China's growth makes mark on U.S. economy

Posted: Wednesday, February 25, 2004

ANCHORAGE Want to know what's keeping crude oil prices high, and what's behind the recent runup in zinc and copper prices? Think China.

China's industrial growth is galloping along with 15 percent annual increases, and the effects are being felt across a broad range of commodity markets, including crude oil and metals.

That's one message Gary Schlossberg, vice president and senior economist for Wells Fargo Capital Management, had for business and community leaders gathered at the World Trade Center's first statewide economic forecast luncheon held earlier this year in Anchorage.

Schlossberg said China's economy is still relatively inefficient in terms of energy use, so that economic growth translates to more demand for energy than is the case for economies in the developed nations.

As much as 20 percent to 25 percent of the new demand for certain industrial metals, like zinc and copper, can be traced to growth in China, as well as one-third of the incremental world demand for crude oil, Schlossberg told the audience.

"China is now the second largest importer of crude oil in the world behind the U.S.," he said.

There are other factors behind the rise in commodity prices including the weak U.S. dollar, he said. Since most commodities, including oil, are priced in dollars, lower values for U.S. currency against other currencies will tend to push up the dollar price for commodities like oil.

Schlossberg said most of Asia's economies are picking up again after the regional recession, and that demand from China is now driving new growth in neighboring countries.

Despite its recent downturn, Asia has been the star economic performer for the world for the last 20 years, averaging a 6.5 percent rate of growth through the late 1990s, well above the world average.

Growth dipped from 2000 through 2003 for the region during its recession, but still achieved a respectable 5.5 percent to 6 percent annual rate of growth, Schlossberg said.

Even while regional growth slipped, China's economy sustained a robust 8 percent to 8.5 percent growth over the past two years, he said. In 2004 that is expected to pick up further, Schlossberg said.

China's exports are expected to slow somewhat as convertibility of the currency, the yuan, to a basket of other currencies is implemented. This will increase the value of the yuan relative to the weaker dollar, making China's exports to the U.S., still its main export customer, somewhat more expensive.

In the long run that is good because it will help prevent the overheating of China's economy, but the country is still expected to sustain growth of 6 percent to 8 percent yearly for the long term, Schlossberg said.

Another growth engine in Asia is India, a sleeping giant that is now awakening.

While China is benefiting from outsourcing of manufacturing from the U.S. and other developed nations, India is benefiting from outsourcing of services in industries like software development and telecommunications. Services are less subject to attempts at trade restrictions than manufactured goods, Schlossberg said.

The United States is still the world's largest economy and its current recovery is now in full swing. It has been a weaker recovery than is normal but domestic growth accelerated in late 2003 and is now right on par with where it should be in a normal business cycle, Schlossberg said.

Growth rates of 4 percent to 4.5 percent are expected in 2004, which is right in line with what economists expect in the third year of recovery in a cycle.

However, the first two years of the cycle were weaker than expected, with growth rates of 2 percent to 2.5 percent compared with the 3 percent-plus that is normally expected in the first two years of a recovery, he said.

The recent U.S. recession was driven largely by industry, because consumer spending remained strong all during the slump. U.S. industry, worried about deflation, cut costs. Much of those reductions were achieved through lower labor

costs achieved by layoffs but also technology, which boosted productivity, Schlossberg said.

Unit production costs dropped and profits have risen, but hiring is still restrained, which is why it is called a "jobless" recovery, he said.

Meanwhile, what kept consumer spending strong was low inflation and low interest rates. Inflation is at a 45-year low and there are no signs of an increase, Schlossberg said.

The conventional wisdom is that interest rates will rise a bit toward the end of 2004 but this will happen because industrial capacity is gradually being absorbed, which could have an effect on credit markets.

The concern economists have is that the tightening of credit may have ripple effects in Asia. The hope is that Asia's regional economies won't meanwhile overheat, causing a replay of the bursting of the bubble in the late 1990s.

Despite that experience, many Asian economies are still inefficient, with weak banking systems, overhanging problem loans and political meddling in the economy, Schlossberg said.

Tim Bradner writes for the Alaska Journal of Commerce and Alaska Oil & Gas Reporter.



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