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Europe Has Pneumonia; China Catches A Cold

Stock and commodity markets were not happy at the start of this week when it became clear that Europe’s long-anticipated recession is helping to slow the Chinese economy, global commerce’s power plant in recent years.

The European Union and China are each other’s largest trading partners, if you consider the 27-member EU to be a single entity. (Among individual nations, the United States, Japan and South Korea occupy China’s top spots, with Chinese-ruled Hong Kong sitting between Japan and South Korea.) It is not surprising that a downturn in Europe would have significant effects back in China. In fact, what may be most encouraging about the situation is how mild those effects could be, at least if things ago according to the Communist-led government’s latest plan.

After several years in which all of the world’s major economies and markets seemed to move in violent lockstep, a healthy degree of diversity is creeping into the system. The natural checks and balances of a diversified world economy are trying to reassert themselves.

China is targeting growth of 7.5 percent this year, and plans for growth to average 7 percent annually over the next five years. The previous five-year plan called for annual growth of 8 percent. The country routinely beat the benchmark, notching a 14 percent gain as recently as 2007.

These would be eye-popping numbers in North America or Europe, but until recently, Chinese leaders believed they needed growth of at least 8 percent annually in order to absorb the approximately 10 million workers who joined the labor force each year. Now, China’s labor growth has slowed thanks to decades of strict family planning and a rural-to-urban migration that has largely run its course. China is realizing both that it can learn to live with slower growth and that it probably has to, because top export markets in Europe and America are not likely to keep Chinese factories expanding at the accustomed rates.

Europe’s economy contracted 0.3 percent in the last quarter of 2011, and the downturn seems likely to continue through at least the first quarter of 2012. This would put Europe in its second recession of the past three years. Fiscal tightening across the continent, combined with ongoing sovereign debt worries, continue to sap consumer demand and business confidence.

Yet the same bleak news that pounded the markets this week points toward stabilization ahead. Slower export demand from Europe and America is prompting the Chinese to stimulate domestic consumption. The Chinese also are allowing their currency to appreciate somewhat faster than in the past. Both of these steps will help keep China’s trade in better balance. Increased demand within China would ultimately result in a greater appetite for Chinese purchases of machinery, food products and consumer goods from the slower-growing Western economies.

Another benefit of slower demand is a reduction in upward pressure on a broad spectrum of commodity prices, ranging from oil to copper. Lower prices for physical inputs allow companies to spend more money on capital projects or on an expanded labor force.

Finally, the improving prospects of the world’s largest economy, namely ours, provide an additional driver to improve conditions elsewhere. American demand powered the world economy long before China took center stage. Though U.S. growth, at less than 3 percent, is not robust, it is helping to offset the slowdowns in Europe and China. The world should see similar contributions from midrange economies like South Korea and Russia (the latter benefiting from high oil prices) and from some emerging countries. Brazil is struggling with rising prices and wages and slowing Chinese demand for its commodities, but an improving U.S. economy is good news for Brazil as well.

There are plenty of short- and long-term risks to the global economy. A financial blowup in Greece or elsewhere in Europe, another nasty confrontation over American government finances, or a geopolitical crisis in the Middle East or the Pacific could derail business confidence in the U.S., causing us to backslide into the rest of the struggling pack. Longer term, the world is full of dangerous economic imbalances, which range from unfunded pensions and entitlements to aging populations and shrinking labor pools. We will deal with some of these issues for many years, or decades, together with other issues that are not yet even on our radar.

But it’s nice to see the current relaxation of the financial contagions that have beset us for the past five years. Europe may have pneumonia, but China has only caught a cold, and we are feeling pretty fit. Things could be better, but we have seen worse.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us,” and Chapter 4, “The Family Business.” Larry was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.

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