China & the US Economy

China’s economy grew at just 6.9% in the third quarter, the lowest quarterly growth since 2009, although it was relatively close to the government’s “around 7%” target.

The Chinese stock markets, of course, had been falling since June although that was off an obscene run up over the prior year and they have recently rebounded on the back of bountiful government stimulus.

And now, of course, there are signs that the US recovery is not as strong as thought and analysts and pundits are naturally inclined to connect the dots. After all, the US and China are the two biggest economies in the world and do a lot of trade, although the US does more trade with Canada than China and China does more trade with Hong Kong and Japan combined than the US.

Frankly, I am increasingly convinced that China’s pivot to consumption, and the inevitable economic slowdown we are starting to see, will, in the end, have little impact on the US and to the extent it does it will be a positive impact, assuming that the US responds in a rational fashion.

There is very little that China makes that the US “has” to have. It doesn’t have enough energy to fill its own needs and most of the products it makes are at the bottom of the value chain, meaning they could easily be purchased elsewhere. It’s not yet a leader in innovation or technology, where the US and Europe currently set the gold standard.

What China has – or has had – is low prices. And the American consumer has snapped them up, allowing low-income families to, perhaps, little a little more comfortably than they might have. The price they paid, however, were stagnant wages and higher unemployment as companies globalized their supply chains in search of lower prices (i.e. lower wages).

In the end, I don’t think it has been a good tradeoff for the average American worker OR the American corporation and the impact of lower prices from China has given the American financial markets a false sense of the country’s financial health and vitality. In fact, I think it is no surprise at all that as China slowed the US was the first developed economy to show signs of growth since the 2008 financial crisis.

What the US has that China needs – or needed – was technology and a developed capital and investment structure. But that ship is long out of port and China is now fairly self-sufficient in both of these areas. The pieces of the puzzle are in country. Now the only task is for the government to implement the reforms necessary to assemble the puzzle.

In the end, therefore, while China and the US may continue to do a lot of trading with each other, I don’t believe that the two economies will be as intertwined as most analysts seem to fear. Each should increasingly look to their own economies, government practices, and monetary policies to explain slow economic growth when it happens.

What about all of the US multi-national companies that made big investments in China? To the extent that they have succeeded, and many have fallen well short of expectations, their success, I would argue, has not benefited the average American. It has benefited the average Chinese and been a key to rapidly rising Chinese wages and China’s ability to raise more people out of poverty in a single generation than any economy in history.

Just as importantly, however, the rise of China and its mutual dependence on the US has allowed one of the greatest polarizations of wealth in human history in both China and the US. The end result, unfortunately, is not unlike the personal financial profile experienced at the height of the imperial era of history. The poor are doing better in some cases, but the rich are doing obscenely better.

The increasing independence of the US and Chinese economies, I believe, will force an unwinding of that unfortunate and ultimately unhealthy trend. The US will not find a long-term replacement for China’s low costs. The recently heralded Trans-Pacific Partnership, even if it does ever make it through Congress, will have little impact on the US. There is no other country in the world that offers the unique combination of robust infrastructure, government support, and a bountiful and hard-working (and clever) work force as China.

Whether the lowest US wages rise due to government mandate (i.e., the living minimum wage) or market forces, the poorest American workers will have to be paid a much higher wage than they have been or the uber-rich are going to find mobs with pitchforks at their doors and more and more critical jobs will go unfulfilled.

The Chinese pivot to consumption will also narrow the wage gap but the pivot will be a bumpy road as many Chinese do not currently have the skills necessary to reap the bounty of such an economy. They will get there, and I suspect they will get there faster than the developed economies did when they went through a similar transition, but the pain, rather than the gain, is sure to get all of the media attention.

In the long term I believe this will be healthy for both countries. Narrowing the income gap will benefit both economies. Forget the argument that the rich fund economic growth and government tax revenue. It’s a relative and partial truth. They do both only because no one else has the money to do so. And they don’t do either to the same extent they benefit from that same economic growth.

The reality is that low wages are a poor way to build a strong economy. It may give it a strong jumpstart but innovation and adaptability are the ultimate tools of strong economic growth over the long run.

The US has the benefit of a strong education system and a mature capital infrastructure to fund the innovation revolution. China, on the other hand, has the advantage of a huge domestic market, a strong national industrial policy, and a highly motivated work force that is willing to suffer a little.

In the end, however, I don’t believe that either economy will have any material longterm impact on the financial markets of the other. It’s an easy narrative for US corporations and investors to blame their woes on the Chinese economy and for Chinese investors to lament robust US GDP growth.

I believe, however, that government policy will make the difference and that policy will only succeed if it supports the growth of wages, not the strength of the equity markets.

When I entered the corporate world more than 30 years ago we openly stated that we wanted to pay higher wages to our employees. In today’s boardrooms, by contrast, the dialogue usually revolves around cutting costs (reducing the wages and benefits of those who actually make or provide the product or service).

That usually leads to a lot of discussion about optimizing the supply footprint – more global trade. The global supply chain is the little green pill that will bring American corporations and their investors back to life. But it, like all of the little green pills that came before it, is a placebo.

There are many inherent contradictions in the behavior of the modern corporation. One that I talk about in my new book, Understanding China, is that fact that while companies spend billions each year developing and implementing processes, procedures, and reporting metrics in an effort to insure consistency and avoid mistakes, they then turn around and pay consultants even more billions to make them more flexible and bring them closer to the ultimate consumer – which usually means, of course, tearing out all of the processes they spent billions putting in place.

I’m not suggesting a return to 1950’s industrial America. Far from it. Germany calls it Manufacturing 4.0 and China calls it Manufacturing 2025 and it is the future of global manufacturing. It’s the integration of IT and automation. And what it means is that companies who are importing products and/or components from half way around the world are going to be at a huge disadvantage.

The leading companies in the world are aggressively pursuing an over-arching concept called LEAN operations. Essentially it involves the elimination of all waste. And there’s nothing more wasteful than having a product or component sitting in a metal container on a ship for weeks at a time as it chugs across the Pacific.

It’s shortsighted and will ultimately force the much-heralded globalization of trade to de-globalize. That doesn’t mean we won’t have multi-national corporations. It does mean we probably won’t have global supply chains except where special circumstances warrant.

So the next time some you hear someone say that the Chinese and American economies are too integrated for one to succeed without the other, don’t buy it. It’s just the latest version of banks being “too big to fail.” Instead of focusing their attention on what’s going on in China or elsewhere in the world, American investors should focus on what’s going on in American boardrooms and the government bodies that manage the macro economy.


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Note:  The views expressed in this post are strictly those of the writer acting in a personal capacity.

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