China’s Slowing New Normal

MILAN – The world’s two largest economies, the United States and China, seem to be enduring secular slowdowns. But there remains considerable uncertainty about their growth trajectory, with significant implications for asset prices, risk, and economic policy.

The US seems to be settling into annual real (inflation-adjusted) growth rates of around 2%, though whether this is at or below the economy’s potential remains a source of heated debate. Meanwhile, China seems to be headed for the 6-7% growth rate that the government pinpointed last year as the economy’s “new normal.” Some observers agree that such a rate can be sustained for the next decade or so, provided that the government implements a comprehensive set of reforms in the coming few years. Others, however, expect China’s GDP growth to continue to trend downward, with the possibility of a hard landing.

There is certainly cause for concern. Slow and uncertain growth in Europe – a major trading partner for both the US and China – is creating headwinds for the US and China.

Moreover, the US and China – indeed, the entire global economy – are suffering from weak aggregate demand, which is creating deflationary pressures. As central banks attempt to combat these pressures by lowering interest rates, they are inadvertently causing releveraging (an unsustainable growth pattern), elevated asset prices (with some risk of a downward correction, given slow growth), and devaluations (which merely move demand around the global economy, without increasing it).