On the official divorce of the stock markets and the real economy

One wonders if January 30 of 2013 may be one of those days like they write into movies set circa 1929: "Oh, Father, don't be such a bore. 'Gross domestic product' is for the university men. All I know is, my Radio Corp shares are up and I'm taking my best gal Millie out for a malted." Or something like that.

On that day the news came down from the Bureau of Economic Analysis that its initial estimate for gross domestic product in the fourth quarter of 2012 was very slightly negative, that's to say, the United States economy actually shrank a bit in the final few months of 2012. Barack Obama ought to praise Almighty God that the BEA doesn't issue those initial estimates as projections and before November 6, because the exit polling found a clear plurality of voters on Election Day holding to the quaint notion that the economy was affirmatively improving, where we now know it was in fact contracting, or at best standing still, at just about that time.

Time was, the stock markets were dependent on what we fusty traditionalists insist on calling "the real economy". A BEA report like the January one showing Q4 2012 GDP at -0.1%, making the first decline since the official, statistical end of the recession in '09, would've been received by the markets as bad news and sent them lower -- and indeed the markets did go lower, only just, but they dusted themselves off and carried on toward their sunlit uplands such that all of two days later, the Dow Jones Industrials and S&P 500 were registering 52-week highs, with the NASDAQ not far off a 52-week high of its own and the Dow crossing 14,000 for the first time since October of '07 when its record of 14,165 was set, putting it one good day away from a new record high. The stocks-and-economy headline for those few days might read something like "U.S. economy shrinks, markets rejoice."

The markets and the real economy were seen in public together hand-in-hand until sometime after the economy found its bottom in '09; as the economy bounced along that bottom in 2010 and '11, neighbors overheard the real economy and the markets squabbling acrimoniously, with the markets becoming by times accusatory; by 2012 as the markets went from strength to strength, the real economy was known to be sleeping on the couch while the markets took the master bedroom upstairs, with the real economy stopping on the way from work for a hamburger while the markets had salmon and risotto at home on the good china; and finally when the Dow crossed 14,000 points two days after GDP came in negative on January 30 of 2013, the divorce papers came through. It's now official: the real economy and the stock markets are well and truly divorced, and they don't much feel like speaking to one another for the time being, either.

I'm not a writer of upper-middle-class American vernacular dialogue circa 1929, and I'm certainly no market analyst, so I offer herewith the considered assessment of Bob Janjuah who despite the funny name was Chief Markets Strategist at the Royal Bank of Scotland, via the pseudonymous Tyler Durden at ZeroHedge.com:

"Real wealth can only be created by innovation and hard work in the private sector, with policymakers, the financial sector and financial markets there to aid and encourage/incentivise. Real wealth is not created by the printing press and by excessive government spending. We simply cannot turn wine into water – after all, if it were that easy, why have we not done this before...

"Sure, central bankers through [quantitative easing] can create a chemical/synthetic concoction that may well get us even more intoxicated than real wine, but like most chemical processes that are focused on by-passing the rules and focused on immediate quick fixes, the "wine" they are synthetically creating will I fear ultimately lead to either a large market hangover (at best) or – at worst – to the "market equivalent" of serious liver poisoning or something even worse.

"The scale of the fallout will I feel be determined largely by how far markets and policymakers are willing and/or able to stretch the elastic band between real world reality and liquidity fed asset markets. Past experience shows us that this band can be stretched a long way, and we know that central bankers have a bad track record at both spotting and managing asset bubbles."

Thus spake Janjuah. And that looks about right. Every ridiculously overinflated boom must bust; the trouble with this bubble is, it's the product of the wholesale printing of dollars and profligate deficit spending, and built on an economy that's arguably recessionary and inarguably enervated. The United States could absorb a crash in 2000 and again in '08, because by those times it was near enough to full employment and coming off good long stretches of healthy expansion in GDP, plus which the American dollar hadn't been debased wantonly in the inflation of the bubbles that were popped in those crashes.

There is just no reconciling the Dow Jones skipping giddily toward its record high, with -0.1 percent GDP and 14.4 percent effective unemployment. A crash in these circumstances, and affecting the dollar that all Americans deal in, could be a catastrophe. 

