What’s good for China is good for America
I am currently on vacation and hadn’t planned on posting, but I thought maybe I should let people know that I didn’t simply disappear. Unless something major comes up I probably won’t do any more posts until this weekend. I’ll try to catch up on comments when I return.
I couldn’t help noticing yesterday’s worldwide stock rally, as well as the news reports attributing the gains to signs of faster growth in China:
FRANKFURT, June 1 (Reuters) – European shares rose almost across the board on Monday as data showing China’s manufacturing sector continued to expand in May boosted Asian stocks, adding to the positive sentiment seen in Wall Street’s higher close on Friday.
At 0818 GMT the FTSEurofirst 300 index of top European shares was up 2.1 percent at 879.81 points, having hit 880.55 points — its highest level since Jan. 9.
‘The trigger for the rally is the Chinese PMI. There are close (economic) ties between China and Europe, and Europe benefits from better economic data there,’ said Heino Ruland, analyst at Ruland Research.
China’s official purchasing managers’ index (PMI) in May recorded its third straight month above the mark of 50 that separates expansion from contraction, fuelling optimism that the worst of the global downturn may be over.
Part of the upswing in China may be due to the falling yuan, which has recently depreciated against European currencies as well as the Japanese yen. Other news reports suggested that Chinese exports have also begun rising, after sharp declines during the fall and winter months.
It is not surprising that signs of economic recovery in China would boost mainland and Hong Kong stock indices. But wouldn’t a weaker yuan and growing Chinese exports represent a threat to European manufacturers? Why did European stocks respond positively to these “green shoots” in Asia?
In an earlier post I argued that a depreciating yuan might actually be good for Western economies if it led to higher worldwide AD. As I recall, many commenters were quite skeptical of this argument. While the enthusiastic response of equity markets to Chinese growth certainly does not prove my point, it at least suggests that investors don’t see Chinese/Western competition as a zero sum game. Chinese growth is a major component of world AD, and thus the income effect of currency depreciation should not be underestimated, particularly when the world economy is severely depressed.
Although the nominal yuan/dollar exchange rate has been stable in recent months, this is equivalent to a yuan depreciation, as Chinese productivity growth is much faster than US productivity growth. And the US stock market also seemed to respond strongly to signs of faster growth in Asia.
I couldn’t help chuckling at the perplexed reporters on one of the financial news networks last night. They seemed confused as to why stocks rallied so strongly despite a plethora of “bad news”:
1. Higher oil prices
2. Higher interest rates
3. GM in bankruptcy
Of course readers of this blog know that I view the first two items as being very good news. Expectations of faster NGDP growth will tend to raise both nominal interest rates and commodity prices. But what about GM? Back in 1953 the CEO of GM (was slightly misquoted as having) said “What’s good for GM is good for America.” There may have been a tiny grain of truth in that observation during the 1950s and 1960s, when GM was perhaps America’s biggest engine of wealth creation. In recent years, however, GM has become America’s biggest engine of wealth destruction. Thus any bankruptcy settlement that makes GM more efficient should be regarded as good news.
For someone as old as me, yesterday’s news looked like the passing of an era. When I studied economics in the 1970s, Mao was China’s head of state and there were virtually no (mainland) Chinese products in American stores. In those days I never could have imagined Wall Street brushing off GM bankruptcy and then soaring on news of a positive PMI index—especially a positive PMI reading from China. This morning I heard on the news that while GM’s American unit is hemmoraging red ink, their Chinese unit reported a 75% year over year sales increase in May. Although most of the actual assembly of these cars occurs in China, there are many spillover benefits for the American economy. Maybe the new slogan should be “What’s good for China is good for America.”
When the world economy is severely depressed we should encourage monetary stimulus (which means currency depreciation) in any country. When those policies produce green shoots, we should welcome the signs of spring; rising stock and commodity prices, and rising interest rates. Let’s not make macroeconomics any more difficult than necessary—in a worldwide recession there are no “competitive devaluations,” only countries doing their share (China), and those refusing to help boost world AD (the Eurozone.)
