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China and America’s Economic Challenge

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Pacific Money

China and America’s Economic Challenge

With a “fiscal cliff” in the U.S. and needed “rebalancing” in China, both have big economic decisions looming.

In the United States, the world’s largest economy, President Obama has secured a second term as leader of the country.  In China, the second largest economy, by this time next week new leaders will likely have been confirmed as well. In both cases, the new leaders will officially begin their terms in 2013, even if Obama has the luxury of being already on the job.  The end of the leadership “contests” in both countries sees the end of a struggle for power which at times got pretty tough.

Obama has already been dealing with a sluggish post crisis-economy, and China’s incoming president and prime minister have also already been battling economic difficulties in their current roles in government.  For both countries, whilst by this time next week the political-leadership struggles may be over, from an economic and financial standpoint, the real challenges are yet to come.

For the United States, the most pressing issue is the impending “fiscal cliff”. This is the term used to describe an automatic package of tax increases and spending cuts with a combined value of appx. U.S. $600 billion.  Time is tight with only weeks before the deadline on 1st January 2013.   Without a deal to either increase the U.S. government debt ceiling, or an extension of the deadline, the U.S. will almost certainly fall into a double dip recession in 2013.

The Republicans have lost the presidential election, and have some pretty hard soul searching to do as to why.  Their control in the House of Representatives and ongoing ability to complicate matters in the Senate makes them extremely relevant though, especially since they can effectively kill any attempt to push the fiscal cliff further down the road.   

China’s new leaders, face an equally daunting task.  Whilst China’s growth rates still far outshine that of the U.S., the economy is facing structural issues which will take years, and a lot of political capital to resolve.  The investment heavy growth model is unsustainable, even if one more burst of investment stimulus may be tempting to a new president and prime minister looking to consolidate their power next year. 

China’s rebalancing must require households to get a larger share of the economic pie, allowing consumption to take over as a growth engine rather than debt-backed investment which is increasingly misallocating capital.  The main challenge for the incoming leaders if they are serious about rebalancing is going to be overcoming the opposition of “entrenched interests” as key policies are reversed. These interests include those linked to state owned enterprises, the export industries, any employers relying on cheap labour, and any firms addicted to what is effectively “subsidized” credit.

If the U.S. tumbles over its fiscal cliff, the outlook for China will become that much harder. A double dip U.S. recession will further batter China’s export markets (pain which will also be felt by countries in China’s manufacturing supply chains) and rebalancing for Beijing will be much harder in the resulting dismal international environment. 

One bit of good news for emerging markets is that Chairman of the U.S. Federal Reserve Ben Bernanke, whose looser monetary policies at the Fed have maintained a comfortable international liquidity situation, is now set to keep his job (whereas Romney had promised to remove him).  In addition, with the fiscal cliff line up now unchanged, it is more likely than before that Bernanke will have to offset a fiscal rooted slowdown next year with even more monetary accommodation.  Generally speaking, abundant liquidity in developed markets is positive for emerging market performance.

Hence neither the U.S. election result, nor the solidifying next week of China’s generational leadership transition will fully eliminate market uncertainties about two of the biggest economic issues facing the world today – China’s rebalancing and the U.S. Fiscal Cliff.