by Jack Crooks
Saturday, October 29, 2011 at 7:30am

Jack Crooks

Bank of Canada governor Mark Carney said the euro-zone crisis poses the biggest risk to Canada’s economy; and it could take years to fully play out.

But that’s one reason why he just announced the BOC has lowered the growth targets from 2.8 percent to 2.1 percent in 2011 and from 2.6 percent to 1.9 percent in 2012. Another big part of the downward revisions was the decline in exports due to a stronger Canadian dollar.

chart

Obviously then, currency valuations make a huge difference!

Speaking of rising currency valuations dragging down a country’s growth, there’s another story in the background of all this euro-zone crisis chaos … China.

China’s economy isn’t exactly looking good.

I saw an article headline yesterday that suggested a Chinese hard landing is merely a tail risk — something that is highly unlikely to occur but would bring about many unforeseen consequences should it happen.

Nevertheless, to help you track the slowdown path China will be taking …

We could point you to STRATFOR’s founder George Friedman’s book, The Next 100 Years. You’ll get a good sense of how geopolitical and global economics will impact China in the years ahead.

Or we could steer you to comments from The Boston Consulting Group’s latest report: Made in America, Again! It highlights the expected renaissance in U.S. manufacturing, noting the impact it will have on China’s heretofore advantage in manufacturing.

While we may have seen imports of refined copper surge to 16-month highs in September and the HSBC China Manufacturing Purchasing Managers Index expand after 3 consecutive down months, China is fighting a need to become less dependent on manufacturing to feed export demand.

Not only are the tides shifting between the U.S. and China, but the recent currency appreciation is hampering China’s advantage elsewhere. Check out this chart of the Chinese yuan versus the Indian rupee:

chart

Clearly a break out!

Of course, this is not all to do with the yuan; the rupee has fallen in value recently amidst a monetary policy shift. But China still must face head-on, from several angles, its narrowing currency advantage.

Bank of Canada Governor Carney also noted that the monetary policy in the U.S. is one of the leading causes for appreciation of the Canadian dollar.

Ben Bernanke exports U.S. monetary policy to China. And its currency is mostly pegged to the dollar. Therefore, China has been forced to decide between inflation-led growth and a reduction in export competitiveness.

Thus, inflation rules the day. Only now are officials considering abandoning a tight monetary policy that aimed to suppress credit growth and avoid a bursting bubble.

Naturally, amidst this inflation, Chinese wage growth is beginning to eat away at the competitive trade advantage for which China has become known over the last decade. This is from The Boston Consulting Group’s report:

  • Wage and benefit increases of 15 to 20 percent per year at the average Chinese factory will slash China’s labor-cost advantage over low-cost states in the U.S., from 55 percent today to 39 percent in 2015, when adjusted for the higher productivity of U.S. workers. Because labor accounts for a small portion of a product’s manufacturing costs, the savings gained from outsourcing to China will drop to single digits for many products.
  • For many goods, when transportation, duties, supply chain risks, industrial real estate, and other costs are fully accounted for, the cost of savings of manufacturing in China rather than in some U.S. states will become minimal within the next five years.

We are already seeing pushback in the United States to policies that have favored off-shoring and enabled trade imbalances. As the market works itself out — inside the guiderails of U.S. monetary policy and away from the shifting landscape in Asia — China will find itself inching closer and closer to that tail risk.

What’s more, as with Canada, the major hit that’s bound to shred the euro zone’s growth to smithereens is going to bog down China.

Now I’d be crazy to suggest euro-zone officials have found a way out of crisis mode …

The European crisis summit didn’t even come close to producing a definitive solution to the Continent’s debt nightmare.

Banks agreed to taking a 50 percent loss on the Greek debt they own and also to raise new capital …

But no action was taken to protect the banks from far larger losses on Spanish and Italian debt.

There was no plan for enlarging the Euro bailout fund — essential for raising the cash that will be needed to save other PIIGS nations.

At best they’ve simply gotten the squabbling out of the way with investor pessimism backing off for the time being. And that means many eyes could turn to the details of China’s slowdown.

So Chinese officials have their work cut out for them. The most they can hope for is a slow deterioration in investor sentiment. Or else the tail risk begins to wag …

And we know what happens if the new “lynchpin” of the global economy shakes loose.

Best wishes,

Jack





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Saturday, October 29th, 2011 at 10:15 am
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