening rapidly, including the yen. If US monetary policy is a cause, and if it focuses solely on the US without regard to global consequences, I am afraid that we are in for a rough ride.
Post Beidaihe, a new direction for economic policy?
China’s economic success has been because of its people, many times in spite of its government. I am going to bet that growth will improve, especially in view of the many recent policy announcements supporting private enterprise and foreign investments by the State Council. I am especially heartened by the surprise July appointment of technocrat Pan Gongsheng. The new head of the PBoC is the right person for that job right now. Pan predicted the real estate bubble and headed off the currency crisis in 2016. In 2014 he said: “If citizens store their wealth by buying houses, it may cause the real estate bubble to burst or even cause an economic crisis.” Sadly, he was not wrong.
Quick takes on the week ahead:
Camp David Summit This weekend President Biden is meeting with the leaders of Japan and South Korea. China has already responded with an especially strong show of military force near Taiwan. Relations between the ROK and Japan are much more acrimonious than most realize due to the legacy of World War II. President Yoon, taking advantage of Korea’s imperial presidency, has tried to reverse this. To quote US ambassador to Japan, Chicago’s own Rahm Emanuel: “China’s entire strategy is based on the premise that the U.S.’s number one and number two ally in the region can’t get together and get on the same page." See also this twitter thread by EconVue expert Eleanor Hughes: https://twitter.com/elleshii/status/1692615995553169916?s=20
Visit of Commerce Secretary Gina Raimondo to Beijing: It is very difficult to both promote American exports and be the enforcer of special export restrictions aimed at China. She has a very difficult brief.
Xi Jinping to visit South Africa to attend the BRICS conference, where he will be the headliner. By mutual agreement with the host, Vladimir Putin will not be attending this year.