Feature Stories | Sep 27 2010
(This story was originally published on 15 September, 2010. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere).
By Greg Peel
Next year, noted former UK prime minister Tony Blair in a conversation with CNBC's Maria Bartiromo this week, China's population will grow by that of Great Britain. Blair's eyes boggled at the thought.
At home at the moment, Blair continued, there is a heated debate underway as to whether another runway should be built at Heath Row. The pros and cons are being assessed – the noise, the environmental impact, the cost, the additional revenue. China is currently building seventy new international airports across the country, he added, again shaking his head in disbelief at the contrast. And there will be more engineering students graduating in India this year than there are working British engineers.
Such stories are merely further evidence of the Shift From West To East. But still the inevitability of this shift is yet to sink home in the West. One reason is that there remains a pervading assumption that the US is The Great Consumer. The US economy is still by far the world's largest on an individual basis, and the consumer represents 75% of that economy. Asian economies are export economies, the West believes, and thus beholden to Western consumption. Hence where goes the West, goes the East.
The GFC proved this longstanding dichotomy to be correct, for all of about five minutes. The resultant collapse in Western consumption immediately affected a collapse in China's dominant export sector. Germany – still the world's biggest exporter – suffered a similar fate. But Beijing jumped on the case very quickly and threw massive fiscal and monetary stimulus at its domestic economy. The West did the same, but the West was trying to provide CPR to an existing consumer base now stricken with excess debt in an attempt to stem an ebbing tide. China, on the other hand, was trying to create its first real domestic economy by turning longstanding savers into first time spenders – some 1.3 billion of them – to induce the first flowing tide.
From September 2008 to June 2010, the real consumption growth, seasonally adjusted, of the US, the EU and Japan (the G3) has remained almost perfectly flat, note the economists at DBS. In the same period, China's consumption has grown by 18%. The world had long been assuming an “industrialisation and urbanisation” rush in China, but had also assumed it would take some time before China's domestic consumption could grow to be a global economic force in its own right.
Well now it is. The irony is that many economists had assumed before September 2008 that China would carry the world through what was then only a “credit crisis” impacting on Western consumption. They were proven to be very wrong at first – from about September 2008 to January 2009 – but have actually proven to be correct two years later. The Chinese economy may still be well behind that of the US by size of GDP, but it is catching up at a remarkable clip. And that's just China.
By rights, Germany should, too, have been in all sorts of trouble without US and EU consumption. Yet despite the European sovereign debt crisis of 2010, Germany's export sector boomed through the second quarter of 2010. It had a little help from a weaker euro, but the driving factor was the large proportion of exports which headed not to the US, but to Asia.
So effective has stimulus been in China that Beijing has been forced to now tighten policy and slow the pace of economic growth. With stimulus now run its course in the West, it has become apparent that the G3 economies have enjoyed no more than a misleading honeymoon of recovery. Austerity measures are in place in Europe and sovereign debt fears linger. A rising yen is crippling Japan's export industry. And the US economy is threatening to double dip.
Stock markets are supposed to be leading economic indicators. Stock markets are currently failing as any reliable source of indicator because investor interest has reached very low levels. For the past six months, stock indices have done nothing but rush backwards and forwards in sharp moves with every little new piece of positive or negative economic data, yet they have ultimately gone nowhere. The stock market is not telling us anything much more than nobody knows what's going to happen next.
In the past week, economists from various houses have been updating their latest views on the Global Economic Outlook. This report summarises the views suggested by Macquarie Group, Westpac, DBS, Danske Bank and Credit Agricole.
There has been much talk of late about a double-dip in the US economy. In theory, a double-dip implies that having enjoyed three consecutive quarters of positive GDP post the GFC recession, the US is now facing at least two in which growth will again be negative. In reality, it's all just a case of semantics. Those three positive quarters were successively less positive and the US housing and unemployment problems have not been resolved. Whether or not GDP growth actually turns negative again is rather by-the-by. But for the sake of the argument, economists generally put the chance of a US double-dip at less than 50%.
