It's not just China

Outlook:

The Chinese data today met the expectations of a slowdown. The WSJ asserts “The Chinese economy is now responsible for one-third of global growth. It is nearly twice the size it was six years ago, and its heft was a key reason cited by the International Monetary Funds for lowering the 2015 global growth forecast to 3.1%.” The 3.1% estimate for 2015 marks the slowest pace since the 2009 recession and the 5th year of slowdown. Looking forward, the IMF cut the world growth outlook for next year from 3.6% in Oct to 3.4% today.

The IMF sees 6.3% for China this year, with 2.6% for the US (from 2.8% in Oct). Europe should get 1.7%, better than 1.6% in October, with the UK getting 2.2% this year and Japan the same at 1%. The ongoing recovery will be “modest and uneven.” Emerging markets will suffer, at 4.3% overall (from 4.5% in Oct) and some more than others, with Brazil down a whopping 2.5% to 3.5% and Russia con-tracting by 1% (when the IMF expected +0.6% in Oct).

The IMF’s solution, of course, is for “monetary policy to remain loose in the advanced world, with countries ramping up public spending where possible and pushing ahead with structural reforms,” ac-cording to Bloomberg.

So it’s not just China. It’s other badly managed economies, too. Only last week Venezuela declared it-self in a state of emergency. As for India taking China’s place as the growth powerhouse, dream on. You can’t botch everything from infrastructure to the civil service and justice system for 70 years and hope to get it fixed in two or three.

The words of an old pop song should be running through everyone’s head: “Got along without you be-fore I met you, gonna get along without you now.” Since when do we allow second-tier countries to run the show? Well, since central banks embraced the “zero bound” that offers little or no return on capital. This is a form of dependence on the state, and central banks represent the state as much as any other in-stitution. The mindset is unhealthy. As former World Bank Pres Zoellick writes in the FT today, “the world needs a shift from exceptional monetary policies to private sector-led growth.”

Instead of letting Summers’ emerging market-driven secular stagnation drag everybody down, one solu-tion is Rogoff’s idea to restructure debt and set the stage for productive investment. Yes, keep rates low but watch out for wasteful government spending on infrastructure. Another idea is nurture the supply side. Focus on the demand side is counter-productive. “… policies intended to boost demand in the near term can actually discourage business confidence in the future; they are likely to rely on mergers, acqui-sitions and stock buybacks rather than big long-term commitments.” Extraordinary policies (like QE) “distort private sector expectations about investments, profits, taxes, valuations and future governmental actions. They em-phasise that the demand that will drive private capital investment, which should sup-port higher wages and profits, is expected future demand.”

This last idea is a little unclear as to what, exactly, the policies should be—presumably tax cuts—but makes the most sense. We are stunned to find ourselves agreeing with anything resembling supply-side economics, which is (on the whole) very bad economics. And yet it’s ridiculous to have China running the global show, too. Without reference to any ideology, imagine what would happen in the US econo-my if we did actually get corporate tax reform and an end to companies moving overseas? It’s amazing that only Ireland has figured this out.

Maybe we will get some interesting food for thought out of Davos, after all.

As for the immediate calendar, today we get the Treasury report on capital flows and tomorrow it’s CPI. Nobody expects much from CPI, and Fed officials are quoted as drawing in their horns on the pace of tightening as a result. If we assume that neither the US nor eurozone central banks can claim success in goosing inflation—not in the face of falling oil—we are in a sort of central bank limbo. Fun-ny, the Bank of Japan has been there for decades. It’s hard not to consider persisting in failed policies due to the lack of an alternative theoretical base is a core failure of economics itself.

Still, that’s the framework we have and we have to live with it. Considering that Mr. Draghi has been the most aggressive of the central bank chiefs, and considering that he, too, is stuck with the new orthodoxy that ever more easing is the same as “stimulus,” we wonder if his speech at Davos will not open the door to more easing. As noted previously, the consensus is shifting from “no change in QE” to “maybe some more QE later this year.”

The probability is rising that Draghi may come up with the equivalent of “whatever it takes.” Or so at least some FX market players seem to think. Breaking a support line is pretty small potatoes when a cur-rency pair is trading in a wide range, but not to be dismissed as old-school.

See the daily chart here. We have a triangle of support and resistance lines that is nearing an apex at 1.0880 by month-end January. By definition, we should be expecting a breakout one way or the other. If to the downside, we would then expect a test of the Jan 5 low at 1.0710 and if that succeeds in producing a breakout, a test of the Dec 3 low at 1.0524. Alternatively, upside resistance lies around 1.0891 today. We smell that the downside is the more likely direction, but stay tuned.