August 13, 2008 | posted by Michael Baxter in China, US economy | comments (0) |

The last 24 hours have seen a number of important developments. Developments with the US, Japan, China and in Europe: developments with sterling – which has fallen to its lowest level against the dollar since the end of 2006, and the continuous fall in the price of oil and other commodities. It seems possible that as the credit crunch passes its first birthday, we are seeing stage two in this saga unfold; maybe the world is re-aligning.

It all started with China. Emerging economies are supposed to grow through borrowing. That’s how it has always been. It happened with the US in the late 19th century, it happened with Japan and it happened with the Tiger economies of Asia in the 1990s. But with China it was different. Not only has China enjoyed an extraordinary period of double-digit growth, it has done so while amassing huge foreign exchange reserves – it has done so while its citizens save at a rate far in excess of the saving ratios in the most frugal of developed economies, and rather than expanding by borrowing from abroad, China has lent money to foreigners so that they could then buy its products.

And many of the world’s developed countries obliged, the US and UK especially. As a result, debt grew and grew in some countries while spare savings just ballooned in China and oil-producing states.

Maybe that is why we really have a credit crunch today. Anglo Saxon borrowings were no more sustainable than third world borrowing in previous decades. So it was clear that countries such as the UK and US had to cut back, rein in their spending. In an ideal world, consumers would have stopped their borrowing of their own volition, but unfortunately it has taken a credit crunch instead. And that has been the story of the last year, the credit crunch has really been a manifestation of something many thought was inevitable anyway, a change in the way the UK and US did things.

Yesterday saw the latest in a long line of evidence to suggest the US is changing. In June US exports rose by a massive 4 per cent on the previous month, while non oil imports dropped by 1.4 per cent in June. The falling dollar has inevitably ceded an advantage to US exporters – while US consumers are buying less from abroad.

As the recent tax credit handed out to US householders slowly trickles out of the system, expect even bigger falls in US imports in future months.

Yet while the US consumer cuts back, the Chinese consumer at last goes out and spends. July saw the fastest rate of expansion in Chinese retailer sales in nine years, with sales up a stunning 23.3 per cent. At the same time, data revealed urban disposable income increased by 14.4 per cent in the first half of this year, and that is after allowing for inflation. Meanwhile, there has been good news on Chinese inflation, which fell to 6.3 per cent in July, the lowest level since September last year.

And so it appears China is at last placing more emphasis on its consumer. It has to, there is no gas left in the US tank, it can no longer expand though importing to countries which are getting further and further into debt.

This is how it is supposed to be; it is called decoupling, that’s the idea that the world is no longer over-reliant on the US.

Yet a dark cloud is on China’s horizon.

A number of commentators have drawn comparisons with the current Olympics and the Olympics in Seoul 20 years ago, and Mexico 40 years ago. In both those earlier examples the economies had been through a dramatic growth spurt – but both economies then saw a sharp slowdown when the Olympics ended.

The Olympics are of course hugely expensive – and there are plenty of examples of economies struggling for years while the bill for hosting the games is paid. But for developing economies, this is especially expensive.

For China, there has been the added cost of closing down factories in Beijing during the Olympic fortnight.

But then again, the Chinese government has plenty of money – it can afford the games. The closure of factories for two weeks may not, in the scheme of things, prove that disastrous – maybe Chinese workers need a holiday – we all feel better and newly rejuvenated after a break, after all.

It also seems we often attach too much importance to apparent patterns. Just because Korea and Mexico experienced a severe economic slowdown after the Olympics it does not mean China will. Any scientific test based on a sample of two would be considered totally meaningless. Yet, just because two developing economies suffered after the Olympics we are expected to believe this proves it will always be like this.

And yet, can China really change the way it grows? Just about every major corporation in the world that is in a position to invest in China has already done so. It is clear that the economic model that has served China so well for the last few years is no longer tenable.

The model needs to change – and there is no guarantee this new approach, an un-tested model focused on Chinese consumers, can work.

So, China needs to change gradually. Gradual change from an economy reliant on overseas consumers to one reliant on domestic markets – and in the meantime it still needs overseas trade.

The rest of the world, of course, needs Chinese consumers. We all need to sell more goods to China.

And yet, while oil has fallen in price, it is still clearly too high. At current prices, trade is expensive. We keep hearing that now is the time to buy locally. They say it is because the cost of food is too expensive, so we need local produce. But this argument has no economic foundations to it at all. Since when has the solution to higher prices been less trade?

The real reason why there is a rise in the supply of products to local markets from indigenous producers has been the high cost of fuel. This is likely to exert even bigger problems as time goes on, and will present a massive problem to China over the next few years.

So, the US and UK slow, and the call goes out for more exports from the countries where consumers have run out of breath.

That is the real reason why the dollar has been falling. It is the real reason for falling sterling too.

But then, the last few weeks have seen evidence that the rest of the world really can’t afford to see US consumers spend less while the impact of the high price of oil is really being felt.

And then yesterday and this morning news broke that two of the world’s largest economies, economies Americans and Brits are supposed to be selling to, could be going off the rails. To find out more, read the next article.