Don't count Chinese chickens before they're hatched

I once heard a U.S. Postal Service worker, while waiting on some unlucky customer, preach for all the world to hear that it was "a matter of when, not if" America was overtaken by China .

But before we start learning Mandarin and hanging portraits of Chairman Mao in every public place, it might be worth considering a second opinion.

The same sort of prophesies were made in the 1980s and into the '90s, when the coming colossus was supposed to be Japan. Or Germany. Or in the 1970s, when the Soviet Union was supposed to have been winning the Cold War.

Today’s visions of a Chinese future got some clarification late last year, when the World Bank reported what may qualify as the world’s biggest accounting error. It found that “the size of China’s economy is overestimated by some 40 percent based on most current measures....” That overestimation was a ballyhooed factoid in more than a few forecasts of Chinese ascendancy and American decline.

It must be said that China is a great power already, and has been for some time. China began its double-digit annual growth in the 1980s; it was a foreign policy obsession in Washington in the 1970s; it has been a nuclear power since 1964; it has had a space program since 1956; it held American-led forces to the 38th Parallel in Korea in the early 1950s; and it has been one of only five permanent members of the Security Council since the UN's founding in 1945.

So China has been a leading power in the world for 60 years. But it is a long way from there to global hegemony. And China is a big country with problems to match.

The numbers show much more than an unstoppable sprint to global domination. China ’s economy is now second only to America ’s, but U.S. GDP is still twice China ’s, and equal to the second, third, and fourth largest economies combined. China is awash in cash -- enough to help finance U.S. debt -- yet mainland China’s market capitalization is not very much higher than tiny Hong Kong’s, and only about a quarter of America’s.

Many Chinese cities – Beijing , Shanghai , Guangzhou -- are truly impressive, even evocative of some futuristic science fiction film. But outside the favored urban centres, China remains profoundly impoverished. 800 to 900 million of China 's 1,300 million souls are peasants, and nearly half the Chinese people live on less than $2 a day.

China ’s success has been largely propped atop its exports to the West, and China produces those exports to Western designs, in Western factories, for Western consumers. The Chinese export economy is an enormous branch plant. And branch plants are derivative and dependent. Taiwan was once the West’s preferred branch plant location. India could easily be our next, or even Vietnam. What happens to Chinese growth then?

And the fear of dependence on China should be mutual. China has precious little natural resources for its size. Even the Chinese staple of soy beans has to be imported, largely from the United States.

China is also getting old. As a predictable consequence of the Communists' forced one-child-per-couple policy, every generation is twice the size of its children’s generation. China 's ratio of retirees to workers hit 1:3 in 2003. So it's not for nothing that China-watchers often say " China will get old before it gets rich."

America, meanwhile, has increased its fertility rate to the highest in 35 years, reaching the "replacement rate" in 2006 for the first time since 1972.

And the one-child policy has had another consequence. The male-to-female ratio in China has already become imbalanced, at 6:5, and it is difficult to see how that trend can be anything but problematic.

The fantasies of a Chinese-dominated world are in some part a product of resentment and contempt for America. And though it may be appealing to certain people to imagine a world in which Washington takes orders from Beijing, such a world would be appreciably less free, less democratic, less humanitarian, even less environmentally-friendly.

The recent satellite shoot-downs may put things into some perspective. When China decided to shoot down a satellite in 2007, it did so unannounced and at an altitude that put the thousands of shards into the paths of other satellites and spacecraft. When the United States decided to shoot down a satellite in February, it informed the affected governments directly, then the international press, and it smashed the satellite at just the altitude to cause the debris to be incinerated in re-entering the atmosphere.

A crass assessment would call both powers bulls in china shops, so to speak, but clearly there is a bad way and a better way of going about being a superpower.

China has been a top-tier global power for some time already, and it has room to grow. But to conjure the future and see China in anything like the role America now plays is wildly speculative and takes far too little account of China’s gargantuan problems.

The kind of nation that denies its citizens the right to have children as they wish, or to worship as they wish, let alone to vote, is not the sort of nation that can hope to compete over the long term with the boundless creativity and energy, the self-correction and dynamism, of the great free societies.

Andrew W. Smith

Published in The Chronicle-Herald, Halifax, Nova Scotia