East Headwinds and 2011

The big news is correctly summarized this week in Barron’s and represents a turning point for the global economy:

Abelson, Alan, 2010. A double hex. Barron's, Nov. 13.

By the two quotes listed below, I think it is safe to assume that there exists a serious question regarding global growth prospects for 2011:

"China, meanwhile, is facing a flare-up of inflation and, to date at least, its efforts to douse it have not been conspicuously successful, despite the proclivity of the chaps who run the country's command economy to put the best smiley face possible on official numbers. In October, the Sino consumer-price index shot up at a 4.4% annual rate over October 2009 and, as ISI Group points out, a 0.8% jump over the previous month."

"Even more ominous, the money supply, which unless controlled acts as the feedstock of inflation, expanded at a scorching 28.7% annual rate and over the past three years has risen some 24%. Not exactly a big surprise, then, that Chinese banks have been on a lending spree; last month alone, they coughed up $89 billion in new loans."

Bottom line, such a rapid expansion of the Chinese money supply almost guarantees a significant problem with inflation. Further, the issue of new loans to business at a rapid pace probably means greater risk of default. Inflation plus defaults equals significant downward pressure on economic growth. Add a policy of currency pegging to the mix and I think equity markets are correct in anticipating the making of an economic disaster.

Given a stable society were a large percentage gain some advantage from an economic expansion, the three pillars of doom (inflation, defaults, and pegging) might not cause a calamity. However, under different political situations this assumption does not hold.

Alan Abelson captures this point brilliantly in the following quote:

"As we've observed more than once, given the sheer size of China's increasingly testy population, and the yawning gap between the comparatively few in the upper reaches of the income scale and the mass of the citizenry, a delicate balance between keeping smoke curling out of its factories and keeping inflation in check is an imperative. Put us down among the doubters that it can pull off that neat financial trick."

I think it is possible that China's growth could slow along with that of Germany. Given weak American growth, the odds are that 2011 might be another lean year in GDP growth, equity prices, and perhaps even certain commodity prices.

Is it too early to look toward 2012?