Global aggregate PMI -- the purchasing managers’ index, a measure of expansion in manufacturing -- increased in July to 51.2 from June’s 50.3 -- a measure above 50 indicates expansion. However, the aggregate masks a divergence -- the developed economies are getting stronger, while emerging markets are getting softer. It seems that in the aftermath of recovery, as China moderates and restructures, the growth baton is passing to Japan, the U.S., and Europe.
Another measure of manufacturing expansion, the Institute for Supply Management’s index, came in very positive in the U.S. in July, reaching a two-year high at 55.4. It’s possible that this leading uptrend in production will soon lead to better manufacturing payroll numbers.
In Europe, with some variation, the story is similar. In particular, new orders versus existing stock improved in most major Euro economies. Germany, the European country with by far the greatest exposure to China’s slackening growth rate, showed a low but steady level of new orders -- suggesting that China’s slowdown has largely been digested.
On the other hand, over in the emerging markets (especially non-Japan Asia), the slowdown is palpable, with July’s PMI dipping negative to 49.4. Non-Japan Asia hit a 20-month low. This makes sense, since these economies are the most exposed to a slowdown in the growth rate of Chinese demand. Brazil and Mexico also showed deceleration -- although Mexico should ultimately be strengthened by U.S. growth, particularly in the automotive sector.
Exposure to Chinese Demand: Highest in Non-Japan Asia
Source: Credit Suisse
China: Less Important Than You Think?
The chart above illustrates why the economic situations of the developed and emerging markets are able to diverge.
China, although its past decade of growth has made it a world economic powerhouse, is far more a powerhouse in terms of output than in terms of demand. In short, a slowdown in the developed economies is much more likely to affect China negatively than a Chinese slowdown is likely to affect developed economies negatively-- with the exception of those heavily reliant on commodity exports. And over the past five years, we’ve witnessed this as the Chinese economy has slowed -- partly in response to its own development dynamics, but largely in response to the crisis in the U.S., and perhaps more significantly, Europe.
The following graphs are illustrative:
Source: Credit Suisse
Chinese demand has been growing; in gross trade data, accounting for 2.9 percent of global GDP in 2012, from 0.4 percent in 1995. The U.S. accounts for 3.8 percent, Europe for 3.6 percent, and Japan for 1.4 percent. But a large portion of Chinese imports are simply processed through the Chinese economy, and travel on to their final destinations elsewhere. China is much less the factory of the world than it is the assembly line of the world. Chinese manufacturing, for example, adds only 4 percent of the final cost of producing an iPhone.
Therefore the graph on the right is more significant, since it essentially excludes those imports that China will turn around and export again. This shows that although China has grown dramatically, the more critical driver of the world’s economic engine is still, for now, domestic demand in the U.S., Europe, and Japan.
As China’s economic rebalancing act progresses, this pattern may shift. But for now, it is more likely that the strengthening economies we see in the developed world will affect China positively, than it is that a decelerating China will stop the recovery in the developed economies. Since so many emerging market countries are dependent on Chinese demand, they’ll hurt more from a deceleration -- which is what we’re seeing in July’s PMI data. And indeed, growth pickup in the developed world will positively affect China -- which we would not be surprised to see occurring soon as well.
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