August 1, 2008 | posted by Michael Baxter in China, US economy | comments (0) |

The US economy contracted in the last quarter of last year. Then again it expanded at an annualised rate of 1.8 per cent in the quarter just gone.

So, that means the economy went within a whisker of recession. Yet 2008, the year that was supposed to have been much worse, has seen a better performance, so far. But the key thing is this. How much of this 2008 comeback is sustainable? Is the spectre of US recession banished altogether – or has it just been put back a couple of quarters?

Meanwhile, the first news broke this morning to suggest China is finally feeling the cost of the US slowdown. But how serious is that? Will China in turn pass its pain back to the US, leading to further problems down the line, which will eventually impact upon the UK? Read on.

One of the problems with official statistics is that the bodies that complete them keep changing their mind. Figures for the final quarter of 2007 were first revealed six months ago, and at the time they suggested the US was still expanding – only just, it is true – but still expanding nonetheless.

Now we hear that actually the US contracted at an annualised rate of 0.2 per cent. Now a recession is defined as two quarters of negative growth – so actually this means the US got halfway towards a recession.

But then Q1 saw a mild pick up, annualised growth was 0.9 per cent. But the real fireworks went off in the quarter just finished, for in that three-month period the US expanded at an annualised rate of 1.9 per cent. At least that’s what the data says now. Who knows what the official data will say in six months’ time. It is easy to be cynical about this, and say that if this data is subject to such revisions why bother considering it. Well, all we can say to that is that it’s the only data we have got. So we are all just going to have to make do.

This is the snag with official data. One doesn’t know for sure whether there has been a recession during a certain period for some time after the event – and when the definitive data finally exists, it is virtually irrelevant.

Then again – it is just words. What difference does it really make to the things that matter whether the US expanded by 0.1 per cent, or contracted by 0.1 per cent. These things are really little more than guidelines, giving us clues as to what is going on.

So, working on the clue that is the latest official data, it appears there are three important things to consider. So listen up, “my dear Watson,” it is time to examine the evidence, step by logical step.

A jump in GDP of 1. 9 per cent, given all this doom and gloom doing the rounds at the moment, may seem quite impressive. But actually, economists had expected better. So item number one: markets were actually disappointed by the data.

Item number two is that massive tax credit dished out by the US government earlier this year. That helped, we all expected it to help, but the US government can’t keep giving money back – the question mark has to relate to what will happen when the tax credit has been spent.

Item number three is a large surge in US exports. Some commentators say that if it wasn’t for this jump in exports, the figures would have been a lot worse. But that, quite frankly, is a silly comment. This is what was supposed to happen. The US is supposed to be exporting its way out of trouble. US consumers are far too much in debt for the US to expand through domestic spending. Drill through it all, and it’s the high levels of US consumer debt which lie behind the credit crunch. And many have been arguing for some time that the United States’ only hope was exports, facilitated by a falling dollar.

But you might at this point say something like, “But Holmes, what of the future?”

And in working out what might happen next, three more pieces of evidence emerge under the magnifying glass.

As the benefits of the tax rebate whittle away, one assumes growth will slow again. Many forecasters are saying 2009 will see another wobble. So pity the next US president, he may have to grapple with recession even as his removal van parks outside the White House.

But, here is a ray of sunshine. US growth in the second quarter was hit by a large decline in inventories. One assumes that once investors have ebbed away, US producers will have to go out and produce more. Changes in inventory levels can be a key factor in determining economic cycles. The inventory of US houses for sale is high, which is why no recovery in that sector is expected soon. But if US inventories across the board have fallen, expect re-ordering soon.

But, then, one more piece of evidence shows up under the magnifying glass, and this time is more of a worry.

This morning it was revealed that the Purchasing Managers Index for Chinese manufacturing fell below the critical no change level in July. One bad month doesn’t spell curtains for Chinese manufacturing, but it’s the first time this index has fallen below the 50 no change score ever – although it is worth pointing out at this stage that data only goes back three years or so.

Why is Chinese manufacturing feeling the heat? Two reasons have been given. Firstly, it is suffering because the US is suffering. US imports have fallen – not surprisingly, therefore China is losing out. Ultimately, the effect of a US and European slowdown on China will be critical in determining the recovery. The world is supposed to be less reliant on the US these days. Given the appalling mess the US economy is in, we had better hope that is right.  So, how the Chinese economy is affected by Uncle Sam’s problems will perhaps be the single most important factor to watch.

If China responds to this through trying to curb US imports, and promote Chinese exports through subsidies and through taking steps to stop the rise in the yuan, then the consequences could be serious for the US, and then the rest of the world, as countries with large deficits on their current account find it harder to trade out of difficulty.

But another reason has been put forward to explain the fall in the Chinese manufacturing index – the Olympics. Many factories in Beijing have shut up shop for the duration of the Chinese show.

So, Holmes and Watson must reluctantly conclude they need more evidence. So let’s watch the next couple of months to see how this story unfolds.