Tuesday, 13 March 2012

China. Spain.

China I
Since China last week announced that its new target for growth was 7.5% and not 8%, the financial markets have been busy discussing with themselves if this was a good or a bad thing. The verdict is mostly that it is a bad thing.

I do not agree. It is only natural that after a 10%-a-year growth target 15 years ago, and years of growth in the 8% to 9% range, growth will slow further. China still generates new jobs at a blistering pace as a growth rate of 7.5% in the world’s 2nd largest economy generates a lot more $$$ than growing the world’s 20th largest economy by 10%.

And 7.5% growth is not just 7.5%. In national accounting, increased imports count as a negative growth element. So China’s long and slow turn towards a growth driven by domestic demand and higher imports rather than exports will necessarily see a negative contribution to growth coming from a steadily worsening trade balance.

So all in all, the slower growth rate is nothing to be worried about. Guess we can sell them some luxury goods...

China II
But there is something else to worried about. China’s reorientation of the economic growth will inevitably lead to a worsening of the current account position. Pulled by its incredible export success over the last decade and a half, China has become one of the largest creditor nations on earth.

The gigantic trade surpluses paired with a fixed exchange rate has given China a huge need to purchase US treasury bonds. If they had not done so, the currency would already have been dramatically stronger than it is now.

The flip side is that China by this policy effectively has allowed the US of A to run similar trade deficits without suffering the traditional consequence of a weaker currency and (much) higher bond yields.

The stock market manages to spook itself when China comes out with a monthly current account deficit. In fact, the US bond market ought to be the most concerned. This asset class has profited the most from huge Chinese demand. It is in that space the adjustment to a smaller Chinese surplus will happen.

Unless of course the USA suddenly falls in love with savings and postponed consumption. When pigs fly.

Spain’s PM Rajoy challenged the new EU budget orthodoxy by announcing that Spain would end up with a higher budget deficit than expected in 2012. His statement last week was initially met with a deafening silence.

But now, some days later, the Euro-zone members are recovering from the surprise, and predictably, they now demand further cuts. Rajoy pointed out that deep cuts already had led to slower-than-expected economic growth, and appears unlikely to cave in, at least not without provoking a debate about the wisdom of punishing depressed economies with further cutbacks.

The outcome of that debate will be interesting as a measure of the strength of the backlash against the German dominance in EU budget matters.

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