The US Federal Reserve’s quantitative easing came on the heels of China announcing infrastructure spending. The measures by these two countries highlight the deep divide between the “two-speed world”.
Cash-rich emerging markets such as China can employ fiscal firepower to counter economic slowdown, while mature markets with deep budget woes – such as the US – must rely on printing money.
Monetary versus fiscal measures
In an ideal world, a country will probably employ both fiscal and monetary measures to counter a slowdown. Monetary measures (including interest-rate reductions and boosting the money supply) usually produce more immediate results, by exerting an impact via the money multiplier in the banking system.
Fiscal measures such as reducing taxes and boosting government spending, on the other hand, require longer to ripple through, yet they can be more effective in the long term. This is because fiscal measures can address productivity and structural issues in a more targeted manner.
For example, a government can choose to invest in infrastructure, education or healthcare. All of these can improve the long-term productivity of capital and labour. A country wishing to counter a slowdown and ensure long-term growth will therefore try to employ both monetary and fiscal measures.
Reasons to remain upbeat
It follows that while stock markets may react positively to both types of announcements in the near-term, the long-term performance may differ between countries that rely on monetary versus fiscal measures.
The US Fed has, to its credit, refined its monetary measures by selectively targeting economic sectors. Instead of simply keeping interest rates low across the board, it has also been buying mortgage-backed securities to boost the housing sector. Yet this does not address the underlying issue of a housing glut, nor does it improve productivity in the housing sector or across the economy.
That is the job of the government, not the central bank. It is no surprise that each successive round of monetary easing appears to be losing its efficacy.
Fiscal easing can have a more positive long-term impact on both the stock market and the economy, although like monetary easing, it can lead to inflation. In this regard monetary and fiscal easing is very similar. They share the same side effect, which can drown out or limit their intended results.
For this reason, long-term investors have reasons to remain upbeat, even if they are concerned about whether the latest announcement by China represents existing or new stimulus measures.
China’s new fiscal stimulus
While financial markets rallied to China’s recent announcement of infrastructure plans, some observers argue that the projects are already contained in the central government’s current five-year plan.
If the recent announcements represent new fiscal measures, then obviously there is reason to be cheerful, as the vast injection back in 2008 after the global financial crisis has led to a boom in the economy. If the recent measures are only details already embedded within the five-year plan, however, it can mean that the Chinese government does not perceive a need for additional measures.
The government can be wrong, of course, just like any other central bank or government in Asia and the rest of the world. But given that this year we are seeing an important once-in-a-decade political transition in top leadership, one would expect the Chinese government to do everything in its power to ensure a stable and vibrant economy, to facilitate a smooth political transition.
One can expect that the Chinese government would rather risk overstimulating the economy than to face any slowdown. Therefore, if the announced measures represent nothing new, then the gesture attests to the top leaders’ confidence in the economy.
In a nation where accurate data and information remain relatively hard to access compared to developed countries, the government’s actions are perhaps telling.
Shedding policy addiction
The other possibility for not adding stimulus is a true determination to rebalance the economy from investment to consumption, even if it entails short-term pain. It is akin to rehabilitation: shedding an addiction to infrastructure spending whenever the economy threatens to slow.
In this case, China can learn from the mistakes of the US and many European countries in terms of the long-term impact of policy addiction. Loose monetary policy has arguably lost its efficacy to jumpstart the economies in the west. Monetary stimulus generally produces faster results. This is why many countries (especially elected governments) opt for it whenever they need to see quick improvements.
However, in more controlled economies such as China, monetary stimulus cannot work as effectively as it does in developed countries. There are financing and capital market activities taking place outside of the banking system, a system that is still developing.
Broken model?
By default, the Chinese government needs to lean more heavily on fiscal stimulus. To circumvent the timeliness issue, China has perhaps compensated with dosage, by injecting an extra-large amount of stimulus that created a “big bang” on the ground as well as to inspire financial-market confidence.
As the past few years have shown, what followed not long after was inflation that led to double-digit wage increases across many industries, threatening the long-term competitiveness of many sectors, especially manufacturing. While an economic slowdown can threaten social stability, the same holds true for inflation and labour protests. What works as a quick fix often has undesirable side effects.
The Chinese government is perhaps therefore returning to its holistic, philosophical roots by not succumbing to the temptation of large quick fiscal fixes. As many Chinese would argue, the Western medicinal model only addresses symptoms but not the root causes.
Betty Ng is investment communications director at Fidelity Worldwide Investment.
