Global Economic Growth Slowing with China a Main Driver

October 7, 2019
Global Economic Growth Slowing with China a Main Driver, Market Commentary

In looking at 2019, we’ve been calling for a slowing in U.S. economic growth of 2 percent, down from a decent growth rate of 2.9 percent, which we witnessed in 20181. As predicted, overall economic growth has slowed this year. During the first two quarters, real gross domestic product (GDP) growth came in at a 2.5 percent average rate. According to the Atlanta Federal Reserve, Q3 GDP is expected to be in the 1.8 percent range. If this happens, year-to-date U.S. GDP growth would be 2.2 percent. We will see how the year concludes. 

Much of the decline in GDP growth this year is attributable to a slowing in business investment spending. We’ve highlighted this fact for quite some time. Consumer spending, which represents upwards of 70 percent of overall U.S. economic activity, remains reasonably robust as the jobs market, arguably one of the prime drivers of consumption growth, remains in decent shape. Gross private, domestic, non-residential investment – a good proxy for business investment spending – grew by 5.9 percent in 2018. That growth rate has shrunk dramatically to 1.7 percent on an annualized basis so far in 2019.

While the consumer’s growth rate (personal consumption expenditures) has grown by 2.7 percent on average this year, the growth in business investment spending has essentially collapsed. Why? Our opinion holds that the collapse in business investment spending has been driven by an increase in the level of economic (and political) uncertainty. All prior economic data is per BCA research.

According to Ned Davis Research, CEO Confidence data is now at a reading of 34, the lowest level since the first quarter of 2009, when the economy was in the depths of the last recession. The index peaked at a reading of 68 in early 2017. CEO confidence has fallen more rapidly over the last 12 months than at any time in the last 40 years. On the other hand, the same research shows small-business confidence, an indicator of smaller, less globally focused businesses outlook, has declined from peak readings as well, but is still at a reasonable reading of 103.1 as of the end of August.  

Why the difference between large- and small-business confidence levels? We suggest the key is trade activity. Larger companies are more sensitive to global economic forces. Therein lies the core of today’s economic work…looking more deeply at the economies that matter more to the United States.

China – Becoming the World’s Problem Child

To start this discussion, we need to understand how important China has become to overall global growth. According to the International Monetary Fund (IMF), China’s economic output represents about 15 percent of global economic activity, but has represented about 30 percent of overall global economic growth. Simple calculations suggest that if China’s GDP growth slows from a historical 7 percent to 4 percent, and the rest of the world continues its growth rate (which wouldn’t likely ever happen), economic growth would go from 4 percent to about 3.1 percent. Global GDP growth of about 2.5 percent has accompanied developed economy recessions. 

China’s economy is hard to examine, because its economic activity, as reported by the officials in Beijing, is very opaque. Chinese authorities tell the world what they want it to know. Often the facts are not being told. Most economists understand this view and accept it as fact.

That being said, we suggest China’s true GDP growth rate is now below 5 percent, as compared to Beijing’s statements that their economy is growing by 6 percent. Due to the interaction of the world’s economies, China’s growth rate doesn’t need to fall to 0 percent for the world to experience an outright recession (We include the U.S. economy in that statement.). 

China’s growth is faltering, despite the central planner’s platitudes of continued strong growth. Numerous attempts have been made over the last year by the communist central planners to stimulate economic growth, but by the best numbers we can see, growth has yet to show any real uptick. The chart below shows the growth rate of both the industrial and consumer sides of the Chinese economy over the last 22 years. As can easily be seen, the growth rate has been declining significantly for quite some time.  

China Industrial Production & Retail Sales

Why is the growth rate in China slowing? What is happening that is beyond the central planner’s reach?

  1. The population base in China is aging. According to an article in the People’s Daily (the official government newspaper), the population of elderly in China will increase from 194 million in 2012, to 300 million in 2025. Elderly people tend to retire or become less productive than younger workers. This increase of 55 percent of elderly over a mere 12 years is exacerbated by the fact that the average worker in China has yet to reach “middle-class” status, never mind becoming wealthy. The upward increase in the elderly weighs heavily on social costs and negatively on worker productivity, which are both drags on overall economic growth. 
  2. Numerous attempts have been made by the central planners to stimulate China’s economy, none of which has yet to sustainably impact positive growth. China’s economy has become very highly levered. Debt outstanding from most segments of the economy has risen dramatically. Private domestic, non-financial debt-to-GDP has risen to a ratio of 208 percent during a time when overall GDP growth has contracted. In the United States, this ratio is 147 percent. This is an indicator that China’s economy has become more levered than the economy in the United States.

It appears that China’s overall economic growth will continue to slow over the long term. This will be driven by factors that are not impacted by tariff’s or other foreign policies. This is important to understand, as the potential impact on global and, specifically, emerging market economic growth, will be meaningful.

Tariff Update

Tariff and trade restrictions imposed by the Trump administration are impacting China’s economy. According to a report from CNBC, numerous U.S. companies are moving planned investments away from China. Additionally, the South China Morning Post has reported that an eastern Chinese city known for its textile production exported 28 percent less in the first four months of 2019, as compared to the same time period in 2018. It appears investment growth is slowing in China, while export growth is also contracting. 

Will the Trump administration give ground and come up with a solution to the China problem? As outlined in an earlier writing, we believe the real problem in China has little to do with actual tariff issues. Instead, the trade dispute is due to the U.S. challenging China’s ascendance to economic power by raising issues of business practices China has exercised in the past from forced partner status to intellectual property theft and forced technology transfer. 

While we may see progress made on the trade talks with China, the real reason behind the conflict with China seems to be issues that may negatively impact the relationship between the United States and China for quite some time. Under the leadership of President Xi, China is attempting to become a more aggressive world power socially and possibly militarily.

Business Surveys

In combination with the weakening global economic picture, U.S. economic growth shows more signs of weakening. Recent business surveys confirm this view. A read of less than 50 suggests contraction and a read above 50 indicates an expansion is occurring. 

Two main survey organizations are suggesting the pace of growth in the United States is slowing. The ISM Purchasing Managers Index is reporting a reading of 47.8, down from August’s report of 49.1. This indicates manufacturing momentum is contracting. The other organization is showing an expansion, as opposed to a contraction.  The IHS Markit Purchasing Managers Index is now at 51.1, up slightly from the month’s earlier output of 50.3.2 So, while one survey is showing further weakness in the manufacturing segment of the U.S. economy, the other indicates output is moving slightly higher. While we have conflicting data, it’s true that both have weakened significantly over the last year. 

The services segment of the economy also appears to be softening. While both are still above a read of 50, the ISM and the IHS surveys have weakened over the last few months. Most troubling, the IHS market survey, at 50.9, is only slightly positive. The ISM Services Index, which showed a strong 56.4 in August, is now at 52.6, a reasonably strong decline in only one month. 

We suggest the U.S. economy remains in an expansion mode. We stand by our view that the U.S. economy will grow by about 2 percent this year. It seems, however, that the U.S. economic growth has been decelerating rather markedly over the last half year. We don’t see much in the cards to lift our domestic growth rate to more than 2 percent as we enter 2020.     

1Bureau of Economic Analysis

2Trading Economics, “United States Manufacturing PMI” 

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