Business World

Monday 19 March 2018

Do we miss the point of Chinese obsession with growth?

Let’s not be what Churchill described as the pessimist ‘seeing difficulty in every opportunity'
Let’s not be what Churchill described as the pessimist ‘seeing difficulty in every opportunity'

Donnacha Fox

My three year old daughter is a fan of the Knuffle Bunny range of children's books by Mo Willems.

The central character is a little girl called Trixie, who is very attached to her toy doll friend Knuffle Bunny.

In the final story of the trilogy, Trixie leaves her friend behind on the plane while visiting her grandparents in Holland.

Trixie's father calls the airport to see if they can locate Knuffle Bunny - only to be told the plane flew on to China, and the caption in the book reads "…and China is very far away!" Indeed it is, possibly rendering it futile to speculate on Chinese economic trends… over 5,000 miles away!

With the disclaimer delivered, that's precisely what I'm going to try to do.

Any discussion about China's economy causes controversy. That's because for a long time, it's been one of the few reliable engines of global growth. Throughout the global financial crisis, when developed economies double-dipped in and out of recession, growth rates in the world's second largest economy comfortably averaged well in excess of 7pc-plus per annum.

The size of China's economy is staggering. Its GDP of $10.4trn in 2014, according to the World Bank, completely dwarfs Irish GDP of €189bn for the same year (source NTMA). But now, Chinese economic growth is slowing, and everybody is getting anxious.

The unexpected double devaluation of the renminbi in August caused widespread suspicion the Chinese economy was much weaker than expected. Investors began to question the reliability of official data with Beijing being accused of "data smoothing".

A mini-stock market rout ensued, with the Shanghai Composite falling by almost a third in just five trading days, prompting massive Chinese government intervention to bolster confidence. Chinese interest rates have been cut five times so far this year, from 5.60pc to 4.35pc, with the most recent cut made on October 23. While Q3 Chinese GDP was 6.9pc, better than forecast, it was still the country's slowest pace of annual growth for some time and below the official target range.

But the obsession whether Chinese GDP will be 7.0pc or 6.9pc this year could mean we're in danger of missing the point. The point is that China is intentionally shifting the focus of economic growth away from heavy industry, manufacturing and construction to consumption and services.

So what if China's revised growth rate is "only" 6.5pc for the foreseeable future? That's more than twice the IMF's forecast for global growth in 2016. I'll take that!

China's "fifth plenum" - a key, four-day policy-setting meeting held by the Chinese Communist Party (CCP) - concluded its deliberations on Thursday last. Apart from officially abandoning its one child policy, the CCP re-committed to the "comprehensive deepening of reform" already underway in China and promised to "significantly raise" the role consumption plays in economic growth.

The policy of increased consumption is taking hold. China's National Bureau of Statistics (NBS), provides a wealth of data on its website. While Chinese PMI data for September showed manufacturing in contraction mode (with a reading below 50), the opposite is the case for the non-manufacturing series (that is, services) with readings in expansionary territory for most of the past year.

It would appear Chinese consumers are acting more confidently, buoyed by successive interest rate reductions and lower energy costs. Total retail sales in the 12-month period to September, according to the NBS, rose 10.9pc while online retail sales surged 36.2pc.

China suffers aspersions about its property market, banking system and allegations of systemic bribery and cronyism. But let's not be (as Winston Churchill described) the pessimist "seeing difficulty in every opportunity". There are positives in China's rebalancing - if we can just force ourselves to sift through all the noise.

Is the Fed about to make a bad call in raising rates?

is the Federal Reserve about to make a mistake raising interest rates at its next meeting in December?

In short, yes, quite possibly.

Fed chief Janet Yellen had for much of this year guided the market to expect the first rise in US interest rates since 2006. We were led to believe only US domestic economic considerations (such as employment, wages, inflation and GDP) would be taken into account in the decision making.

Then in September, new variables (such as Chinese economic weakness and global stock market volatility) were cited as reasons for not increasing rates. This confused investors and put a dent in the finely tuned communications machine that is the Fed.

It's not often that share prices fall because interest rates did not go up, but that's exactly what happened. Last week's Fed statement however, left out references to "global economic and financial developments..." and pointedly added in a reference to potentially raising rates in December.

The Fed's communications malfunction and about-turn is again illustrative of the fact that central bankers aren't infallible. They're human just like the rest of us! Despite having the best forecasting tools available, they can still get it wrong and misjudge the trajectory of data. And also, events sometimes just get in the way.

The best example of "policy errors" for a long time was Japan throughout the 1990s. Twice during that decade, the Japanese monetary authorities prematurely raised interest rates at the first sight of economic buoyancy, only to cut them again soon afterwards, as growth stagnated. Current official Japanese interest rates are 0.10pc and have been below 1.0pc for almost 20 years.

Former ECB president Jean Claude Trichet's premature double interest rate increase in 2011 is another good illustration. The ECB raised rates around the same time Portugal asked for an €80bn EU-IMF bailout, in April 2011. Interest rates were again raised in July 2011, the same month that Greece requested its second international bailout. The ECB's only mandate is price stability. But now core eurozone inflation is 0.20pc - dangerously below the official target of "close to, but below 2.0pc" and that's despite ECB rates of 0.05pc.

Current ECB president Mario Draghi is so concerned about anaemic eurozone growth and lack of inflation that he's set to launch an even more aggressive version of the QE programme he started earlier this year - possibly as early as next month.

So should the Fed raise interest rates in December? The IMF and the World Bank don't think so. Both institutions are concerned about a premature rise in US interest rates and want the Fed to wait until next year, when they expect the US economy to be on a stronger footing.

The IMF is also worried about the surge in US$-denominated debt in emerging markets, and the potential impact that a sudden rise in US rates would have.

When you look at some of the data the Fed will take into account in reaching a decision, it's hard to see where the warning lights necessitating a rate hike are.

Data from the US Commerce Department on Thursday, showed Q3 GDP of 1.5pc, missing estimates and down from a growth rate of 3.9pc in Q2. The report also said US inflation declined to 1.3pc and average monthly job gains in Q3 slowed to 167,000 from 231,000 in Q2.

With disinflationary pulses from low commodity prices still rippling through the global economy, the Fed will likely continue to adopt a "wait and see" policy in December. In the meantime, let's wait and see!

Donnacha Fox is an executive director with wealth management firm Quilter Cheviot. Opinions expressed in this article are those of the author personally and do not necessarily reflect those of the firm

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