The Global Economic OutlookAugust 19, 2014
Trust is an essential element of strong economic expansions and it is particularly lacking of late – especially outside the US and UK. For Western Europe, the tension with Russia over Ukraine has erased all of the goodwill developed since the fall of communism. Within Europe, a lack of political consensus and undercapitalized banks are limiting risk taking as they did in the US at the start of our recovery. In Japan, the failure of the third arrow to spur growth has been compounded by the impact of the tax increase – and the fear of the one to come two years off. In China, the government’s corruption campaign has undermined the long tradition of guanxi (relationships) that is the real glue in all contracts and investments. Commodities producers around the world are caught by the slowdown. In Latin America, Argentina is devolving into chaos, while Brazil missed an opportunity with the World Cup and is limping toward the Olympics. The Middle East is again in turmoil, from Israel, to Iraq, to Afghanistan, to Pakistan. Increased certainty – in governments, or policy, or just outlook – could show the way to expansion. However, we see few signs of the kind of leadership that would result in that confidence. We expect the global economy will need to go through a correction before currently disparate groups can coalesce behind leadership that can generate a stronger recovery.
Our primary concern remains with slowing activity on the global factory floor, China. This week a wave of fresh data came from the Middle Kingdom ranging from mildly disappointing to scary weak. The usual managed data – retail sales, industrial production and fixed asset investment – came in slightly weaker than anticipated, suggesting that the government is still incrementally lowering expectations. Fixed asset investment was reported at a 17.0 percent growth rate (yes, that is what they still report) weaker than the estimated at 17.4 percent (everyone plays the game).
We believe that the corruption campaign is as much a factor in the slowdown as the credit crunch. In China, much of business is done on a personal handshake level. Hierarchical pyramids of mentors and mentees determine success and control. With the heads of many pyramids being caught in the corruption net, those further down are frozen by lack of government access and uncertainty about whether they are safe. In the US, where the system worked on access to finance, the collapse of Lehman and its aftermath injected a tremendous lack of trust between lenders and borrowers, causing a plunge in growth from which we have not yet recovered. In China, where connections are essential to success, uncertainty about the safety of relationships may be freezing the system – even as the government is going to the whip hand to stimulate new growth. Rebuilding trust even under the old rules will be difficult, and more so if the rules of the game are changing – which is the intention of reform. Bottom line, the developed world was able to adjust post Lehman in part because China continued to grow so fast. Now, China is making its adjustment with little help from the developed world. That makes us nervous about the sustainability of global growth.
The preceding is an abridged version of a commentary for McVean Trading and Investments, LLC and has been reposted here with permission of the author.
The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.