A significant challenge in predicting the outcome of the current economic crisis is that it is global, with multiple stake-holders each with their own interests, but with a lot of inter-dependence. The intertwined nature of the global economy means that no single player can deviate from the norm, without paying a significant price itself.
This interdependence has a significant impact on asset ownership strategies. In this article I will discuss how foreign, especially Chinese, ownership of US based assets will be affected.
The US as the Driver of Global Growth
They used to say that if the US sneezes, Europe catches a cold. Western Europe is playing its part well with the Cold; but they have also been joined by Eastern Europe, which has caught a severe flu. Asian economies show symptoms of allergies, though it likely to be seasonal.
The drop in US economic activity is giving the Western European economies a hard time; they also have their own sub-prime mess with the loans made in Eastern Europe to finance economic expansion. Eastern Europe will not recover until consumption in Western Europe recovers, which in turn will not recover until the exports to the US recover. Japan is in a similar boat with exports tumbling.
The emerging Asian economies have been affected but still continue to grow as internal demand continues to be strong in India and China.
China Stimulates; Recklessly Perhaps?
From the US perspective the biggest wild-card is China. The Chinese central planners have relied on the US consumer to help lift the Chinese people out of poverty. They are now trying to encourage domestic consumption with massive stimulus; however consumer behavior does not change overnight. The Chinese are culturally tuned to saving, and to expect them to become profligate spenders at a time when millions are being laid off from empty factors is over-reaching.
Another factor to keep in mind is that the pace at which the stimulus money has been spent in China has raised questions about the nature of due-diligence done in making those loans. Until now the Chinese were growing at a break-neck speed and any over-investment was quickly absorbed by rising demand. However, the same reckless style may not work out this time, since demand growth is bound to slow down, given the global economic conditions.
China and USD Based Assets
There has been a lot of speculation about the Chinese controlling the US bond markets, the Chinese dumping US Treasures etc. in the financial media. Given the size of the China’s USD denominated holdings, it is natural for the Chinese to be worried about the financial turmoil in the US. With the current uncertainty in the global financial system, it is also prudent for them diversify their holdings away from paper assets into hard assets, like commodities and gold.
Economic Destinies Joined at the Hip
However, until their local economic consumption reaches a level that can challenge the US consumers, China will continue to need a healthy US. The Chinese have been dependent on the US consumer appetite, and their entire capitalist model is based on export-driven growth. Their economy and fiscal policies cannot make a sudden U-Turn from that model, especially since any significant disruption could result in civil unrest. The fear of civil unrest is strong within the CCP since the absence of vents to express dissent leads to an accumulation of pent-up frustration; which can blow up at the most untimely moment.
The Hesitant Financier
Given the dependence of their economy on the US consumer, the Chinese cannot afford to take any action which will significantly destabilize the US markets or hinders US recovery. This means the talk of the Chinese dumping US based assets or stopping the purchase of US Treasuries is perhaps overdone.
The Chinese may not like what is happening in the US, but they do not have any other viable alternative market as of today. They cannot afford to pull the plug on the US since the repercussions on their own economic and political system will be severe. Plus as a significant owner of USD denominated assets, it is against their interest to trigger a collapse in US based assets.
How Long Will this Affair Last?
This situation of the hesitant financier is unlikely to continue for too long. Within a decade, the size of the economies outside the US will reach a point where the dependence on the US consumer as the driver of growth will severely diminish. Further export oriented economies like China will redirect efforts to spur domestic consumption and bring their economies back into balance with global norms.
However, it is premature to call an end to central role of the US in the global economy. The flight to the dollar and US treasuries in Q4 2008 is ample evidence that regardless of what the pundits may say, when fear was in the air, everyone rushed to the perceived security of Uncle Sam.
After more than half a century of global leadership, the US’ central role will not change overnight. But the US can also not afford to be complacent. In the next few years, there will be alternatives available which will be big enough to offer the US serious competition. We have perhaps a decade to fix our house, before we lose the safety net provided by the bigger the safer economic group-think.