Wednesday, June 10, 2009

China's domestic demand and other notes

Brad Setser starts a wonderful discussion on "How can we explain growth of China while all other export oriented economies continue to slide?" Thereafter follows a range of serve and volley explanations that are delicious treat for thought! Here are my views:

Walmart sales increased when other retailers went bankrupt because Walmart was lower cost than most. Same logic, I believe, explains partly why Chinese exports did not slowdown as much as others.

China’s monetary expansion will have two components – domestic stimulus and US treasury demand. It will be interesting to understand which will be bigger and will there be any crowding out effects.

If you push large liquidity through the system fast – high value, long-term assets (houses, stocks, etc) tend to inflate. This keeps overall inflation low (since these do not form part of consumption basket) giving an impression that everything is fine. This corners the excess liquidity to one end of the pool. Eventually the system breaks but till that time we have fantastic illusions.

Problems of Europe
Europe is about 13 billion giant (excluding Russia). Problems of Europe will impact world recovery to the same / slightly more than problems of US. We have somehow left Europe out of discussion.

Domestic demand / Market
Creating domestic markets is not easy and does not simply happen by throwing capital. Domestic tastes and preferences, as we see in India, are lot different than we anticipated. Same logic should hold for China.It is easier to customize goods (like restaurant services) are easy to manage – but inflexible goods (capital goods e.g.) take long time. The changes cascade from consumer side till they reach the top end. Examples:

  1. A large part of textile industry may be geared to service cotton clothes – whereas Chinese might prefer silk. (OK I simplified it a bit too much)
  2. You take milk, some producers added some hormones to aid milk production. Resulting milk was not safe for children. Now we need institutions, legal, regulatory etc that create a feedback system to discover and curb such practices. These complex frameworks anchors in democratic setup – leading us to political minefield.

If someone clarified the entrepreneurial scene – we may actually get better clues about domestic demand. Large entrepreneurial pool backed by venture funds experimenting with products and distribution is the best way to create (and an indicator for thriving or potentially thriving) domestic market.

The easiest part of domestic demand stimulus is to allow top brands to enter the domestic market and give them some price leeway through currency appreciation. Louis vitton bags, Chanel perfumes etc will kick start domestic consumption faster.

Psychology of excess
This is one of the problems facing China. In its quest to stimulate – it might create excesses that can haunt it later. Large ammunition is mega problem if it explodes in you own backyard.

China is our hope
Our global recovery hopes are pinning on China. The question is does China know and will it take the responsibility?