‘The Perfect Storm” is more than a movie (and book) title; it was a real meteorological event. In October 1991, Hurricane Grace, moving north along the East Coast, collided with a massive southbound low-pressure system from Canada. Result: A storm of record-setting intensity that created high winds and waves in excess of 80 feet high just offshore in the Atlantic Ocean.
China could set a perfect storm in motion that would create destructive waves of its own, including a recession for the U.S.
The perfect economic storm might begin with a low-pressure area. China’s economy now fits that description. Its GDP growth rate has tumbled significantly over the past few years and there is a long list of problems that must be solved to get the situation turned around. Near the top of that list would be its aging, less-productive labor force and the stalled level of foreign trade. And, certainly, the disappearing wage differential and the increasing discomfort of foreign investors with the bureaucratic obstacles and restrictions do not help matters.
China is an economic force. By some measures China’s economy surpasses ours. How that was achieved, though, may create swirling currents of stress as its economy tries to recover from a developing low-pressure system fronted by a precipitous drop in both output and productivity.
The rapid growth of the Chinese economy was fueled by debt, both private and public.
Household debt in China, as a percentage of household income, is considerably higher than in the U.S. or any other developed economy. And public debt, which was used to sustain and bolster the economy each time it faltered, is at a troubling level. Bond rating agencies and other financial analysts are wavering between skeptical and nervous about China’s debt picture and are particularly worried about the country’s municipal debt and the private sector’s bond quality. Bloomberg called China’s municipal and local government bonds a “time bomb.”
Meanwhile, Europe is preparing for its own developing low-pressure area. Central banks there are switching to a stimulating posture as the members’ economies falter and some even move into negative territory.
European financial markets will be expected to fund the effort to bolster the economies there. Central banks will buy bonds in order to keep short term interest rates low, and governments will issue more and more bonds to fund “pump-priming” public investments that will keep employment and incomes from shrinking. All that is normal and expected during a low-pressure period, and it is probably absorbable, if painful.
If, though, China’s low-pressure system were to collide with Europe’s low-pressure system, we would have a perfect economic storm — powerful enough to drag the rest of the world, including the U.S., into its damage zone.
Like the perfect storm in weather, economic events must happen at just the right time and the forces must be at just the right strength. China’s economic low-pressure area may not appear in Europe’s financial markets with enough strength to cause a catastrophe if, for example, the government finds a way to shore up things without resorting to a major debt increase.
The European economic low-pressure situation also could be resolved without a disastrous collision. The Europeans talked themselves into their approaching recession and can talk their way out of it. Psychology-based recessions can turn around to growth and prosperity in an amazingly short time. We’ve seen an example of that in our own country over the past two years.
Perfect storm or not, there is still a question of whether China’s and Europe’s problems will spread to the U.S. economy and possibly cause a recession here. As demand for borrowed funds drives up their interest rates, ours would logically be dragged alone with them — it is a global market, after all.
On the other hand, psychological factors may play an important part in capital movement. It is quite possible that U.S. markets will see an increase in long-term funds as investors seek a “safe haven” from the turbulence and debt demand of other markets. This could drive U.S. long-term interest rates even lower than they are now, which would encourage our domestic investment and spur our economy to new heights.