[In fairness to Europe, they lead the world in addressing another global concern—CO2 emissions.]
Yesterday’s news doesn’t mean that we are out of the woods yet. While the markets have moved sharply higher in the past three months, the level of stock and commodity prices, as well as inflation spreads, are still indicative of a very depressed economy where nominal growth expectations remain lower than policymakers would like to see. After all, we haven’t yet heard President Obama come on TV and call on Congress to sharply curtail the fiscal stimulus. Until that happens, and indeed until many months after that happens, there can be no thought of raising the Fed’s target interest rate.
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3. June 2009 at 03:44
Yep. The signs so far are good (touch wood).
Some might argue that rising interest rates on US government bonds are a sign of rising default risk. Stephen Gordon points out that Canadian government bond yields have been rising too, following US yields very closely. This observation contradicts the default risk hypothesis, because Canadian debt and deficits are much lower than US, as a ratio to GDP, so default risk is presumably minimal. But it confirms the optimistic interpretation, since Canadian and US economies tend to rise and fall together. http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/06/canadian-longterm-government-bonds-yields-are-increasing-as-well-.html
Next post: so, what caused the improvement? Monetary policy? Fiscal policy? Fixing the financial system? Or none of the above? (This should keep economic historians busy for decades.)
Enjoy your vacation!
3. June 2009 at 07:56
Prof Sumner, what incentive would Pres Obama have to curtail any of the fiscal stimulus, even if the economy is rolling forward in the second half of this year, esp as we approach midterm elections?
4. June 2009 at 09:01
Van: He has very little. You might be interested in reading James Buchanan’s “Democracy in Deficit”. It’s a bit long Van: He has very little. You might be interested in reading James Buchanan’s “Democracy in Deficit”. Politicians’ face incentives to continually expand the debt because the gains are short term and the costs are longer term. Eventually, people will start accusing Obama of being irresponsible, but most people think he’s being reasonable right now.
What has always puzzled me about China is, why don’t they start spending their US dollars? They have a huge pile of them sitting around and they could easily expand import demand for US goods and services. They could buy a number of things that would help improve the unstable countryside and it would lower their exposure to increasingly risky Treasury bonds. I’m guessing that the reason has to do with internal politics.
6. June 2009 at 06:32
Nick, The Canadian comparison is very interesting, and tends to confirm my hunch that yields are rising because of increases in expected NGDP growth. I might add that stocks have also been rising rapidly, which hardly signals increased fear of government default. If the government were expected to default on its debt, the stock market would probably do very poorly. In addition, expectations of faster growth actually reduce the risk of default, as rapid NGDP growth reduces futures expected deficits—indeed it is the major factor determining deficits.
Cause? What caused the change? I’m not sure how to answer that question. One answer is luck, as the events were a surprise to the markets, and hence the policymakers. But what sort of events? I have no idea, but something that made monetary policy more expansionary than expected. It could have been something that raised the Wicksellian equilibrium real rate of interest. Perhaps faster than expected recovery in Asia, for instance. But that’s just a wild guess. I don’t think economics is capable of answering that question, and am not sure we should even try. It’s better to let the market figure these things out. The market is much smarter than we are. They started to sense things improving faster than expected in late March, and now we seen some real world numbers (fewer job losses, etc) that the market sniffed out earlier.
Van and Azmyth, I see why you two are so cynical, but in the end I don’t think that sort of ad hoc theorizing is convincing. First you need to think about why Clinton ran a contractionary fiscal policy during his 8 years in office? Second, is Obama really that different from Clinton? If the economy is overheating I don’t see why Obama wouldn’t want to do the same fiscal policy as Clinton. Don’t get me wrong, I think you are right that he won’t cut back on the fiscal stimulus anytime soon, but that’s because I expect sub-par NGDP growth for quite a while. But in that case the Fed would also have no reason to tighten. If the Fed even thinks about tightening, the 90% of stimulus that is not infrastructure projects needs to be repealed first.