(Originally published in the business pages of the Melbourne Age and Sydney Morning Herald, 24th March 2010)
When I first began writing about the global economy, more than twenty-five years ago, what would be considered a reasonably comprehensive coverage for an Australian audience required a discussion of the United States, Japan, Germany and Britain. Those four countries accounted for about 55% of the world economy, and took about 45% of Australia’s exports. They were the major sources of foreign investment into Australia. Their central banks were the only ones whose decisions mattered to us; the exchange rates among their currencies were the only ones in which we took a keen interest; their stock markets set the tone for ours.
These four countries are still important today, of course, but less so (especially from an Australian perspective) than they used to be. They account for about 42% of the world economy, and take less than 30% of our exports. These days, any analysis of the global economy – and especially one intended for an Australian audience – would be considered grossly deficient if it did not devote considerable attention to China. China is now the world’s second biggest economy; it is the world’s largest exporter, and second-biggest importer; it has the world’s largest foreign exchange reserves, and is the US Government’s largest individual creditor; the decisions of its central bank can move markets around the world; and the exchange rate between its currency and the US dollar is a matter of keen interest to governments and investors alike. For Australia, China is now our largest single trading partner; it is a major influence on the prices we receive for many of our most important commodity exports; and it is likely to become an increasingly significant source of foreign investment.
Developments in the United States remain as important as ever to prospects for the global economy and the tone of financial markets; and neither Europe nor Japan can be ignored. But it’s surely telling that (by way of example), the roughly 1000-word discussion of the international economic environment in the Reserve Bank’s most recent quarterly Statement on Monetary Policy devoted a little over 200 words to economic conditions in each of the United States, China and other emerging East Asian economies, and about 125 words (plus a special two-page supplement) to India, but only about 125 words to Europe and fewer than 90 to Japan.
China’s rapid recovery during 2009 from what had been a pronounced economic slowdown during 2008 has been an important factor in Australia’s relatively benign experience of the recent global financial crisis. It wasn’t as critical to avoiding recession as the resilience of the Australian banking system and residential property markets, or the timely and (for the most part) effective responses of monetary and fiscal policy to the global downturn. But it certainly played a major role in shielding Australia from the collapse in exports experienced by most other industrialized economies during the latter part of 2008 and much of 2009; and it has been the most significant factor driving the revival of the resources investment boom which seems likely to be one of the major drivers of growth in Australia’s economy in 2010 and 2011 as the last year’s monetary and fiscal policy stimulus is gradually withdrawn.
In the first few months of 2010, the Chinese authorities have begun to wind back some of the monetary policy stimulus which played such a key role in lifting China’s growth rate from just over 6% at the beginning of last year to more than 10% by the end of 2009.
Bank lending quotas were reduced; the proportion of banks’ assets required to be held in the form of reserves at the central bank has been increased by 1 percentage point; maximum loan-to-valuation ratios for property investment lending have been lowered; and some short-term interest rates have been marginally increased.
Some adjustment to what the Chinese authorities have for some time described as a ‘moderately loose’ monetary policy stance seems appropriate in view of the rapid rebound in property prices (the official measure of real estate sales prices rose by 18.5% over the course of 2009, after declining by 2.8% through 2008), and by the turnaround in the trend in consumer prices from a decline of 1.8% over the twelve months to July 2008 to an increase of 2.7% over the twelve months to February this year. The re-emergence of inflation is largely the result of higher food prices (especially grains), but the authorities will nonetheless have been mindful of the fact that the surge in food prices in the first half of 2008 was an important contributor to the slowing in China’s economy that was already underway before the global financial crisis punched a hole in China’s exports.
Financial markets (and many commentators) have responded to each of these (comparatively modest) moves by the Chinese monetary authorities as if they had been slamming on the brakes, such that a major downturn in Chinese economic growth was imminent.
As is the case with the Reserve Bank’s four increases in Australian interest rates since last October, these moves by the Chinese monetary authorities to unwind some of the stimulus they provided in very different circumstances during the depths of the global financial crisis should instead be seen as an indication of their confidence in the strength and durability of the recovery which is now under way, and as a sign of their determination to prevent the emergence of destabilizing ‘bubbles’ of the sort which caused so much grief in the United States and Europe. In neither Australia nor China has monetary policy yet come close to being ‘tight’; and in neither country has there yet been any decision to withdraw fiscal stimulus any more rapidly than envisaged when their respective stimulus measures were initially instigated.
China’s leaders remain concerned at the external risks to China’s continuing economic growth, highlighted by Premier Wen Jiabao’s recent warning of the possibility of a ‘double-dip’ recession in the world economy. This is probably one reason why China remains for the time being committed to a fixed exchange rate for the yuan against the US dollar. Whether, and if so when and in what way, China may modify its exchange rate regime will be one of the most important economic policy decisions to be made in the next year or so. I think (for reasons that deserve a separate column) China will eventually return to a more flexible exchange rate regime, but at a time of its own choosing, rather than in response to external pressure: indeed the risk is that persistent external pressure may lead China to delay a move that is in its own best interests.
Just as Australia has benefited more than any other ‘advanced’ economy from China’s rapid turnaround over the past year, we will be more vulnerable to any future Chinese downturn. However the measures that the Chinese authorities have been taking in recent months should be seen here as reducing that prospect in the near term. They do not, however, lessen the importance of ensuring that we have the wherewithal to respond to the episodes of weaker growth in China that will inevitably occur over the medium term.