Europe and China: How Their Troubles May Benefit Us

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Aug 14, 2014 1:30:00 PM

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Europe and ChinaYesterday, we talked about how the U.S. government deficit, while improving, is still way too high, posing serious problems for the future. Today, I want to touch on two other problems that you might think have been solved—but haven’t.

Trouble brewing abroad

Developments over the last several days have brought the economic performance of both Europe and China into serious question.

Europe: As reported this morning, the German economy shrunk over the last quarter, while the French economy stalled out over the past year. For the eurozone as a whole, growth dropped to 0.2 percent in the second quarter, down from 0.8 percent in the first.

And things will most likely get worse, as the sanctions imposed on Russia start to bite Europe as well, along with creating possible energy supply disruptions. The weak economy, coupled with an unrepaired banking system, leaves Europe quite vulnerable to a potential financial crisis.

China: Last month brought a shocking decline in lending to the lowest level since October 2008—the month before Lehman’s collapse, and the month before the Chinese government was forced to launch a major economic stimulus program. Arguably, this is a good thing, a reflection of the government’s attempt to rein in credit.

But if the cause is, in fact, a decrease in demand for loans, the magnitude of the unexpected drop may signal bigger problems ahead. Signs that might be the case include the fact that housing sales have dropped by 10 percent over the first seven months of the year, despite measures taken to bolster the market. Housing and lending have been critical to supporting China’s growth, and these two discouraging data points suggest more weakness ahead.

What does this mean for the U.S.?

Slowing growth in Europe and China raises concerns in a couple of areas:

  • Export growth. Growth in the rest of the world supports U.S. exports, which is good for our economy; slowing growth will reverse that.
  • Corporate profits. U.S. companies reap substantial profits from elsewhere in the world, and weakness will hit company earnings and potentially their stock prices. The costs are real.

On the other hand, there are also benefits to slowing growth abroad:

  • Low interest rates. U.S. interest rates have remained surprisingly low, driven in part by demand for the safety of U.S. assets (as compared with, say, those of Russia or China).
  • Low oil prices. Despite turmoil in the Middle East, oil prices have stayed low. In fact, they’ve declined recently, driven by weakened demand from the rest of the world, even as U.S. supply increases.
  • More robust consumer spending. Low oil prices directly support U.S. consumer spending, and lower prices are likely to continue as growth elsewhere in the world remains slow.

Overall, weakness in the rest of the world reinforces many of the trends that have led to the U.S. recovery—and should help to accelerate it.

A position of strength

Just as with the deficit, the very real good news coming out of China and Europe in the past few months doesn’t mean that the underlying issues have gone away, and you can expect to hear much more about them in the months ahead.

The difference this time, though, is the U.S. is much better positioned to ride out any emerging trouble than it has been over the past five years. Although we can expect more problems ahead, they should at least be more manageable.

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