(May 7, 2012 edition of Forbes) My Feb. 28, 2011 column predicted that in China “a hard landing is likely” and “a recession in Europe is inevitable.” Both are unfolding.
China just reported its slowest quarter of GDP growth since 2009, with the economy growing at an 8.1% annualized clip from January through March of 2012, down from 8.9% in the final three months of 2011. Growth has been slipping steadily from the 11.9% pace in the first quarter of 2010, and Beijing seems unable to stop the slide at this stage of the game.
China’s response to the Great Recession was massive fiscal stimulus that amounted to more than 12% of GDP, twice the relative size of the U.S. package. Shock therapy worked last time around for China, nearly doubling GDP growth within a year, but it came with strong inflationary side effects. Food prices rose by double-digit percentages, stinging Chinese who live on subsistence incomes. Stocks stunk, Chinese savers couldn’t invest abroad, and banks paid negative deposit rates.
Housing boomed, since alternative investments were few, but prices rose beyond the reach of many would-be buyers. So the government tightened property financing.
They got what they wanted: House prices fell for the fifth consecutive month in February. Don’t look for a turnaround. Premier Wen Jiabao said in March that house prices “are still a long way from an appropriate level.”
Meanwhile, China’s central bank hiked bank reserve requirements from 15.5% in early 2010 to 21.5% last year. That’s a caveman tactic and amounts to credit allocation. The People’s Bank raised rates only 1.25 percentage points to keep cheap loans flowing to inefficient state-owned enterprises that employ around a quarter of Chinese and produce 45% of GDP.
What chance does the nonindependent Chinese central bank have in effecting a soft landing when the independent U.S. Fed, with all its sophisticated tools, tried 12 times in the post-World War II era to cool the economy and avoided a recession only once, in the mid-1990s?
Manufacturing is already in contraction, along with retail sales. Exports dominate consumer spending, which is a tiny 34% of GDP. In Brazil it’s 58%, 60% in India, 58% in Germany and 71% in the U.S.
... Europe is a disaster. Bailouts have no terminus, and another Greek rescue is coming. The second bailout gave bondholders €31.50 in new securities for each €100 in old, but the market prices the new paper at 25% of face value.
Cutting off Greece risks contagion and runs on banks in Portugal, Spain and Italy. The European Central Bank has temporarily papered over the problem with €1 trillion in 1%, three-year loans to member banks to spend on sovereign issues—no one else will buy them. The ECB is loading up Germany’s balance sheet with Club Med debt. How much can it stand?
German Chancellor Angela Merkel demands austerity for deadbeat countries, since letting them off the hook invites more profligacy. And she’s right. International Monetary Fund head Christine Lagarde says austerity will drive the Greek economy into depression and civil chaos. She’s right, too.
The euro zone financial crisis has spilled over to the real economy, as banks, businesses, households and governments throughout Europe are all trying to retrench. Rising joblessness and falling retail sales—even a 1.1% drop in February for stalwart Germany—confirm the slide.
With the continuing debt crisis and the faltering real economy, I look for a 5% to 6% peak-to-trough drop in GDP, similar to the 5.5% decline in 2008–09. I also see the euro, which I’m short, falling from the current 1.31 U.S. dollars toward parity, even if the euro zone remains intact.
The threat to the U.S. isn’t so much through trade with Europe—euro zone exports are equal to only 2% of U.S. GDP—but through financial conduits. American banks have 25% of their total foreign exposure in the euro zone. The collapse of MF Global, laden with euro zone debt, may be the canary in the coal mine.
THE GOOD NEWS: If both China and Europe experience measurable GDP contraction, then the price of oil will likely decrease to some extent.
THE BAD NEWS: If both China and Europe measurable GDP contraction, and, given that the US never really left the 2008 Great Recession, then one can expect the US's ongoing recession/depression to escalate.