In The Balance

21/01/2011 at 3:15 pm

What an interesting week. In China, stock market nervousness intensified, with the Shanghai Composite off 3% on Monday, up just under 2% over the next couple of days, down 2.9% again on Thursday and 1.4% better today to close the week down 2.7% overall. Underlying this skittish behaviour were familiar worries about the threat to growth posed by monetary policy tightening in the face of higher inflation. Familiar too was the spillover of anxiety into other markets, with equities in general enduring patchy declines.

At the same time, yesterday saw the release of upbeat labour market figures in the world’s largest economy, with US unemployment claims continuing to fall. Figures on US housing came out too, with existing home sales much stronger on the month. Now one month’s data does not a summer make – especially for the housing series, which has been volatile in recent times and hit record lows during the second half of last year. But as readers of this blog will know, this data is of a piece with reports on the mortgage market and results from US banks that suggest the worst of the subprime crisis is now behind them.

In other words, it looked this week as if the market was ignoring further signs of recovery in the US and focusing on potential trouble in the Far East instead.

It may appear that this can be justified by reference to the growth contribution of China, and developing economies in general, over the last couple of years. Using the IMF’s most recent (October) estimate, for example,  2010 growth was forecast at 4.8% for the world as a whole, with developed country growth at 2.7% within that and growth in emerging economies powering ahead at 7.1%.

Let us turn to the US and China specifically. Real US GDP in the third quarter of last year was 3.2% above the same quarter in 2009 – a rate of growth exactly in line with the post-war trend. In China, the third and fourth quarters of last year saw annual GDP growth in real terms of 9.6% and 9.8% respectively. On the face of it, this would appear to justify the markets’ seeming view that a Chinese slowdown carries more weight than a US recovery. Given the relative sizes of the Chinese and American economies, however – roughly US$5.5trn and US$14.5trn – these rates of growth translate into similar values of production in dollar terms: $539bn for China and $464bn for the US.

Another way of looking at this is that a return to the lowest rate of growth experienced by China in the recent recession (6.5% p.a.) would be balanced in terms of aggregate world output by an increase in the rate of US growth of 1.2%.

There is no certainty that either of these things will happen in practice. US growth did run at about that level above trend following the recession of 1982, but picked up a lot more slowly after the (much milder) recession of 1991. Nor is there anything to indicate that a policy-driven slowdown in China would be sufficiently severe to take growth down by over 3%. And there are of course interactions to consider between the two economies: any growth in the US would likely soften the impact of slower domestic demand in China by boosting exports.

It is nonetheless worth bearing in mind the relative sizes of these (and other) economies when we are looking at the outlook for world growth, as well as the different relative rates. Should the US gather itself for an above-trend performance this year that would go a long way to balancing out the effects of a policy slowdown in lesser economies – even one as big as China’s.

Of necessity this has been a brief look at a complex area, but on the face of it the one-sided direction of equity markets this week could turn out to have been unfairly skewed.


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