By John Richardson
HISTORIANS will end up concluding that falling emerging market currencies and stock markets – the prelude to what could be a full-blown crisis – is really about China and not about the US Federal Reserve. The Fed is just a sideshow to the main event of what is going to drive not just emerging markets, but also the global economy, over the next few years.
Why? Because China has spent far more on stimulating its economy since 2009 than the Fed – in fact, crunching the data a little further, when you add shadow lending, it has raised total credit from $1 trillion in that year to $10 trillion in 2013. This compares with Fed spending since 2009 of $2 trillion on Treasury Bonds and $1.5 trillion on Mortgage Bonds.
The blog’s colleague, Paul Hodges, in a new Research Note, provides a detailed description of why the when has become the now. Major economic reform is underway in China, involving a drawdown in this credit. What does this mean for the global economy?
Paul, in the Research Note, reaches seven conclusions, which we entirely we agree with. They are:
- Domino effect. The destabilising of emerging economies in a wide arc from Argentina through India and Indonesia to Turkey.
- Double-digit growth. The leadership have already made clear they intend to bulldoze polluting factories, and to devote major resource to cleaning up the one-sixth of China’s farmland currently contaminated with toxic waste. Therefore the days of double-digit economic growth are unlikely to ever return.
- Deflation. Premier Li confirmed in October that maintaining employment was his key priority. China’s producer price index has already been negative for 22 months, and it seems likely that exports will be a key focus for policy during the transition. This will export deflation – as volume rather than profit will be the priority.
- Export demand. China’s main export focus will no longer be the cheap textiles and plastic products of the past. Instead it will create jobs via an aggressive drive to sell affordable cars, smartphones and relatively high-value chemicals into emerging and Western markets, based on the major new capacity installed in recent years.
- Dollar strength. China’s economic crisis will come as a shock to most of the financial community, as did the US subprime crisis. We can therefore expect China’s currency to begin to fall in value, and the US$ to rise, all other things being equal. This, of course, will also help to boost China’s exports.
- Domestic demand. The focus of China’s domestic demand will change. Sales of high-end western luxury goods will continue to decline as the anti-corruption campaigns continue. Instead, the focus will be on affordable necessities such as $50 refrigerators for the 90% of the population who earn less than $20/day.
- Debt. China’s record $1.3tn holding of US debt was built up as a form of vendor finance, to support US purchases of China’s products. But this strategy is no longer relevant, so we may well see China slowly reduce its holdings for use at home – potentially putting upward pressure on Western interest rates.