The Chinese and U.S. economies are changing—but it’s too soon to call it a ‘new normal.’
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.
Those countries lucky enough to fall in the penumbra of Chinese demand have, until recently, grown rapidly. A new global middle class has appeared, and their demand for goods and services was purported to be the next wave of global growth. But many of the new emerging middle class are reliant on the ‘old’ Chinese growth model. Few, if any, are well equipped to prosper from the ‘new’ Chinese growth model. This is a disconcerting prospect. At least for the time being, the straightforward, commodity-driven growth of the past is no longer viable. Whether or not the emerging middle class was a side-effect of a commodity bubble has yet to be seen, but the “after normal” economy rewards commodity driven growth far less than the “normal’ economy did.
The United States is also paying close attention to China. The devaluation of the yuan in September was probably what caused the Fed to pause before raising rates. The effect of such a move was an unknown to the Fed, and the unexpected nature of it raised some alarms in the market. At least on the surface, this was a move toward a greater role for the markets in pricing the yuan—something the West should have cheered. Western markets sold off sharply on the news, however. The devaluation of the yuan is not an immediate game changer, but if the weakening is persistent, the United States will be importing deflationary pressures from China. This happened in the early 2000’s, and it did not end well.
What’s Next For America?
For the U.S. economy, ‘after normal’ involves a rapidly changing economy and a Fed with an impossible task. America is in the midst of a demographic shift, and technology is rapidly altering the skills necessary to compete in a transforming job market. Meanwhile, the Fed is attempting to slowly ‘normalize’ its policy without allowing the economy to overheat or fall into a recession.
Because there is now a global workforce, many jobs can be automated or outsourced if wages rise too much. This contestability of labor is keeping wages low, even as unemployment falls. Contestability is one reason that the Fed should be concerned about America’s own commodity-linked employment. The Yellen Fed’s labor market goals should be directly connected to ensuring that the United States has created enough uncontestable jobs for the Fed to further normalize. These uncontestable jobs are the type that will lead to—or at least allow for—future wage pressures. Prime examples are the jobs in America created by the current shale oil boom and construction jobs during the housing boom.
Another factor at work in the United States is the multi-decade rise of part-time employment as a proportion of the labor force. In many ways, the United States is fertile ground for the kind of jobs created by Uber. Uber allows for part-time work and flexible hours, the jobs are non-contestable (at least until there are self-driving cars), and the complacency factor is counteracted by surge pricing.
Technology is usually a good thing. It nearly always enhances our lives and makes us better off, but it has a habit of evolving—sometimes very quickly. Technology can enhance and degrade the usefulness of certain skills as well as render job experience entirely useless. The digital technology shift of the past couple decades may be far more important than we thought—especially given the low savings rates of Boomers and their need to stay involved in the workforce. The pace of technological change may explain, at least in part, why the current recovery has been so poor: too many people with too few technology skills remain in the workforce. The inability to reach out to the cutting edge of technology may be holding back the U.S. economy.
What’s Next to the Federal Reserve?
The Fed has, at the very least, had a hand in creating the current situation. It also has a tremendous amount at stake in getting its policy correct over the next several years. Not simply because its job is to set interest rates and use other monetary policy mechanisms with judiciousness and care, but also because it is coming under increased scrutiny from nearly every angle.
To operate efficiently at the Zero Lower Bound (where Fed Funds is near or at zero), the Fed has been forced to be transparent in its intentions and thought processes. But this has side-effects. Policy transparency from the Federal Reserve allows other central banks to anticipate its actions—and respond accordingly. This arrangement has its benefits and its consequences.
One consequence is that the other major central banks are forcing a revaluation of the dollar—whether the Fed likes it or not. By transmitting its policy function, Yellen and the Fed have essentially allowed for the euro and yen to rebalance lower.
Transparency removes the pain point of coordination, but it creates the ability to game the system as well. The Fed has tolerated other central banks piggy-backing off its policy transparency for some time, but now it is making it difficult for the Fed to enact its own policy. Although transparency and loose policy coordination are inseparable elements of the present moment, the Fed is rightfully concerned with potential abuse and amplification of its actions by others.
For now, ‘normality’ for the United States does not change too much with the first rate hike. Interest rates—especially on the long-end—are likely to remain relatively low for an extended period of time. This is partially because the U.S. economy could tip near or into recession with a sharp jump, but also because the Fed is going to be hyper-vigilant.
Tipping the United States into a recession would destroy any remaining confidence in the Fed, and cause more saber rattling from Congress about using a monetary policy rule. The Fed wields a tremendous amount of economic power in its monetary policy, and there may be some jealousy emanating from the halls of Congress. But creating a rules-based system with checks against deviation may harm the Fed’s credibility by showing consistent gaps between the Fed’s targets and reality.
At some point, there will be a ‘new normal,’ but the Chinese and U.S. economies, as well as the U.S. Federal Reserve, are not there yet. For now, we are simply in the ‘after normal’ phase with little direction on the future path of the global economy.