The world’s two leading economies have divorced! The US is having to deal with inflation while China is experiencing a period of deflation. Because of the great level of interdependence among countries in the global economy, it is usual to expect economies to follow the same business cycle. Moreover, so many other economies are dependent on what happens in China and the US that they follow the fortunes of these two economic superpowers.
The Federal Reserve of the United States has increased interest rates for a whopping 11 consecutive times in its efforts to combat inflation. The Bank of England and the European Central Bank are following suit in different degrees.
The July data on inflation in the US shows a rate of 3.2% compared to 9% a year before. Core inflation (that is excluding food and energy prices) is at 4.7%, which is decidedly high. This has brought its negative impact on a number of social and economic elements. However, fighting inflation is the number-one priority in the US.
The July economic data for China has not matched expectations. Retail sales rose by 2.5% against an expected 4.5% rise. Industrial production rose by 3.7% in July from a year ago, below the 4.4% increase analysts had expected. On a year-to-date basis, real-estate investment fell by 8.5% from a year ago as of July, a greater decline than as of June. China is also having to deal with youth unemployment and negative investment sentiment. Foreign investment has decreased and price inflation is -0.3%, meaning deflation.
There has been talk on a decoupling of the US economy from the Chinese economy for months. The US government had wanted this for strategic reasons and, in fact, used a more euphemistic term such as ‘de-risking’ the US economy. However, such a divorce between the two economies, in that they have a diametrically opposed economic environment and the trajectory of the respective economies is in opposite direction, occurs very rarely. In the current scenario, we do not have a de-risking process but a real decoupling.
How this decoupling (or divorce) of the US economy from the Chinese economy will evolve will impact international markets in the future
In reality, China has always been able to manage past slowdowns in the global economy better and to feel its negative effects less. It has consistently relied on the US market for its exports and gradually became a leading economy. We should not rush into conclusions on the basis of the bad economic news of the past months. Neither should we rush to any conclusions on the US economy, which still needs to resolve its governance issues related to a Republican-led House of Representative and a Democratic president.
However, there are some considerations to make. This year, growth in the gross domestic product is likely to be at 3% for both economies. However, such a growth rate, although the same, is not the same for both countries. For China, a 3% growth rate is low given that it is still an emerging economy. For the US, a 3% growth rate would push it to nearly full employment.
The second consideration is the way out of deflation for China. It exists. Using traditional economic thinking, in a country where prices are going down, there is also a devaluation of the currency. With a devaluation of the currency, China can achieve stronger economic growth through exports to the Western economies. That had worked in the past. Will it work again now, given the not-so-good relations between China and the US?
This situation will be evolving in the coming months, and I would say even in the next two years. Political and economic considerations will get intertwined. However, how this decoupling (or divorce) of the US economy from the Chinese economy will evolve will impact international markets in the future. As always, the role of the EU in such a scenario is not to be ignored.