In one month's time, the Federal Reserve will put its finger to the wind to determine if the time is right for lift-off from near-zero interest rates. Policy makers may find that the prevailing Westerlies - the winds blowing from east to west in the middle latitudes - are just too strong and decide, once again, to table any change in interest rates.
I refer to the winds blowing from China, which has been taking aggressive steps to prop up its economy. In recent months, the People's Bank of China cut its benchmark rate, lowered bank reserve requirements, intervened to support the stock market after a one-month, 30 percent decline and, just last week, devalued the yuan by 1.9 percent. At the same time, the PBOC reiterated its commitment to a more market-determined exchange rate, allowing the yuan to weaken further.
The various interventions suggest concern on the part of China's leaders about slower economic growth and increased capital outflows. China's real GDP expanded 7 percent in the first half of 2015 compared with a year ago. That sounds like a rapid pace, but it represents below-trend growth for the world's No. 1 exporter. Besides, analysts don't trust China's official statistics, which never seem to correlate with measures of electricity consumption or rail cargo volume.
Even China's export machine is sputtering; hence the desire for a weaker currency. Exports fell 8.3 percent in July from a year earlier. Imports declined 8.1 percent year-over-year, the ninth consecutive month of declines. China's purchasing managers index for manufacturing stood at 50 in July, the dividing line between expansion and contraction. (While the PMI is a qualitative, not a quantitative, index, it tends to reflect actual manufacturing activity.)
Other emerging market economies, already struggling, are now under pressure to let their currencies slide. That, in turn, will make it more difficult to service and repay dollar-denominated debt.
Growth in Europe is tepid. Real GDP for the 19-country euro zone rose 0.3 percent (1.3 percent annualized) in the second quarter, with Greece the stand-out for its surprising 0.8 percent growth rate (3.1 percent annualized). Japan's economy contracted in the second quarter. The U.S. economy continues to chug along at 2 percent. So who will be the driver of global growth?
The key lies with Beijing, according to Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley. China accounted for one third of the growth in global GDP this decade, Sharma writes in a Wall Street Journal op-ed. That compares with a 17 percent contribution from the United States and less than 10 percent from Europe and Japan.
Where does this leave the Fed? For a central bank that always talks about headwinds to economic growth, China represents one strong gust. In a speech to the Providence, Rhode Island, Chamber of Commerce in May, Fed chair Janet Yellen listed the economic headwinds that have slowed the recovery from the 2007-2009 recession, some of which are abating: the debt overhang from the housing boom/bust; tight fiscal policy at the federal, state and local level; tighter lending conditions in the private sector; weak economic growth abroad; and a stronger dollar.
That was three months ago. Since that time, the prices of industrial commodities, from copper to aluminum to crude oil, have renewed their slide. Some commodity indexes have retreated to levels last seen in 2009. China is a huge consumer of raw materials, so the message of the markets isn't exactly encouraging.
And while China's communist party has never been shy about setting prices or allocating credit, China's debt has been growing at an alarming rate. Total debt, including government, corporate (financial and non-financial) and household, soared to 282 percent of GDP in 2014, according to a report by the McKinsey Global Institute. Nearly half of the debt is tied to real estate, the prices of which are finally starting to deflate. We all know how that movie ends.
The Fed constantly reminds us that any change in interest rates is ultimately "data dependent." Jim Bianco, president of Bianco Research, was curious as to exactly which data would prod the Fed to move in September. He compared various economic indicators from September 2012, when the Fed delivered open-ended quantitative easing of $85 billion a month, to the current period. With the exception of the unemployment rate, which has fallen from 7.8 percent to 5.3 percent, the idea of a "data dependent" rate hike next month is unpersuasive, he says.
Nominal and real GDP growth were stronger three years ago, the trend in employment growth and consumer spending is about the same, and "and inflation is meaningfully lower now," Bianco says. "If the Fed was truly data-dependent, the economy was better positioned for a hike in Q3 2012 than it is currently."
Keep an ear out for Fedspeak in the next month. And keep an eye on the winds blowing from East.
Caroline Baum is a contributor to e21. You can follow her on Twitter here.
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