A growing China, a growing Asia.

The world breathed a sigh of relief this week when the US Government chose not to commit collective suicide just yet, although I suspect we will be reliving the drama as early as next January.

We also heard that Chinese GDP growth had accelerated from 7.5% to 7.8% annualized.  Given the determination of the authorities to make sure that the economy did not fall off a cliff, these numbers should hardly be a surprise. As with all numbers out of the Middle Kingdom, we should treat them with a certain degree of skepticism, but what matters most at this juncture is whether they were better or worse than 7.5%, rather than whether they were 7.8% or 7.7%.

The World Bank released its October East Asia Pacific Economic update, titled Rebuilding Policy Buffers, Reinvigorating Growth. This confirmed the rebound in investment in China, showing that FAI was responsible for more than ½ of the GDP growth in Q2.

FAI in China is like QE in the US, or ECB bond buying; to misquote Saint Augustine; we all want it to end, just not yet. So we should take comfort from the recent increase in Developed World forecasts from the IMF, and the nomination of Janet Yellen to replace Bernanke as Fed Chairman.

I have to assume that the consensus is correct, and that Yellen will be a “dove” when it comes to Fed Tapering, so that it will only happen slowly thus keeping policy more simulative for longer. The US should also enjoy further stimulus from the increased use of cheap shale gas.

Recent announcements from the Bank of England suggest they are in no hurry to raise rates before 2015, and the Japanese are forging ahead with Abenomics.   This all suggests to me that current IMF projections are too low, and they will be raising them again early next year. I doubt by much, but it is again the direction that is important.

If global growth is slowly being rebalanced, with the Developed Markets doing a better job of pulling their weight, we should see international trade accelerate. One of the most interesting graphs in the whole World Bank report was one for the Baltic Dry Index, showing a bounce to levels not seen in two years, which suggests such a pick up.

Baltic Dry index 5 years - Bloomberg

Paradoxically, one of the factors that vexed investors earlier this year should also help the EAP countries in this regard, namely the weaker currencies. Despite all the hysteria, the Asian Currencies had actually appreciated since the onset of the GFC, leading to fears of over valuation. That appreciation hasn’t been eliminated by this year’s weakness, but the currencies are clearly less overvalued than they were, improving export competitiveness.

Going one stage farther and looking at the underlying relationship between the whole QE program and Foreign Exchange appreciation within the major EAP countries, it is hard to find a significant correlation, suggesting that, barring a self-fulfilling panic, the effects of Tapering will be considerably more muted in the real economy.

China recently over took the US as the world’s largest trading nation (measured by Exports  + Imports), so it is seems axiomatic that China should be a major beneficiary of this firmer growth. At the margin, as global growth absorbs more Chinese exports, China can – and hopefully will – cut back on stimulus investment spending, just as the US should ease back on QE.

Easing back on stimulatory infrastructure spending as International trade picks up the slack is about as close to orthodox Keynesianism as it is possible to get these days, something the West has ben particularly poor at these last 50 years, so am I being overly optimistic that China will handle the withdrawal better than most Western Nations?

I think the key difference is that China knows its economy is gradually decelerating, and that the chances are they will need to make further stimulus investments during the current leadership period. They have made 7.5% the base line for growth for the next ten years, so they need to make sure that they have the ability to stimulate effectively should they feel that target is in danger of being breached. They also recognize that the economy is currently highly unbalanced and that the reckless pursuit of growth could undermine their long-term aims. As the World Bank report says, “The authorities recognize that growth has become too dependent on the continued expansion of investment and have articulated the need to internally rebalance the economy toward consumption-led growth, starting with the current five-year development plan.” This is not something I expect them to get perfectly right, merely good enough.

To be clear, I am not suggesting a dramatic pick up in growth and a return to the good old days. What I am suggesting is a marginal acceleration above the current projects, confirming the existing trend.