Last Week's Highlights

Concerns about the sustainability of recovery in the wake of the European debt problem preoccupied the markets this week. Oil, stocks and bond yields all fell, even though the news on the domestic economy was generally good. In fact, The Conference Board Leading Economic Index® for the U.S., after a big jump in March, gave a mere fraction of that back in April. Still, fears of a slowdown and/or of deflation sent the markets back into the bear's lair in late spring.

THE SITUATION ABROAD

Much of international trade is financed. Thus, the problems in financial markets, including a fallout from the public debt problem in Europe, is causing more than concern. The three-month LIBOR (London Interbank Offered Rate) has almost doubled — from .25 percent to nearly .5 percent since February. Thus, among other consequences, higher borrowing costs could slow export-driven economies and sectors. There are two possible outcomes. It is possible these concerns are overblown and markets will re-right themselves, and rates will come down. Or the drop in business and consumer confidence will gain momentum of its own, slowing economies, slowing trade, bringing financial markets down further and therefore resulting in a significant slowing down of the global recovery. The latter remains a low probability, but a probability that can be expected to grow the longer it persists.

FACT OF THE WEEK

Zero. In actual fact, the retail inflation rate in April was less than zero. There is some criticism that the ongoing weak housing market is forcing down rents, which negatively impact the cost of home ownership. These two components comprise almost 40 percent of the total CPI. But the story elsewhere focuses on small increases or outright declines in prices of vehicles, clothing, and household furniture and appliances. And, absent the influence of housing, inflation could be falling to zero. The problem is that it would be occurring during a period of deleveraging. Therefore, it could make it harder for consumers, businesses and financial institutions to dig out from a mountain of debts. Thus, even no inflation has a cost.

QUESTION OF THE WEEK

China's economy is the strongest in the world today. Why doesn't China open its markets more to imports from elsewhere?

It is true that China has the fastest growing, though not the biggest economy in the world. And that growth can be expected to continue at least over the next few months. The Conference Board Leading Economic Index® (LEI) for China rose 1.1 percent in March, following a 0.4 percent rise in February and a 0.8 rise in January. That gives China's measure one of the strongest performances among the ten for which LEIs are calculated (including that for the United States). Construction is booming in China at the moment, a big factor in this positive record.

It might be surprising that China's imports are in fact growing very rapidly. For example, imports of nonferrous metals (some of the material used in construction) are almost 20 times higher today than they were in 2004. Nor are the imports limited to raw materials. Imports of vehicles and parts are almost 15 times higher over the same period. An argument could be made then, that China might open up wider and allow even more goods to come in. But these data clearly show that China has not been closed over the past few years. Finally, any appreciation in the exchange rate of the yuan could increase the purchasing power of Chinese consumers. That has the potential to lift imports even more.