Will the ECB and Fed Follow Where China Leads?
By Frank Holmes, CEO and Chief Investment Officer
U.S. Global Investors
Every month, policymakers track purchasing managers’ indices (PMI) around the world as they consider fiscal and monetary actions. To us, a PMI is a measure of health of companies around the world, because it includes output, new orders, employment and prices across manufacturing, construction, retail and service sectors.
Today, the J.P. Morgan Global PMI for May came in lower at 50.6—just above the level indicating expansion—and China’s HSBC Manufacturing PMI fell to 48.4. Both numbers were below their respective three-month moving averages. Historically, we’ve seen China’s PMI number leading the year-over-year change in exports by three to four months, so when the PMI has increased, a few months later, Chinese exports have historically risen, and vice versa.
China’s HSBC PMI tends to be more reflective of export demand, as it is compiled by private parties, covers a smaller survey sample and is weighted toward smaller businesses. Therefore, a lower PMI number indicates lower export demand.
With Europe’s growth in a deep freeze, China is feeling Europe’s pain. While many think the U.S. is receiving most of the Chinese-made goods, Europe is actually China’s largest export partner. Nearly 22 percent of China’s exports head to Europe, contributing nearly 6 percent to China’s GDP; only 17 percent of exports from China are shipped to the U.S.
With fewer exports to Europe, China’s GDP growth could be affected, but probably much less than one might think. Listeners of our webcast a few months ago heard Andy Rothman from CLSA explain how China has become less dependent on the world for its growth. As you can see from the chart below, CLSA had already assumed net exports of goods and services out of China to be negative this year because of slower growth from Europe and the U.S.
Yet, China clearly has the upper hand in controlling growth. Take a look at what happened in 2009 when exports declined dramatically: The government stepped in with a massive stimulus package devoted to bank lending and infrastructure construction. This effort significantly boosted overall GDP growth and “pushed the Chinese economy out of a deep slump,” says research firm BCA Research.
Despite net exports falling about 4 percent in 2009, GDP actually grew more than 12 percent.
China won’t put the pedal to the metal like it did in 2009, though. Premier Wen Jiabao recently said that the government “should continue to implement a proactive fiscal policy and a prudent monetary policy, while giving more priority to maintaining growth,” according to Bloomberg News. China is more like Goldilocks: The government wants the economy to be not-too-hot or not-too-cold.
The important thing to remember is that the government will want to avoid the expansion that was “associated with the earlier plan that led to higher CPI, asset price inflation and a surge in lending to non-priority projects,” says J.P. Morgan. Rather, the focus is on making sure the country shifts to a “more sustainable trajectory of growth,” says the research firm.
With the renewed eurocrisis, “Chinese authorities are currently facing an extremely complex and unpredictable situation,” says BCA. They’ll continue to monitor the situation and not make any drastic moves; rather, “Chinese authorities will stay on high alert and act promptly to rescue growth in case of external shocks,” says BCA.
