Oh, what a difference

Back in 2005, Germany had the highest unemployement rate among the major economies of the EU (of the big four including France, UK, Italy and the PIGS economies of Portugal, Ireland, Greece and Spain). Ireland had the lowest. Today, as Moody's downgrades the credit rating of six European countries, Germany has the lowest unemployment among them all. How fortunes have changed in such a short span of time. It should be noted that the Deutschland during the global financial crisis went alone in not stimulating its economy.

Could this be a case of free-loading? Stimulus only works when everyone does it, otherwise some of the fiscal spending leaks out through imports of foreign made goods, not benefiting the local economy. Germany, having benefited from the stimulus spending of its neighbors during the GFC, does not relish its present role in bailing out its ailing neighbors. A classic case of "no free lunch."

China's Hard Landing: Is it around the bend?

Last June, I speculated that a hard landing in China might be around the bend. That was even before the US downgrade and EU debt crisis unfolded. Now it seems the events of 2007 culminating in the collapse of Lehman the following year and the global stimulus in response to the North Atlantic crisis that followed may have returned to bite the People's Republic.

Reports of China's heavy handed treatment of foreign companies, defaults on loans and a slowing property market are developing into a credible narrative. Doomsayers like Rhoubini and Chanos have spoken. They predict the hard landing is on its way. Meanwhile confidence in China still remains strong with the EU looking east for help in financing its stability fund and Australia still expecting to profit from this Asian economy's thirst for iron ore and other mineral deposits as it did during the last global downturn.

What happens next depends on the ability of China's authorities to handle the current softening of global demand for its exports. Back in 2008, it engaged in a massive fiscal stimulus program. The unwinding of that stimulus is what gives the impression to many that it was headed for a soft landing. It can very easily turn the tap back on if the situation deteriorates. Their effectiveness at reading the situation will determine whether it has a soft or hard landing.

China Before the Fall?

There is somethings seriously wrong with this picture:

China's dependence on investment (accounting for almost half of its economy in 2009) means that any slowdown in investment will lead to something akin to a "hard landing" in the West (an abrupt correction of monetary and fiscal policy leading to a contraction). Having experienced double digit growth since the 1980s, a hard landing in China would mean less than stellar growth of 7-8% triggering higher unemployment. Nouriel Roubini who warned investors against US sub-prime mortgages has predicted with "meaningful probability" that this slowdown of investments will occur in 2013.

Back in 2008/09, China got a foretaste of what is to happen when it grew by a mere 6.6% in the first quarter and consequently saw 20 million migrant workers in urban centers losing their jobs. The stimulus measures put in place to boost domestic consumption and investment might be coming back to bite the economy with much of this spent on redundant infrastructure (as Nouriel Roubini noticed when he took the hi-speed train from Shanghai recently) or lent to local governments and state owned companies leading to a property and debt bubble.

One phenomenon that has come out of this are the so-called ghost towns built by local governments with stimulus lending. Andie Xie, former chief Asia economist for Morgan Stanley has called China's stocks a big ponzi scheme and warns of either a US or Chinese crash in 2011.



Indeed investors have begun to question the sound governance of Chinese companies. Another leading indicator is inflation. With Premier Wen Jiabao now hinting that it cannot be contained within the government target of 4 percent, meaning that the government is unwilling to lift interest rates in the near term fearful of the effects that would have on growth, the scene is set for an abrupt correction of policy settings leading to a hard landing.