While markets are having a shaky start to 2016, the chatter of commentators proclaiming the ‘new normal’ at which the global economy has supposedly arrived has been steady. It is true that the economic framework for the United States, and the trajectory of the global economy, is different than that experienced over the past few decades, but it is also far too soon to form a complete picture of what that ‘new normal’ looks like.
Of course, how the world got to this moment is a much clearer. The now ‘old’ normal was defined by an aggressively growing China and a monetarily loose U.S. Federal Reserve. The two were intertwined to a degree: the Fed was reacting to the deflationary pressures brought on by the reduction in manufacturing employment, and China was encouraging a surge in its manufacturing base. Meanwhile, the emerging world—largely reliant on commodity exports—was benefiting on all sides: a weak dollar inflated global commodity prices while surging Chinese demand worked to push prices higher as well. This ‘dual stimulus’ propelled the world through the beginning of the twenty-first century.
The financial crisis brought this to a crescendo of sorts. Yes, the Fed had raised interest rates, but it was too late to avoid a commodity bubble. In response to the collapse, China undertook a massive stimulus program, that effectively bailed out its commodity trading partners, so much so that Australia and Canada were largely insulated from the worst of the global downturn.
The dual stimulus set the stage for the ‘normal’ of the beginning of the twenty-first century—the awkward interaction of a booming global economy and a transitioning U.S. economy. As manufacturing jobs were off-shored and then automated, the U.S. economy found ways to cope. First, it utilized the housing boom, and then the shale oil and gas revolution—both of which required the highly paid, low-skilled labor critical to inflating America’s bubbles. Now that the bubbles have popped, the question lingers as to where the next low-skill employment boom will occur.
The question for the Chinese economy is whether it is transitioning (to a consumer-driven economy with expanding services) or faltering (due to excessive leverage and inadequate financial structures). Either way, the demand for raw materials is unlikely to be as robust as it was in previous periods, and this spells trouble for much of the emerging world.
Also troubling is the monetary pivot taking place in the United States. Leading up to and following the financial crisis, U.S. monetary policy was highly accommodative. This pushed the dollar down and commodity prices higher. However, as the Fed began to taper its quantitative easing strategy, the dollar began to strengthen. Beyond the pressure placed on the complex by stagnating or falling demand, the resurgent dollar weighed on prices. The Fed ended the dual stimulus, and left the world in an unfamiliar position—without China and without the Fed.
There are those who see the current headwinds as transitory—the view the Fed appears to hold. But there is also the less sanguine view of secular stagnation. Secular stagnation, if true, would hold that growth is going to be slow for an extended period of time, and that monetary authorities will have little ability to jolt their economies out of it.
To a degree, no one has seen this before. There are certainly correlations to be drawn with different points in recent economic history (and it always rhymes), but there has never been an investment boom like China circa turn of the twenty-first century. The United States following World War II could be pointed to as a parallel, but the scales are wildly different.
What’s Next For China?
China has taken this opportunity to become more involved in the global economy, either through engaging with Western institutions or creating similar, seemingly parallel ones. With its “One Belt, One Road” initiative, China is attempting to regain its historical position in global affairs and economics. This takes investment in other countries, and that takes institutions and capital. The Asian Infrastructure and Investment Bank is one such structure, and it will play a critical role in the development and potential success of China’s economic plans.
China has also pursued and gained a place in the Special Drawing Rights at theInternational Monetary Fund, which gives the yuan official reserve currency status. The People’s Bank of China had recently begun to allow the yuan to move more inline with market forces, and has now shifted toward using a larger basket of currencies to determine the value of its own currency—a move away from a dollar-dominated methodology.
In terms of institutions and currency, ‘after normal’—the transitional spot we find ourselves in today—is a test of whether or not China has the ability to be a viable alternative to the West. This has yet to be seen. But China is certainly attempting to create alternatives to the long-standing Western structures.