I said yesterday that China’s domestic growth remained strong and that the threat to Chinese growth was external — a slowdown in the developed world. This morning’s trade figures seem to cohere with that view. China’s exports rose 15.9% YOY in October, a slightly slower rate of growth than expected, while imports increased 28.7% vs. a market expectation of 22.2%. An FT article this morning discussed the danger posed by a housing contraction in China, but I do not know whether, even if that happens (prices have yet to fall, although volumes may be down), a fall in residential investment means the same thing in China as it means in the US. Residential investment is a leading indicator in the US because it indicates financial weakness among households, and US recessions are usually caused by a fall in household spending, which has knock-on effects in other sectors of the economy. Should China be expected to have the same kind of business cycle? In that country, investment spending, to a large extent government-funded, is the driver of growth; strong investment spending means that people are employed and have money to spend, and hence consumer spending is also strong. In other words, the direction of causation in China probably runs from investment to consumption and not the other way around. A fall in residential investment may therefore not mean very much for the Chinese economy.

Italian bonds moved up yesterday after LCH Clearnet raised margin requirements for trading them. Analysts at IHS Global Insight and elsewhere said that Italy could survive several quarters of high refinancing costs because the country has a low level of private debt and the government is running a surplus before debt repayments. I do not think we should be as sanguine about the situation as the analysis suggests. As Paul Krugman has said (based on a paper by Paul de Grauwe), there is a crossing-the-Rubicon element to rising bond yields: once investors begin to fear a default, bond yields can rise to the extent that default becomes attractive. That means that Italy could be the victim of a self-fulfilling panic. If there is a reason to be sanguine, it is my belief that European policy-makers — via the EFSF or ECB — will not allow that to happen.

Tim Duy makes an excellent point about how a European recession could play out. Europe risks a vicious cycle. Peripheral austerity will reduce demand for exports from the core countries, and thus weaken them; the core will implement further austerity in response; and that will weaken the peripheral countries, which will be forced into more austerity, and so on. There are two important point to take from this idea. First, it is remarkable that European politicians believe that austerity will work. Second, the transmission mechanisms are slow, which means that the slide into a deep recession will be protracted if it is caused by this vicious cycle, leaving room for short-term risk rallies.


Australian employment growth 10k a.e. Not especially strong, despite excitable reporting.
Australian unemployment falls unexpectedly to 5.2%.
China trade surplus rises but less than expected.
French IP -1.7% d.e., Italian IP -4.8% d.e., Sep. Further evidence of a bad September in Europe.

Next 24 hours:

MPC Rate
US trade balance
Initial claims