The third party than needs to make a New Year’s resolution is the political leadership in China. Their resolution should be to continue reducing domestic inflation, speed up economic growth and do some things for the global economy that will be ultimately in their best interest.
China’s economic performance may be the most important global economic variable—and the most unpredictable—in 2012. Here we have the second largest economy in the world that has been growing in the range of 8% to 10% annually for a decade. By way of its large external sector it continues to have a huge influence on the global economy. Its massive trade surpluses and resulting accumulation of foreign exchange reserves have arguably been a factor in the very low level of global long-term interest rates.
China’s size, growth rates and desire for a bigger role on the world economic stage raise the possibility of its playing a hugely constructive role in a global economy that is struggling. But that outcome is far from certain, so appropriate New Year’s resolutions appear to be in order.
China is not without economic problems. Its industrial production has been falling since mid-2011. It’s year-over-year GDP growth has been trending downward for more than a year. It’s true that the 9.1% year-over-year growth rate posted in the third quarter is the envy of many countries. But it is down significantly from 11.9% in the first quarter of 2010.
While virtually every country would like to keep economic growth as strong as possible, China’s need is stronger than most because weak economic growth could raise the possibility of social unrest.
It also has another problem: inflation, which can also lead to some serious social problems. Tighter monetary policy does appear to have taken a big bite out of inflation, but those policies are also one of the reasons for slowing economic growth.
Even though government speed in China is capable of matching the speed of some financial markets, the fact of a looming leadership change in late 2012 may slow decision-making in the coming months.
Chinese concerns don’t stop at its borders. It is a country heavily dependent on exports, and while its international current account remains solidly in surplus (nearly US$58 billion in the third quarter of 2011), that is only a little more than half of the surplus recorded a year ago. Exports are up, but imports are more so. The latter trend is likely to continue, aided by a rising currency and fueled by the developing middle class. Export growth may remain soft both because the currency is rising and its two large non-Asian markets—the U.S. and Western Europe—are either growing very slowly (the U.S.) or are likely in recession (Europe). Europe has come cap-in-hand begging for some funds to help resolve its debt crisis. So far, China has resisted any direct contribution, but has reserved the possibility of investing through the International Monetary Fund. Having been a member of the World Trade Organization for a decade, the country appears ready to exert more influence on the world economy.
Chinese economic growth—and its influence on global growth—could go either way in 2012. A continuation of the slowing trend and/or a failure to contain inflation would hurt both the Chinese and the global economy. That would depress prices of commodities that are so important to Canada, as well as the external value of the Canadian dollar. However, the outcome for China might be better than that.
Here are a few resolutions for China to consider. Allowing its currency to rise against the U.S. dollar would help to quell the fires of domestic inflation and reduce trade tensions with America. A rising yuan should help reduce the U.S. current account deficit. With one move, China would lessen international imbalances that are holding back the world economy and curb domestic inflation. With inflation tamed, China would be in a position to further ease monetary policy and perhaps fiscal policy in order to stimulate economic growth.
Next, China might contribute to a solution to help end the European debt crisis by providing funds through the IMF. It would potentially gain two things: it would help Europe get back to economic health, which would be good for Chinese exports, and China would gain some of the international clout it desires.
We know that there are New Year’s resolutions that should be, but don’t get made and there are those that get made and aren’t kept. Making and keeping these three resolutions could make markets much more palatable—and less volatile—for your clients in 2012.
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