Data out of China this week was unimpressive. Bank lending slowed sharply from June (to $85bn from $150bn). Weakness was apparent in industrial production, retail sales and housing transaction volumes. Most alarming was the sharp slowdown in exports. At a positive 1% year-over-year, July export growth sank from June’s 11% and was significantly below expectations of 8%. And with exports to Europe down 16%, this data point is one of the clearest indications yet of how the rapidly deteriorating European situation is hitting China. An article from Friday’s Wall Street Journal, “Trade Slowdown Squeezes Asia”, did a commendable job of describing how “the slowdown under way in China is already rippling across Asia…”
There’s a common perception in the marketplace that Chinese authorities can flick a switch and reflate their economic boom on command. I have tried to make the case that China – and “developing” economies more generally – are in an altogether different circumstance these days than they were back in 2008/9 (fragile instead of robust, from a Credit Bubble perspective). Importantly, these Credit systems and economies were previously enjoying robust inflationary biases. As such, “developing” systems proved extraordinarily responsive to stimulus measures – and were well-positioned to assume the desperately needed role of global locomotive coming out of the ‘08 crisis-induced global recession. I see only added support for the view that “developing” financial and economic fragility will be one of the big surprises unearthed by the unfolding “European” crisis.
Especially in China, as the downturn gathers momentum, markets confidently anticipate aggressive stimulus measures. A Bloomberg headline captured the sanguine mood: “Slide in China’s Export Growth Increases Odds of More Stimulus.” Deteriorating economic fundamentals have been the first surprise to the bullish consensus view, and a tepid response to stimulus measures will likely prove the second.
The impotence of post-Bubble stimulus measures remains solidly on display here in the U.S. I have not been as bearish as others on near-term U.S. economic prospects. Yet it’s ominous that zero interest rates, the nationalization of mortgage Credit, massive Federal Reserve monetization and market interventions, and 8-10% annual fiscal deficits equate to such a feeble recovery.
Throughout Europe, things proceed methodically from bad to worse. Spanish and Italian economic data, in particular, continue to be depressing. Meanwhile, it is increasingly apparent that the German economic juggernaut is showing the region’s ill-effects. Market participants pay little attention to the data, though, as they now wait anxiously for the unveiling of the game-changing Draghi Plan. Many anticipate the positive impact a new liquidity push could have on securities prices, although few expect much help for the real economies.
But the cautious consensus view believes that the Draghi Plan at least protects against “tail risk.” Cleverly, the ECB bought a few weeks by assigning details of the plan to various committees. This was sufficient to run the bears, reverse risk hedges and, again, run things amuck for so-called “market neutral” trading strategies. And especially now that the Merkel government is viewed as having capitulated, Mr. Draghi is thought to enjoy a window to pursue more open-ended Fed-like quantitative easing. Moreover, with an isolated Germany holding only one vote in a newfound, majority-rules ECB, the hope is that the Draghi ECB can finally move decisively toward assuming the role of buyer of last resort for European (for now, chiefly Spanish and Italian) debt.
The Draghi Plan could very well support European debt markets. Yet I really struggle with the notion of the ECB as savior for the euro. Desperate central banks are easily more apt to hurt rather than help their currencies. In a crisis environment, a central bank often must choose between flooding a system with liquidity to bolster debt and asset markets - or instead restrain liquidity creation in hope of stemming capital flight and stabilizing the value of its currency. Mr. Draghi would like to tough talk both securities markets and the euro higher. But European policymaking credibility is badly depleted. So markets will force his hand into coming with a substantial bond-buying strategy. Such a plan risks liquidity abundance fanning problematic capital flight.