Is the noose tightening around the US recovery?

Flash PMI data for Europe shows a worsening of conditions in manufacturing and weakness in service sector growth amidst gathering austerity and further deterioration of sovereign debt dynamics in Portugal, Italy and Spain.  

Chinese flash PMI data also shows weakening conditions.  Chinese growth has been predicated on vast increases in gross fixed capital investment, especially since 2008, which cannot continue for a number of reasons:

  • too much capital investment reduces the return on capital – exemplified by the small PCE component of GDP growth and increasing your dependence on external sources of demand (exports);
  • too much capital investment and too low a return on that investment exposes the financial system to default on the underlying loans, impacting both the stock and the growth rate of broad money supply;
  • under performing debt dampens monetary dynamics (prevents reallocation of capital to growing sectors) and sectors that will need finance to meet potential growth in PCE;
  • in order to increase consumption as a % of GDP savings need to be reduced (hence investment needs to fall), and since future growth in consumption depends on fast growing economic sectors, this may not be capable of being financed post a long period of excess gross fixed capital investment.

A decline in external demand for Chinese goods may deprive the Chinese economy of a vital return component which it may need to enable it to restructure and rebalance.   As noted in Prof Pettis article I referred to in yesterday’s post, the countries that need to stimulate consumption (Japan, Germany, China) are unable to do so for one reason or another, while these same economies exposed to weaknesses in external demand: other economies need to reduce their own structural imbalances away from the consumer, but are failing to do so, again for a number of reasons.

Of note is the the recent recovery in the US economy: over the last year some 80.7% of GDP growth (Q4 2012 over Q4 2011) has come from the PCE component of GDP, and while the rate has fallen over the last two quarters (Q3 due to the large increase in net exports and Q4 due to the large contribution of inventories), the growth in the US is still overly dependent on domestic demand.   It needs to export more, save more and invest more and post recovery dynamics seem to be reaffirming the PCE and debt dependent fundamentals of the economy.

So if Europe, China and Japan are all acting as counter weights to a US restructuring, the noose is most definitely tightening over the US recovery. 

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