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U.S. and China: When the giants unwind

Published: Dec 30, 2013 10:34 p.m. ET


Commentary: Withdrawal of stimulus could well cause a fresh crisis



BEIJING (Caixin Online) — China and the United States, the primary sources of economic stimulus since 2008, will begin to unwind their stimulus in 2014. The Fed’s announcement of its first reduction in quantitative easing and China’s rising interbank interest rate are signals of what is to come. The main driver for the unwinding is concerns of bubbles, not that economies are strong enough.

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Even if no financial turmoil emerges, some assets are likely to come under strong pressure. The economies that depend on commodity exports and/or hot money to plug their current accounts may see their currencies under more pressure. The Australian dollar AUDUSD, +0.00%  and Brazilian real USDBRL, +0.00%  are highly vulnerable. The Indian rupee USDINR, +0.00%   is another weak currency. The Canadian dollar USDCAD, +0.00%   and Russian ruble USDRUB, +0.00%  may come under pressure too.

Stimulus and growth

After the 2008 financial crisis broke out, I predicted widespread monetary and fiscal stimulus all around, and such stimulus wouldn’t bring back sustainable and sound growth, eventually leading to another crisis. I also predicted that stimulus advocates would blame the failure on insufficient stimulus. My predictions have come halfway true so far. Another financial crisis will make them wholly true.

The magnitude of the United States’ stimulus could be measured by national debt rising from 62% to 100% of GDP and the Federal Reserve’s balance sheet more than tripling from 2007 to 2013. The impact on asset prices is reflected by a 60% increase in household wealth from the crisis low and 21.4% above the 2007 peak — a level considered to be a bubble that led to the 2008 financial crisis.

During the same period the U.S. economy has expanded by 6% in real terms and 15.8% in nominal terms. The current level of total employment is still below the pre-crisis level. It is obvious that the U.S. stimulus policy has had an outsized impact on asset prices and small one on the real economy or employment.

Andy Xie, economist


It appeared that the U.S. stock market was ready to spike like in early 2000 when the Fed sounded its warning. The market consolidated afterward. But, when the Fed backed off in September, it went on a tear again. When the Fed took its first step in December, it was viewed as too small to have an impact. The market has continued its rally. The S&P 500 SPX, +0.33%  rose by 30% in 2013. It remains to be seen if the Fed could prevent a rerun of 2000: The market surges in the first quarter of 2014 and falls sharply afterward.

China’s stimulus, mainly through lowering credit standards, led to a 175% increase in M2 money supply from 2007 to 2013. The main growth consequences are a 61% increase in electricity production and an 82% increase in nominal dollar exports.




Neither China nor the United States has built a sustainable growth dynamic with stimulus. As the stimulus side effects — bubbles and rising leverage — become the main show, unwinding stimulus becomes urgent. This is why both countries are likely to take tightening steps.

Smooth tightening is rare

Unwinding stimulus is usually a dangerous business. One never knows how much hot air the stimulus has created. When it leaks, it could cause a big explosion. For example, the Fed’s tightening cycle in the past usually triggered an emerging-market crisis. As the United States itself isn’t on a strong growth path, the risk at home is substantial.


The surging stock market has been driving household wealth in this cycle. As 10% of the United States’ population own most of the stock, the wealth effect isn’t broadly based. This is probably the main reason for the weak economic response to the stimulus.

Similar to the past, the Fed’s tightening cycle could trigger another emerging-market crisis. When the Fed mentioned that it could taper QE, emerging markets tumbled. Those with persistent current-account deficits, like Brazil and India, saw a mini-crash in their currencies.

The hot money into emerging markets could be between $ 3 trillion and $ 4 trillion during the Fed’s easing cycle. If a fraction of it returns, the shock to the monetary condition in some emerging economies could be severe enough to trigger a banking crisis. I suspect that several major emerging economies would have to raise interest rates aggressively to maintain financial stability. Otherwise, a currency-cum-banking crisis could happen.

The risk at home for the Fed is much higher than during the previous tightening cycles. The U.S. economy is still quite fragile. The improving labor market is due to declining wages for the re-employed. Hence, its contribution to demand is limited. The stock market could be 50% overvalued. The Internet sector is a vast bubble similar to what happened in early 2000. If the bubble pops, it may lead to reduction in corporate capex, which could pull the economy back into recession.

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