If a bailout is like mopping up a financial mess, economic stimulus packages are meant to keep as many people as possible from slipping and falling. China just launched a half-trillion-dollar stimulus to bolster its economy. Will that do the trick and limit damage to the world’s most powerful emerging market?
Let’s begin by noting that China’s rising domestic consumer demand became the cornerstone of a popular "decoupling" hypothesis over the past few years. That’s where market observers predicted that even if growth slowed in the U.S. and other leading economies, the Middle Kingdom could keep surging forward based on internal spending.
China’s household savings rate has been one of the highest in the world over the past decade. That means that local consumers aren’t as tapped-out as Americans, who are now being weaned off of credit cards and are using layaway again now that lending is tighter than ever.
In case of an export slowdown, foreign currency reserves held by the government could also come in to keep growth up.
The official People’s Daily made its case in 2001, even before the beginning of China’s current boom.
The counterbalance of domestic demand meant that "even if the country’s export business suffers the worst setback, it can only affect China’s economic growth by one percentage point at most." At least that’s what the Communist Party organ said that spring.
Yet there were other traditional capitalist voices that echoed the sentiment up through recent months.
In an article from March of this year called "Decoupling is Not a Myth," The Economist also pointed to the fact that half of China’s exports now go to other developing nations, instead of the U.S. The other BRIC nations (Brazil, India, and Russia) topped Beijing’s new buddy list as this year started, showing a 60% increase of incoming Chinese goods from early 2007.
As for goods flowing into China, exporters based in smaller regional countries like Malaysia and Indonesia have increasingly targeted China instead of the U.S. Shipping to a major power closer to home means padded margins and good-neighbor relations for such Asian countries.
China’s Economy: What a difference a year makes…
Chinese GDP growth dropped down to 9% year-on-year in the third quarter. That would be great for most countries – especially the U.S., where we’re facing an actual drop.
But 9% means a plunge when you consider the 12% change China enjoyed in ’06-’07, and a low point for the past five years.
Now, the credit crunch and liquidity crisis have turned Beijing’s worries about "hot money" inflows into heavy interest rate cuts, Olympic euphoria is behind us, and more foreign manufacturers are moving operations to places like Vietnam for relative cost advantages. Millions of jobs go with them.
So this past Sunday, November 9, the Chinese government unveiled a $586 billion plan to prop up spending and employment over the next two years. It’s based on investing in lasting infrastructure like subways, roads, rural irrigation, health care… not bridges to nowhere. This is where developing countries have a strange advantage. They’re building infrastructure for the first time in many cases, not scouring the landscape for places to launch upgrade projects.
The International Monetary Fund has urged similar steps for countries around the world. Out of all of the central banks and governments, though, sitting on what is now nearly $2 trillion in foreign reserves means China has a rainy day fund to beat everyone else.
The State Council – the top-level government body which announced the stimulus – said on Sunday that $18 billion of those trillions would be spent on public projects and payments in Q4 alone.
For comparison’s sake, take a look at what is already happening in the only 3 world economies more powerful than China:
Germany is set for about $30 billion in business assistance and help for consumers buying big-ticket items like cars.
Japan is going to loan out about 10 times Germany’s commitment, with $275 billion to small and medium-sized enterprises (SMEs)
The United States already sent out rebate checks this year, and President-elect Obama has promised to make a stimulus his first order of business in the Oval Office, if a package doesn’t get passed in the lame duck session.
Of course, the United States is still the hub of the global financial system. A recession here means that worldwide growth averages will swoon, even if China can get back above 10% yearly growth.
Towards a Unified Global Stimulus
At the G20 summit in mid-November, the circle of leading industrialized nations will expand to include top developing economies like China and Brazil, and all ideas will be taken seriously.
Until now, the approach to solving this crisis has been piecemeal and largely decentralized. Each of the G20 countries has lowered interest rates at its own leisure and announced different levels of spending as a function of total GDP. We’re also not in sync on how to implement efficient regulations to prevent another mess like this from happening.
One thing is for sure: all the theories of how things could and should turn out need to take a backseat to the unified action that will restore confidence and revitalize the global system.
In the very short term, the response to China’s stimulus is mostly positive. The Shanghai stock exchange popped to the upside on Monday by over 7%. Japan’s Nikkei 225 index also gained more than 5%. India and Hong Kong also rose, but Australian equities weren’t as effervescent.
Australia’s iron ore and coal industries have boomed because of China’s demand, and Sydney traders may be tougher to convince that China’s appetite is going to be restored by the stimulus.
No matter what hypotheses were formulated this year or years ago about how to deal with a major global financial crisis, a trial-and-error attack won’t calm our nerves. Let’s hope China and the rest of the G20 can announce a plan in unison before 2009 rolls around.
Regards,
Sam Hopkins
P.S. – My colleague Steve Christ is one analyst that refused to jump on the Chinese bandwagon. His subscribers have banked gains twice this year by betting against the dragon. He went long the UltraShort FTSE/Xinhua China 25 Proshare (FXP) banking gains of 28% and 17% as the Chinese market stumbled.
But that story is old news now to Steve. These days he’s ahead of the curve again urging his readers to invest in "Safe Harbor Investment Covenants".
To learn more about why these investments are so hot right now click here.
