Global Growth is Slowing and China is the Wild Card

Written by Stephen Swanson

Over the past two weeks a spate of manufacturing PMI and confidence surveys and have been released for many developed and emerging market economies, offering an insight into the depth and breadth of what is often referred to as a synchronized, global economic slowdown.

It’s beyond the scope of this note to review every country. We will look at most of the major economies comprising the $70 trillion global economy to get a sense of major PMI trends and the depth and breadth of the current contraction. It would also be useful to get a sense of the current rate of global growth and develop an idea of how growth might unfold in the future along with a discussion of the likely geographical distribution of future growth and factors that will determine its absolute rate and its rate relative to the past.

In the US the final Markit manufacturing PMI fell to its lowest level for three years in September.  At 51.1, down from 51.5 in August and lower than the earlier flash estimate, the PMI was consistent with only a modest expansion of the U.S. manufacturing sector. However, the ISM PMI factory gauge rose to 51.5 in September from 49.6 in August marking an end to three months of contraction. New orders were largely behind the improvement in the ISM PMI but the divergent trend between the two data series is a bit troubling notwithstanding similar readings for the month. But these divergences, while vexing, are not uncommon in the US economy as the data suggests very modest but uneven and fitful growth

In the euro-area manufacturing contracted for a 14th month in September according to Markit, suggesting the economy likely struggled to avoid a recession in the third quarter. At 46.1 the index indicates contraction and has remained below 50 for fourteen months and fell as low as 44 in July. Germany edged closer to stabilization, but still saw output fall for a fifth straight month.

Italy saw a steep drop in activity, although the rate of decline eased to a six-month low. The real causes for concern were France and Spain, which both saw accelerated downturns in manufacturing. The month-on-month decline in the level of the French output Index was among the sharpest in its history hitting its lowest level since April 2009

U.K. manufacturing shrank more than economists forecast and export orders declined for a sixth month. A measure based on a survey of purchasing managers fell to 48.4 from 49.6 in August, according to Markit and the Charted Institute of Supply.

China’s official PMI showed factory activity shrank for a second consecutive month in September, even though the index rose slightly to 49.8 from 49.2 in August. The September PMI indicated that the economy, while still sluggish, was at least no longer deteriorating. New orders increased to 49.8 from 48.7 in August. That was partly driven by an increase in the export order sub-index to 48.8 from 46.6, underlining a slight improvement in external demand.

In contrast, the HSBC PMI came in at 47.9 in September, up slightly from 47.6 in August and signaling an eleventh successive month-on-month deterioration in Chinese manufacturing conditions although with the rate of deterioration moderating. As with the US we have divergent data series largely because the official PMI is known to suffer from crude seasonal adjustment methodologies and focus exclusively upon large state owned enterprises while HSBC incorporates more refined SA factors and measures activity across small and medium scale enterprises.

China’s official non-manufacturing industries are also struggling, expanding at the weakest pace since at least March 2011 as officials struggle to reverse a continuing slowdown. The PMI fell to 53.7 in September from 56.3 in August weighed by weakness in construction services, transport and generally lackluster new orders.

The BOJ’s Tankan survey showed that big Japanese manufacturers are feeling significantly more pessimistic, registering -3 for the September quarter compared to -1 for the June quarter.

Manufacturing data for South Korea out Tuesday showed a sharp decline in orders and activity and economists believe there’s likely more gloom in store.  HSBC’s Purchasing Managers’ Index for September printed at 45.71 down from 47.50 in August. The September result was the fourth straight monthly reading below the 50-point level.

In Taiwan, HSBC’s PMI survey showed manufacturing activity slowing in the third quarter, with the index staying below the 50 level for the fourth month running at 45.6.

The JP Morgan consolidated global PMI, produced by Markit from national PMI surveys, rose from 50.9 in August to 52.5, though the improvement was largely driven by a jump in the volatile ISM non-manufacturing index for the US. Taken together worldwide PMI surveys remains far weaker than seen earlier in the year, but show faint signs of picking up or contracting at a slower rate in September. From the report: September’s mild acceleration at the headline level masked the ongoing divergence between the performances of the global manufacturing and service sectors. Service providers continued to report solid growth of business activity, with the rate of expansion the quickest since March. In contrast, manufacturing production fell for the fourth month running. The latest expansion in global output was heavily reliant on the US, where economic activity rose at the fastest pace since March. The UK, Brazil, Russia and Ireland also saw output increase. The Eurozone, in contrast, remained the principal drag. Output in the euro area declined for the eighth month running and across its four largest national economies. Japan also reported a contraction.

