Sunday evening as the Asian markets opened for Monday trading, there was an announcement that went unnoticed by most investors. The Japanese government adjusted their third-quarter GDP report to show that their economy shrank 1.9% rather than the originally reported 1.6%.
Why does this matter to U.S. investors?
First, this is coming on the heels of China lowering interest rates in order to try to stimulate their economy. Secondly, the European Union is doing everything they can in order to keep the GDP growing in the Euro Zone. Should China and Europe fall into a recession like Japan, the United States will likely fall into recession as well.
If you think back to 2007, the worldwide recession really started in the United States. It was late summer when the credit markets ran into a liquidity issue and as a country living on debt, the economy slowed as there wasn’t enough money to keep the economy growing and so it shrank. Because of the size of the U.S. economy, most of the rest of the world also slipped into a recession. China was one of the few exceptions as their internal spending was enough to keep their economy growing.
While the U.S. has a huge trade deficit, meaning we import more than we export, we still rank third in the world as an exporter at approximately $1.5 trillion each year. Our largest export partners are Canada, Mexico, China and Japan. So while we may import more of than we export, we still rely heavily on China and Japan to purchase our goods and if China joins Japan in a regional recession, it is highly unlikely that the U.S. will be able to keep the economy growing.
I wrote about China’s rate cut a few weeks ago and how that move could impact government debt in the U.S. This could also cause a problem as the Fed is getting ready to start raising interest rates which will slow domestic spending to some degree. Add in the fact that China has been the biggest purchaser of U.S. government debt over the last few decades and all of the sudden the problem is magnified.
If China slips into a recession, they won’t have as much money to buy our debt and the demand for the bonds issued by the U.S. government will decline. When demand declines, the price falls. When the price of debt instruments fall, the interest rates rise in order to make them more attractive to buyers. If the Fed raises rates and then the demand for bonds falls due to Chinese demand falling, domestic borrowers could get hit with double the impact and that would crush the domestic economy.
With the U.S. GDP growing at approximately 3.5%, it isn’t growing fast enough to sustain a hit from exports declining and domestic demand declining due to interest rates rising. Consider this, China’s economy was growing at approximately 13% at the beginning of 2007. By the time the worldwide recession was over in 2009, the growth rate was just over 6%. And remember, they have and had a much larger internal economy than what the U.S. has.
While this is something you need to move on today, it is certainly something you will want to keep an eye on as we enter 2015. You can’t just follow domestic economic reports anymore. The world economies are so intertwined these days that it would be difficult for any country to avoid slipping into a recession if the rest of the world was in one. The U.S. is no different in that regard.
