U.S. vs. China: Divergent Economic Paths

In the history of finance, two countries as interdependent as the United States and Chinese have rarely taken such divergent macroeconomic paths.

The United States

The Fed published Friday evening the latest consumer credit statistics, which were really abysmal!

As you can see in the graph, below, the $17.50 monthly plunge in November is the worst ever recorded.

This illustrates that, despite all the Fed's efforts to reflate the economy, banks are still not lending (hike in reserves deposited at the Fed by commercial banks) and consumers aren't borrowing either (consistent with de-leveraging process.

In such a situation, we still see no inflationary danger (core PCE) in the US, and thus no risk of the Fed hiking key interest rates in 2010, and we aren't counting on 2011 either: just check out the December 2011 Fed Funds Futures at 97.70, i.e. a yield of 2.30%.

And Sunday evening's comments in Shanghai by reputed hawk, St Louis Fed President, Bullard, also go in the same direction:

• The Fed's liquidity programs (are) not an inflationary concern
• Interest rates may remain low for quite some time
• Any risks of igniting inflation by mishandling the Fed's exit from its support policies lie two to four years in the future
• Markets should be focusing on quantitative monetary policy rather than interest rate policy.

China

Meanwhile, China, which has been riding an unprecedented, administrative credit wave (600bn yuan for the first week of 2010!), continues to post incredible statistics, like the foreign trade figures this morning.

Exports have practically made up for the entirety of ground lost since the beginning of the crisis (+100% since February 2009).

But, above all, imports have also climbed to a new high, overtaking those of June 2008, at $112.30bn. They have indeed rebounded 118% since the dip of January 2009.

Still trade balance continues to show a strong surplus of $18.45bn, making it higher than that preceding the pre-crisis period from 2004 to June 2008. Such a performance will undoubtedly reignite the debate about the needed revaluation of the Renminbi!

In any case, as we have repeated time and time again in these lines, according to Mundell's incompatibility triangle, if China wants to maintain its currency peg, it will have to take much more coercive measures to control capital movements unless is wants to allow control of its monetary policy to fall totally into the hands of the Fed.

However, this type of coercion is not really compatible with an economy that aims to become the world's second largest in terms of GDP this year, and its American-style interest rates of 0% on a fast-expanding credit market cannot last forever either - Especially since Chinese officials have no intention of taking their collective foot of the stimulus accelerator, as illustrated by the comments on Sunday of Finance Minister, Xie Xuren, before the CCP politburo:

• China will extend active fiscal policies aimed at countering the global economic slowdown into 2010
• Departing "too early" from those policies could damage the economy
• China's active fiscal policies in 2010 would focus on expanding domestic consumer demand

Japan

The last point, which we find increasingly worrisome, is the possibility that Japan will move to an increasingly aggressive currency policy, as advised by PIMCO's McCulley and Masano in their latest article: Where Exit Should be an Oxymoron: The Bank of Japan.

The danger of falling into a Japanese-style situation has been one of our major themes for quite some time, as we have insisted on the need for the BoJ to be inventive.

But what is interesting is these two gentlemen argue that the BoJ should intervene directly on currency markets, by selling the yen in unlimited quantities to fight deflation, making use of all available arms (like the Swiss).

However, if the Japanese take this path, imagine the consequences for the eurozone, which is already suffering under the weight of its strong currency (despite the efforts of the Greeks)!

Keep a close watch on the euro/yen exchange rate which, at 134, remains close to its average since March 2009: if investors were to anticipate such a move, the yen could leave this range pretty quickly, with the main resistance point being at 139; and then what … 170?

In such a situation, the ECB could view this as one more factor tying its hands, as interest rates remain low for ‘for an extended period of time’.

Consumer credit in the US