9/04/2009

What can we learn from the insight that the U.S. consumer is saving more and Chinese exports are falling? The chart below from Bloomberg has an interesting story to tell. The yellow line represents the falling growth rate of Chinese exports vs. last year. The white line shows the rising savings rate of the U.S. consumer.

As the global recession reached its depths, China’s export growth fell, going negative at the end of 2008. This should be no surprise as U.S. consumers were buying much of China’s exports. As the recession wore on consumers curtailed their purchases causing the Chinese to cut their exports. As China’s exports fall, it is forcing the country to find new ways to help their economy grow.

To replace export growth, China has turned to expanding bank lending as a part of their stimulus package. Professor Michael Pettis from Peking University writes a blog titled Chinese Financial Markets. In his June 30^th and July 8^th entries, he discusses the dramatic expansion of bank lending in China. I encourage anyone who wants to learn more about the Chinese financial system to read Michael’s blog. In June, new loans in China leapt more than 150% from May according to Professor Pettis.

As you might believe, many people believe this rapid expansion of lending will have serious consequences later. The Chinese government seeks to achieve an 8% growth rate to offset the affects of the falling exports. The expansion in lending has several results, some good and some bad. On the positive side, it encourages growth in consumption as more Chinese move into the middle class. This in turn helps the Chinese economy to continue to grow, while it stabilizes the political environment. It also funds further development of infrastructure that is a part of the large government stimulus program. According to the central government, almost 70% of the $586 billion stimulus package goes into infrastructure.

All this spending is intended to help offset the falling exports and keep the Chinese economic miracle on track. There is a good chance the massive expansion in credit will result in a new debt bubble. Professor Pettis expects this might happen in a couple of years. In the mean time China will be buying raw materials, manufactured and consumer goods to help fuel this growth. This growth in demand will have a positive affect on the exports of other countries, including the U.S. This is one of the reasons I believe exports will be a more important contributor to the recovery of the U.S. economy for several years.

What about the U.S. consumer and their higher savings rate. As the chart above shows people are saving more, which means they are spending less. Less spending translates into fewer imports to the U.S. Less spending also contributes to a slower economic recovery. In addition, the U.S. stimulus program is contributing to the higher savings rate as people put at least some of the stimulus money into the bank to help them replace the money they have lost over the last few years in the financial crisis.

If you are one of those people who have a job paid for by the stimulus, you will tend to put any extra you earn into a rainy day savings, as you remain worried about the longevity of the job at hand. You cannot blame people for saving more. In fact, longer term it will turn out to be a positive as higher savings provides capital for growth, money to help fund the growing U.S. debt and a cushion against another economic recession.

The question on many economists’ minds, will this higher savings rate be sustainable? I believe it will. First, they remember what happened either to them or to their parents and they do not want to see that happen again. Second, as evidence is showing from the “cash for clunkers” program, money spent on new cars is reducing spending on other consumer durable goods such as household appliances. There is just so much money to go around.

Third, the younger generation has seen first hand what happens when people spend too much and many are determined to be more reasonable in the future. Thank the green movement, as well as the extravagances of the 1990’s and 2000’s. In addition, college students have sizeable loans that they must pay off. Earlier generations did not face such a large debt when they started their work career after graduating from college.

All of these factors will help to sustain the higher savings rate in the United States. Unfortunately, a higher savings rate will limit the ability of the consumer to be the major driving force in any economic expansion. Instead of a 3% growth rate in consumer spending as we have experience in the past 20 years, the U.S. is more likely to see spending by people rise at the 1-2% rate for several years to come.

As mentioned at the beginning of this article, the expansion of U. S. consumer savings and falling rate of exports from China has an interesting story to tell. As investors, we should more cautious when considering that the cyclical recovery of consumer spending will be the same as it has in the recent past. In addition, the growing middle class in China means they will be demanding more goods and services, some of which will be imported. The companies that export to China will benefit from the growth in demand for their products.

For those who want to learn more I suggest reading:

Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles by Joe Ellis is an excellent book on how to predict macro moves of the market.