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U.S. Recession, China to the Rescue?

Economics / Recession 2008 - 2010 Mar 26, 2009 - 12:04 PM GMT

By: Hans_Wagner

Economics Best Financial Markets Analysis ArticleOn Friday March 13, 2009, Chinese Premier Wen Jiabao urged the U.S. to guarantee its “good credit”, expressing concern about the safety of his country's huge holdings of U.S. government debt. China is the largest holder of U.S. debt. It is estimated that 70 percent of the country's almost $2,000 billion foreign exchange reserves are believed to be in U.S. dollar assets. In addition, Chinese officials believe the country will be able to grow their GDP by eight percent in 2009. Mr. Wen has acknowledged that this may require additional stimulus to bolster the economy. Will China be able to rescue the world's economies and cover the U.S.'s growing deficit?


Economic Contraction

In January, exports were down 17.5% from a year before, while imports were down by 43.1%. In addition, in January exports shrank by 25.7% accompanied by a 24.1% drop in imports. In February, China's trade deficit fell to $4.8 billion from $39.1 billion in January and over $8 billion compared to the same month last year.

This rapid drop in exports and imports indicates the affect of the less than robust global economy on China's financial situation. According to various sources, a significant number of marginal factories have closed shop forcing millions of Chinese workers into unemployment. Many of these people moved from the poorer rural areas the factories in the Eastern urban regions. Now many are moving back to the small farms they once came.

To help stimulate China's domestic consumption, the regime is offering government-financed discounts on purchases of a number of manufactured household items such as refrigerators, televisions, motorcycles, and computers to many of the rural provinces. The discounts can amount up to 40% off in an effort to stimulate the sluggish export manufacturing industry. The government hopes to boost rural sales of consumer good by 2.5%. Through this program, officials hope to fuel the ailing export industries reducing their reliance on exports for their sales. Many question how much money the very large rural community has to spend. The Chinese are noted for their propensity to save up to 40 percent of what the make to prepare for a rainy day.

Add in the $585 billion stimulus effort to help kick-start the Chinese economy, and we have a significant effort to help revive the sagging Chinese economy. Much of this spending will be for infrastructure, though it is unclear how far reaching the spending will be. In the last few years most of the infrastructure spending has focused on Beijing and the surrounding areas to display the progress of the country for the 2008 Summer Olympics.

The government remains fearful of the social consequences of wide spread unemployment. Unrest by the growing number of unemployed people, especially in rural areas is raising concern among Chinese government officials. China has a history of economic unrest leading to revolutionary changes in the government. Add in the corruption that tends to be rampant and a severe drought in parts of the country, you have the making of difficult times for the Chinese leadership.

Given these conditions, it is unlikely that China is able to be the engine to pull the world's economy out of the current deep recession. The Chinese consumer recognizes the troubles they face and they will tend to withhold spending just in case. While additional spending on infrastructure should help boost some parts of the Chinese economy, it will not be enough to drive the export growth. The infrastructure spending will encourage consumption of commodities like steel, copper, concrete and aluminum. The recent rise in the price of these commodities reflects this increased demand. However, this is not enough to rescue the rest of the world's economies.

Investing in U.S. Treasuries

Officials believe China holds about $696 billion in U.S. Treasuries. These holdings have lost 2.7% since the beginning of 2009. Had they been invested in securities from another country such as Germany, the United Kingdom, Japan, or France, they would have lost three times as much. China's timing in the equity market has not been very good as well. Their $10 billion investment in the Blackstone Group has been cut in half.

Should China decide to sell some of their U.S. Treasuries, it would cause a precipitous drop in the value of their current holdings. China could stop adding to its hoard of Treasuries. However, if they were to embark on such a venture, market action would lead to a further slow down in export sales, something China can ill afford. The concern expressed Mr. Wen should be taken as though it comes from any large investor. The U.S. is growing its already large deficit even more. At some point, there comes a limit to the ability of the U.S. to service its debt, much like a stretched homeowner, who finds they cannot afford the growing mortgage payments. Mr. Wen does not want to be left holding the mortgage when its value starts to plummet. In the mean time, he has no other choice but to continue to hold and buy Treasures to help prop up his own economy.

The Bottom Line

As investors, we should not count on China to rescue the U.S. economy from its doldrums. They have their own economic problems caused, in part, by the earlier ravenous consumption by the Western World. As the U.S. economy recovers, it is unlikely consumers will return to their old spending habits. There are no more rapidly growing assets that can be leveraged to feed the old spending pattern. Consumers will be left to live within their means and even save a little.

The vaunted Chinese export machine will feel the affects of the more conservative spending by consumers. This will slow the growth of the Chinese middle class, causing China to face a slower growing economy. They will not be able to prosper on their own, as they are linked inexorably to the rest of the world. China cannot rescue the rest of the world and the rest of the world cannot rescue China. For better or worse, we are in this together.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Copyright © 2009 Hans Wagner

Hans Wagner Archive

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