We're All Keynesian Now - or - What Nixon and Mao Talked About in 1972

China just announced plans to spend $586B over the next two years for internal infrastructure spending and other measures to get things moving. That is a very large amount given that the Chinese economy is $3.2B. If one believes that China's growth rate currently is "only" around 5% or so, down from the reported 8% target they just announced fro the 3rd quarter, then the Chinese Government clearly feels that they must do something to bridge this gap and keep confidence up. Clearly this stimulus will be meaningful to prop up the economy, as well as the current Communist regime.

One wonders whether this stimulus will be effective. Remember, the real issue in China is not pure, raw GDP growth but whether or not they can effectively grow their internal consumption market. Right now, they have a long way to go as consumer consumption is less than 40% of total GDP. The majority is internal investment and exports. One thing they can do, which I would imagine is in the works, is to use their surpluses to create good social safety nets available in most other developed economies (think, Social Security, Medicare), that currently do not exist. This would go a long way to help smooth the expected impacts of business cycles on consumers and spur spending.

While it can be argued that a major benefit of the Chinese people is their ability and willingness to sacrifice and save, this only goes so far. Think about Japan. They have shared many of the same cultural attributes as China but now appear to be in a deflationary spiral because they can't get people to spend more money and their demographics are so poor. China is kind of like Japan but only larger. Now that being said, they have much more runway ahead of them than Japan, which appears to be fully developed, for lack of a better phrase. There is still mass poverty in China and a strong secular shift from an agrarian to an urban society. That shift still has many years to play out.

So all that being said, can China overcome in the long-term those issues that have plagued Japan? That remains to be seen. This short-term stimulus may solve some problems for the Chinese government and economy today, but doesn't address those longer term issues discussed above.

Given that, one has to wonder if the Chinese government doesn't spend a lot more effort and money to foster an internal market and less time and energy looking to develop their export markets (via current account deficit supports). These things are not mutually exclusive but it would appear that if successful, the mix of GDP in China will shift from heavily export oriented to more internal investment and consumption. This reduced reliance on exports, tied into a reduced current account deficit, means less funds to prop up the US economy. That should force an even more rapid unwind of US consumer spending as there is no longer a group to support above-equilibrium consumer consumption.

That leads to a subject closer to my heart - the US Treasury market. The US Government just announced the re-issue of 3 year Treasuries. That reminds me a lot of the bridge financing that has plagued many sectors during this credit expansionary boom (including commercial real estate, which I am most familiar with). It is a reliance on a debt market that will hopefully allow the US government to roll over its debts when the come due. Sounds like playing with fire. If the market disappears (read above), then the US government will be paying massively high yields to repay these debts. Or of course, they will be forced to print massive amounts of money. Bad news either way.