But what positive growth there will be will be modest and choppy over the next twelve months.
In fact, this view is no different to the view the bulk of economists had last year. While stock indices surprised many in rushing up in 2009 and surprised again by faltering in mid-2010, the script is actually playing out as expected. That script always assumed short but sweet fiscal and monetary stimulus and a rapid inventory rebuild from the depths of GFC de-stocking, which would affect strong GDP growth in the near term before fading out in the medium term. Smooth out the cycle and all we have is a long and difficult road out of a devastating recession. Almost text book stuff.
“We have expected a global slowdown in growth during the second half of 2010 for some time,” note the economists at Danske Bank. “This is because the strong tailwinds during 2009 and early 2010 were bound to fade and new headwinds appear”.
Danske notes that the US recovery to date had been driven by inventories and investment but these have only benefited the manufacturing sector. Private consumption has experienced the worst post-recession recovery since World War II. And many of the tailwinds of 2009-10 have now become headwinds for 2010-11. Housing stimulus has only served to front-load otherwise typical demand, stealing from the future to stimulate the present. The same can be said of “cash for clunkers” across the globe. Everyone who wanted a new car rushed in and bought one. Now nobody needs one, at least for a while. A black hole of end-demand was always likely to appear.
Emerging market tailwinds have also become headwinds to some extent. The world is in a panic that having stimulated China's economy so effectively, Beijing will now bring it in for a hard landing in a desperate attempt to control inflation, at risk to the entire global economy. But recent data suggest China is coming in only for a soft landing, and also that perhaps the US won't double dip.
But then respected houses such as Blackrock and Goldman Sachs are working on the assumption that the Fed will be forced to re-implement quantitative easing because, either way, the US economy will need it. As for China, well, Beijing is likely just as confused as everyone else, and as a result has been pushing and pulling the policy levers as required by each new set of figures. Beijing started slowing its runaway growth in early 2010, had to reassess when Europe looked like going under, relaxed when it didn't, but is now faced with a “will it, won't it?” dilemma on a US double dip.
What we do have, therefore, is two sets of policymakers on either side of the globe ready to act as necessary to achieve a desired result. And those actions will be inverse. If the US economy does deteriorate dramatically in the second half of 2010 and deflation threatens then we know the Fed stands ready to implement QE2 to support the economy, notwithstanding whatever the US government might do as well. If the Chinese economy does appear to be picking up speed again, as the latest set of data suggests, then Beijing will act quickly to tighten policy and head off inflation.
Beijing will not be as quick to act if the US is heading down the gurgler, or if Europe blows up again.
So what we will quite possibly end up with, and indeed economists are mostly suggesting what we will likely end up with, is a somewhat ironic imbalance of the West desperately trying to ease monetary policy to prevent deflation while the East desperately tires to tighten monetary policy to prevent inflation. The next twelve months will see anaemic growth, if not contraction, in the US before stimulus will help things to improve by the second half of 2011. Most economists do not expect any change to the Fed's cash rate before late 2011. Asian economies will face a modest, but not destructive slowdown in domestic demand in the near term before authorities are forced to jump back into tightening when the Fed starts to ease.
Still hanging over all of this is Europe. Quite simply, were sovereign debt problems to resurface again then Beijing would delay further tightening measures and the Fed would likely jump into action immediately. If Europe sails through and the risk of debt restructuring gradually fades then austerity measures can also begin to be wound back, likely prompting the need for Asia to tighten the screws again.
All up, the West will be reluctant to let go of its supposed hegemony while the East will be wary of racing towards hegemony too quickly. Everyone still needs each other at this point, and little will come from upsetting the applecart. Economists generally agree that while there are still obvious risks engulfing the global economy, the most likely outcome is a slow FY11 (using the Australian financial year) before a more sustainable recovery in FY12.
The problem from a stock market perspective is that a year is a long time to wait.