Broadly speaking, the data shows the US is wobbling along the course of the new normal with paroxysms of growth here and there although Global Economic Intersection recently downgraded its outlook in response to a simply awful durable goods report; the euro area is flat lining with the core economies growingly increasingly vulnerable with a distinct bias to the downside; Japan is, well, Japan and as John Mauldin saying “a bug in search of a windshield”; South Korea, which is viewed as a bellwether of global trade, is confirming the contraction in global trade while suggesting things will get worse before getting better; much of South Asia and Indonesia is pausing; and China is still struggling with the global slowdown and its own problems of an over heated housing market, massive over investment, surplus capacity, quandary over policy response and a pending change in leadership. Economic malaise appears to be in a global orbit.

In terms of actual global growth, the JP Morgan Global PMI suggests that the global economy is expanding at a mere 1.5% to 2.0% annual pace which is considerably less than that expected by many economists and global organizations. Handelsblatt, a German daily, reported on Friday that the IMF now expected global economic output to expand by 3.3 per cent in 2012, down from its July estimate of 3.4 per cent. The fund will also lower its forecast for world growth in 2013 to 3.6 per cent, from its 3.9 per cent July estimate. This is higher than the Markit JP Morgan estimate, in part, because the latter is based upon current tracking activity, as opposed to full year forecast, and obvious political constraints preventing the IMF from being excessively cheerless.

Nonetheless, the IMF forecast assumes a slow but steady recovery and resolution of the most pressing issues of the day, including the slowdown in China, the European sovereign debt crisis, continued deleveraging in the US and agreement on means to avert the US fiscal cliff. However, Oliver Blanchard of the IMF last June warned of meta uncertainty gripping corporations across the globe and more recently warned that it could take ten years for the global economy to emerge from the financial crisis of 2008. And this was qualified by adding China has addressed its housing bubble, will avoid a hard landing and resume growth, albeit, at a slower rate. In other words, the GFC will correct in ten years assuming China is not infected.

Needless to say, this is a big assumption and is at odds with the views of others (many) that the financial crisis may spread to China and prolong the time needed to repair and restructure its economy through reducing its reliance upon investment, which is close to 48% of GDP, and exports while expanding the role of consumption spending. It’s a crucial issue because many countries are highly dependent upon trade with China and many view the Middle Kingdom and its neighbors as the as the only catalyst for global growth.

As an expert on China, Michael Pettis believes China’s growth after restructuring could fall to 3% to 4% from the current rate of approximately 8% which is already down from double digit growth. He adds: But to say that a development model has reached the point at which it no longer generates healthy growth, along with which debt is building up at an unsustainable pace, and which will require a very difficult adjustment, is not the same as to say that the country will collapse, and especially not the same as saying that it will collapse with in six months or a year. Jim O’Neil of Goldman Sachs, though, believes China’s problems will be resolved and will see growth of 7.5% over the coming decade.

Given the fact that China accounts for close to 10% of the global economy and has accounted for 30% to 40% of global growth in recent years, a reduction in Chinese growth of 4 percentage points would severely diminish the most promising catalyst for global growth and reduce growth (global) by 0.4 points.  Western economies suffer from excessive deficits and debt; unfavorable demographics; and developmental and economic maturity. Even though economic turbulence has merely moved eastwards in its global tour and structural shifts are underway, China, Indonesia, Vietnam and the Philippines offer the greatest opportunities for global growth. Columbia, Peru and other countries in Latin America may offer promise as well.

The prospect for reduced secular growth in developed Western economies is not a novel thought as early economic thinkers saw constraints and limitations to economic growth. John Stuart Mill’s most important contribution to political economy was arguably his theory of development: that growth was a function of capital, labor and land (or natural resources). Mill felt that sustainable development was only possible if growth in labor was exceeded by growth in land and capital productivity, rather than debt. While the model has changed, the outcome has not. The long term annual growth rate of the US economy has slowed from its historical average of 3.4% to a 20 year moving average of 2.5% and 10 year moving average of 1.7%.

As the US remains the world’s largest economy, and the single most important influence on international economic trends, the importance of such long term deceleration is self-evident: US contribution to global growth has been and continues to decline and must be offset by growth in China. If it is, then the IMF forecast may be realized but if it is not and the Pettis thesis prevails, then global growth will be far less than expected and exert profound influences on reduced incomes, wealth, standards of living and corporate profits. Global angst will become the prospect low growth will become a permanent feature of the world economy.

And it just so happens Martin Wolf over at the FT wrote this week on such a possibility.

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About the Author

CautiousInvestorStephen Swanson has a degree in economics and an MBA. His corporate experience includes several executive positions including a divisional VP assignment. More recently he has left the corporate world and has been investing in financial instruments and real estate, with interests expanding into S&P futures and commodities. Stephen is known on the internet under the pseudo nom CautiousInvestor and is a frequent commentator at Seeking Alpha where he also posts blogs.