The U.S., Europe and China – a summary of my macro views
I was recently asked to lay out my assessments on the economies of the United States, Europe and China – in short form – for a televised panel discussion I will be taking part in this week. It occurred to me that I might share my thoughts with readers of Two Cents:
United States
The U.S. cannot rebalance through currency devaluation or reflation given, respectively, the ability of our principal trading partner/creditor to prevent the former, and domestic debt deflation preventing the latter. Protectionist measures are not conceivable. Thus, disinflationary pressures will dominate and eventually force the balancing of wages and prices relative to our global competition (not parity, of course, but what is necessary to have us produce more of what we consume and reduce net imports).
The downward pressure on real wages (following an increase in real wages during the brief recessionary deflation) is steady and ongoing, with nominal wages now beginning to fall as well. The fall in nominal wages will continue, as liquidity induced inflationary pressures subside and prices and asset values will, of necessity, begin to respond accordingly.
The U.S. economy will not produce sufficient growth to prevent the foregoing adjustments, as a consequence of the aggregate impacts of (i) extraordinary levels of outstanding household and government debt, (ii) the likelihood that continued deficit spending is off the agenda and tax increases will eventually be required, and (iii) the continued drag of falling real asset values – on both households and creditors.
Monetary intervention amounts to pushing on a string at this point. What is really called for is New Deal type fiscal intervention – concentrating on getting people back to work.
But even the foregoing prescription is a conventional cyclical response. As I noted above, however, the thing that ails us is really more secular (i.e. the unprecedented global competition that proceeded from the collapse of socialism and the entry into the competitive labor force of 3.5 billion aspiring capitalists).
Europe
There is no “grand solution” that sufficiently ring-fences the problem of the PIIGS indebtedness. Ultimately this will be a political issue: Either preserve the Eurozone through additional wealth transfer and risk assumption by the core in favor of the periphery, or endure the unendurable and face up to the failure of the entire Euro enterprise. I do not believe that the polity in the core will support stable governments backing the former.
China
China will be successful in containing inflation sufficiently, and will avoid a hard landing. The slowing of excess liquidity creation by the U.S. will help as well.
The banking system in China is not that of the west – the banks in China are subsidiaries of the state, those here are merely de facto so. The state will recapitalize as necessary – and there is no currency issue offsetting its ability to do so. Having said that, I question whether growth won’t itself be sufficient to bail out loans that are currently out of the money.
China, and the other emerging markets, have enormous “bench strength” in tapping still-peasant-level populations to limit wage and price inflation (somewhat less so in terms of coastal asset inflation). China has dedicated its prodigious infrastructure spending to inward (inland) expansion – connecting dozens of cities/prefectures with coastal ports. The impact will be the tapping of cheaper labor and the redistribution of productive capacity to hold down prices until domestic demand (over the next decade) begins to replace more of offshore demand by the developed markets.
Developed market demand is likely to remain fairly static during this period – as discussed above. But just as the Asian Tigers displaced the Japanese in the ‘90s, the other emerging markets will continue to challenge China if prices get out of hand. Although they are developing infrastructure and capacity at a far slower pace, the other emerging markets constitute a cap on the export of price inflation from China to the developed world (which, again, should diminish with the ending of U.S. QE). The biggest threat to China is not her internal pressures, it is a renewed collapse of demand OR greater wage competitiveness, in the west (the two of which are not mutually exclusive).
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