It’s even more disconcerting to realize that the forces in play are ones that have little to do with the American economy and a lot more to do with Europe and China. (China in particular, where bubbles seem to be bursting all over the place with the fallout being felt everywhere else.)
In times like this, I seek out the thoughts and perspectives of my brother, Nelson Nones, an IT specialist and business owner who has lived and worked outside the United States for nearly 20 years — much of that time spend in the Far East.
To me, Nelson’s thoughts on world economic matters are always worth hearing because he has the benefit of weighing issues from a global perspective instead of simply a more parochial one (like mine).
Yesterday, I had the opportunity to ask Nelson a few questions about what’s happening in the Chinese economy, how it is affecting the U.S. economy, and what he sees coming down the road. Here are his perspectives:
PLN: What is your view of the Chinese economy — and what does the future portend?
NMN: I’m a real pessimist when it comes to the current state of the Chinese economy. I also think the Chinese will turn on themselves politically as their economic house of cards is collapsing — so look for a sharp upturn in political and social turmoil as well.
Just as the bubble burst in the U.S. and Europe in 2007-08, it’s bursting now in China — and the rest of East Asia (South Korea, Japan, Thailand and Singapore) are going to get caught in the fallout because of the extent to which their economies are reliant on trade with China.
PLN: What do you look at, specifically, for clues as to future economic movements?
NMN: The barometer to watch is the price of oil. It plummeted in 2007, presaging the “great recession” in the West.
Oil prices began to drop again in 2014. The U.S. oil benchmark fell below $40 per barrel on August 24, 2015, a level not seen since 2009. I believe the underlying root cause is a sharp contraction of East Asian demand due to the economic bubbles bursting over here, coupled with persistently high supply as Middle Eastern oil exporters compete against American producers to protect market share.
PLN: How will these developments affect the U.S. economy?
NMN: The oil bust will continue in the U.S., dragging the economy down. But energy prices will be lower, buoying other parts of the American economy. For instance, the domestic airline sector will benefit and consequential demand for Boeing jets will grow.
U.S. imports — specifically, imports from China and the rest of East Asia — will become cheaper as China and other countries allow their currencies to fall in order to protect their exports.
This is probably a “net-neutral” for the US economy in that American exports will be hurt due to the relatively stronger U.S. Dollar, but American consumers will benefit from lower prices. So, the direct economic impact is likely to be mixed.
PLN: So, why worry?
NMN: The real risk, in my opinion, is a global liquidity crisis. Over the past quarter-century, China and other East Asian countries have accrued enormous wealth. But they didn’t hoard their newfound wealth; they invested it both domestically and overseas.
China has invested ginormous amounts of cash in domestic infrastructure and housing. That money is already spent, and a sizeable part of the investment has already gone to waste in the form of corruption, new housing that nobody wants, underutilized transport infrastructure and non-performing loans made to inefficient state-owned enterprises.
All of this will eventually need to be written off (that’s why their bubble is bursting).
But China has also invested lots of money in overseas financial instruments. Think of the Chinese as the folks who financed the Federal Reserve’s Quantitative Easing program as well as Federal debt in the U.S. But as the Chinese run out of cash at home, they will increasingly need to liquidate their overseas investments just to pay their bills.
This poses a very real threat to the fiscal stability of U.S. and European governments, and to the supply of capital in U.S. and European financial markets.
The Federal Reserve is likely to be caught in a double-bind. On the one hand, if the Fed raises interest rates in response to the reduced supply of capital (as it is widely assumed they will, later this year), they risk choking off the tepid U.S. recovery currently underway.
This would also cause the U.S. Dollar to strengthen further, thereby exacerbating the negative impact of the Chinese bust by making U.S. exports less competitive in global markets.
On the other hand, if the Fed leaves interest rates where they are (basically zero), then they won’t be able to attract enough capital to roll over the public debt that the Chinese are trying to liquidate. In other words, the Fed risks a “run on the bank.”
The Fed can deal with this by printing more money (more or less what the Chinese did in 2007-8), but this would inevitably introduce inflationary pressures in the U.S. It would also lengthen the time it takes for the Chinese to right their ship, because it will put downward pressure on the U.S. Dollar, thereby constraining whatever the East Asians can do to boost exports.
My guess is that the Federal Reserve will “blink” and keep interest rates at zero (and also print more money to pay off the Chinese) in hopes that (somewhat) cheaper imports will offset (some of) the inflationary impact of printing more money.
This is equivalent to kicking the can down the road.
PLN: Do you see any impact on the 2016 Presidential race in the United States?
NMN: As a result of kicking the can down the road, I foresee little impact on the 2016 U.S. Presidential race — but watch out in 2020 when the hangover is well underway.
Alternatively if the Fed raises interest rates, I suspect the Democratic Party candidate will be more vulnerable because the short-term economic pain will be much higher in the U.S. The incumbent party will get most of the blame. Fair or not, that’s just the way bread-and-butter issues play out in American politics.
PLN: What about unrest in China — might that have political repercussions in America?
NMN: The way I see it, political or social turmoil in China will have zero impact on the U.S. Presidential race. Americans of nearly every political stripe or ideology dislike or distrust Chinese governance, yet unlike the “China lobby” of the Cold War era, they have no appetite to intervene in what they rightly perceive to be internal Chinese affairs.
Or they’re clueless about events in East Asia. Or they just don’t care.
So there you have it — a view from the Far East. If you have other perspectives, please share them with our readers here.
Update (8/28/15): A few days after this post was uploaded, I received this follow-up from Nelson: