- China is offering incentives to bolster consumer spending as economy slows
- U.S. is removing monetary stimulus
- Chinese consumer spending rebounded in June after three months of decline
- Global growth could be impacted by a sustained deceleration of the U.S. and Chinese economies, even if they do not enter into recessions
The world’s two largest economies are adopting starkly different approaches toward consumer spending, with the United States raising borrowing costs to cool demand in a bid to rein in 40-year high inflation, while China is attempting to boost spending and rejuvenate an economy set back by a renewed outbreak of Covid cases. Both strategies could have ramifications for global growth.
Consumer spending is the bedrock of U.S. growth, accounting for almost 70% of economic activity, and investors are closely watching if the Federal Reserve’s (Fed) removal of monetary stimulus – four interest rate hikes through July 2022 -- and possibly more to come according to the federal funds futures market. The Fed has also begun quantitative tightening to shrink its nearly $9 trillion balance sheet. The Fed’s aim is to remove monetary policy stimulus, while hoping to avoid tipping the economy into a recession.
By contrast, China, the world’s second largest economy, is easing monetary policy, bolstering liquidity in the financial system and introducing a slew of measures to boost consumer spending in the world’s most populous nation with 1.4 billion people as inflation remains well within the Peoples Bank of China’s (PBOC) target of 3% this year.
In this article we will examine how these differing approaches centered on consumer spending in the two economies that account for 43% of the global gross domestic product could have ripple effects on global growth and trade, and impact financial and commodity markets.
Economic stimulus in China while U.S. Raises rates
In an attempt to make consumerism foundational to its growth that is now led by exports has been offering a raft of incentives at the federal and local levels such as expanding tax refunds and shopping vouchers (Figure 1). And to bolster business activity and jump-start growth, the central bank is injecting liquidity into the banking system, having effectively loosened monetary policy by reducing short- and medium-term lending rates earlier this year.
Figure 1: Jump-starting the Chinese economy
And these initiatives seem to be bearing fruit, at least in the short term. Consumer spending in China rebounded in June after three straight months of declines. Retail sales rose 3.1% in June from a year ago after falling from March through April (Figure 2). Retail sales fell 3.5% in March from a year ago, tumbled 11.1% in April and was down 6.7% in May. It’s still early to tell if the rebound in June is sign of a possible turnaround in consumer spending, but it offers a glimmer of hope in China’s growth story.
Figure 2: China’s slew of incentives help to rebound retail sales in June
Consumer spending has been gaining in importance in the Chinese economy. China’s final consumption expenditure, the value of goods and services purchased by households excluding dwellings, totaled $8.12 trillion in 2020, accounting for more than half of its gross domestic product estimated at $15.92 trillion at that time, according to the World Bank.
The growth of consumer spending in China is a significant part of the country’s rise to become the world’s second largest economy, helped along the way with its accession to the World Trade Organization in 1990 that opened up markets across the globe for the export of Chinese products.
The beginnings of consumer spending in China were modest, totaling just $230 billion in 1990. But with exports starting to boom and incomes rising, final consumption expenditure crossed the $1 trillion mark in 2004, passed the $2 trillion mark in 2008 and jumped past $5 trillion in 2014.
During this period, China was growing at an envious pace, starting at just under 4% in 1990 and racing to a peak of 14.2% by 2007 as economic reforms kicked in, creating a burgeoning middle class. As an example of their purchasing power, the sale of new electric vehicles January through May 2022 surged 111.2%, according to data from the China Association of Automobile Manufacturers.
As incomes grew, so have savings. Disposable personal incomes in China have also been growing at a rapid pace over the past 10 years, almost doubling from 2012 to just over $7,000 in 2021. Renewed challenges from the pandemic have, however, soured the mood of consumers. Lockdowns and restricted movement in mega-cities like Shanghai led to a decline in consumer confidence, which fell in April and May to around 86 from a range hovering around 120 from June of 2021. As a snapshot of what consumers spend their money on, data shows that nearly 33% of per capita consumption expenditure goes to the category of goods, alcohol and tobacco, followed 22.5% for housing and 12% on transportation.
While China has been attempting to boost consumer spending, the Fed has been on an opposite track as it has began removing monetary stimulus by increasing interest rates for the first time in nearly four years in March 2022 with a 25 basis-point (bp) hike, followed by 50-bp increase in May and 75-bp increases each in June and July. There are expectations for the Fed to raise rates further by the end of 2022, with the federal funds rate peaking around 3.50%. (Figure 3).
Figure 3: Fed has been raising rates to remove monetary stimulus
While the Fed is raising rates, they are doing so from a very low base – effectively zero. That is, the Fed is taking its foot off the accelerator, but not yet hitting the brakes. The two main impacts of the Fed’s removal of monetary stimulus have been (1) to raise home mortgage borrowing costs, which are already beginning to cool the housing market, and (2) to raise the hurdle rate for equities contributing to the equity downturn in the first half of 2022.
Simultaneously, but probably not due to Fed actions, as the economy struggled with rising inflation, the economy contracted 1.6% in the first quarter of 2022 and by 0.9% in the second quarter -- while two quarters of negative growth is considered a recession by some quarters, the National Bureau of Economic Research (NBER), which hosts the committee that officially dates recession, considers unemployment and real personal income as much more important indicators; and the labor market remains quite robust. The Fed is also known to put much more weight on labor market conditions than real GDP.
Inflation had remained flat for about two decades, hovering around the 2% mark, until the pandemic, when a burst of pent-up demand snagged supply chains, sending prices for a variety of consumer products higher. This was exacerbated by Russia’s invasion of Ukraine earlier this year, leading to an increase in prices for commodities such as oil and grains.
U.S. consumer spending has been resilient in nominal terms even as inflation began rising just over a year ago as disruptions to the supply chain caused by a pandemic-related shift in demand from services to manufactured goods began elevating prices amid rising average wages and savings.
Disposable incomes of Americans have been rising steadily over the past decade, hitting a record high $2.17 trillion in March 2021 at around the one-year mark of the pandemic in the U.S. At this point in time, large segments of the American workforce were sequestered to contain the spread of the disease, and working from home had become a viable alternative to taking public transportation as Covid cases were on the rise before the mass roll-out of vaccinations.
The build-up in disposable incomes during the sequestration, which deprived many the access to the simple pleasures of dining out, going to a movie theatre or an outdoor sports event, was unleashed in the form of demand for remodeling homes, buying new cars and other manufactured products, which helped China to become the first major economy to recover from the financial pressures of the pandemic.
This surge in spending saw a sharp decline to around $1.9 trillion April 2021, and with disposable incomes levelling off around that level through April this year. Even at this level, disposable incomes are historically high. For comparison, the lowest level of disposable incomes were recorded in 1959 at $351 billion.
There are a few reasons behind the rise in disposable incomes in the U.S. One of them is due to stimulus checks sent to Americans who qualified to help them cope with the pressure of the pandemic. The U.S. Government Accountability Office said the federal government sent $931 billion between April 2020 and December 2021 to individuals who were financially stressed.
Additionally, the tight labor market has led to a strong increase in average hourly wages for American workers. Average hourly earnings for all private employees excluding the farm sector rose by 0.3% to $31.95 in May, with hourly wages rising 5.2% over the preceding 12 months, according to the U.S. Bureau of Labor Statistics.
But the first signs of how the rise in inflation might be affecting consumers showed up in May 2022 when there was a drop in retail sales for the first time this year. But that could be an aberration, with retail sales in June rising 1%. But there could still be an underlying nervousness among consumers amid concerns over the possibility of an impending recession. Data from the U.S. Census Bureau shows that retail sales have been on a downtrend from January, before contracting in May. Between January and April, the growth in consumer spending had tapered from 2.7% to 0.7%.
In addition, consumer confidence as measured by the Conference Board fell for three straight months from May through July, with the board’s expectations index, measuring consumers’ short-term outlook on income, business and labor market conditions, falling sharply to its lowest level since March 2013.
In China, the inflation rate has been inching higher, rising to 2.5% in June from 2.1% in May and April, but it remains well within the country’s target rate of 3% this year (Figure 4). But the food prices have been rising in China, increasing by 2.9% in June, compared with 2.3% in May, according to the country’s National Bureau of Statistics. In particular, the price of fresh fruit is up 19% from a year ago, but meat prices are down, with the price of pork, the meat of choice in China, falling 6% in June.
Figure 4: Inflations levels in the U.S. and China
As the world’s two largest economies accounting for 43% of global economic activity, the pace of their growth can have a significant impact on how the world economy performs in 2022 and beyond. China’s economy grew a meagre 0.4% compared to a year ago in the April-June quarter, down from 4.8% in the first quarter. That is, the Chinese economy is performing well below its full-year target of 5.5%. In real GDP terms, the U.S. economy contracted by 1.6% in the first quarter and by 0.9% in the second quarter – while this is unlikely to be deemed a recession by the NBER given the low unemployment rate, it does indicate a material deceleration of the U.S. economy after a rapid rebound in late 2020 and 2021. The burning issue is whether elevated inflation into 2023 might lead the Fed to hike rates more than the federal funds futures markets currently anticipates.
China has the potential to cut rates to foster growth as inflation is still relatively low, but the country can barely afford to see any significant increase in inflation that could, in particular, impact its large rural population. Food security is also a key issue for the world’s populous nation. How these two nations perform economically through the year could hold the key to any potential recession in the global stage, already experiencing disruptions from the war in Ukraine. China is banking on exports, and to a lesser extent on consumer spending, to keep its economy on track, while the U.S. is hoping to cool inflation as its top priority. Which tact might prevail could have implications for the rest of the world. Any slowdown in China’s growth could impact prices for a range of commodities from oil to grains to metal due to its outsize role as a leading consumer of these products. Prices for copper, considered the barometer for the health of the global economy, is down 21% from a year amid growing concerns over China’s slowing growth and the possibility of a global recession (Figure 5). Proceed with caution, uncertainty ahead.
Figure 5: Copper prices have retreated
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All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.