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Chart3 Sept
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Chart2 Sept
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– September 15, 2015

China slowdown creates a headwind but not a major threat to U.S. economy
External shocks tend to affect an economy quickly through capital markets and more slowly via trade. In the short term, capital markets react both to solid information and unsubstantiated rumors. As noted, global capital markets have already reacted to a surge in uncertainty regarding the outlook for the global economy and China in particular.

Somewhat less immediately, external shocks affect economic growth through trade. Exports and imports are direct components of gross domestic product (GDP), the main measure of a nation’s economic output. China’s on-going devaluation of its currency, the yuan, against the dollar since early 2014 (Chart 1) makes U.S. exports more expensive in China and U.S. imports of Chinese goods cheaper. While this can have an impact on trade volumes, the more important factor may be the underlying demand. U.S. exports to China have been weakening since 2010 when Chinese GDP growth began to slow. Estimates from the Organization for Economic Cooperation and Development (OECD) show China’s growth is expected to continue decelerating through next year, suggesting a weak demand outlook for U.S. exports (Chart 2).

Conversely, slow but steady improvements in U.S. consumer spending imply a pick-up in demand for Chinese goods. Again, a cheaper yuan may compound both of these trends. Furthermore, both trends would be detrimental to U.S. growth, as slowing exports and rising imports would worsen the net trade balance and directly reduce U.S. GDP.

A third transmission mechanism for shocks that can affect the economy is through foreign direct investment (FDI). In an environment where the yuan is depreciating, U.S. investment in China might get a boost, while Chinese capital commitments in the U.S. may be marginally restrained. In our view, neither of these potential developments is a major risk, as U.S. investment in China makes up just 1.2 percent of all U.S. FDI abroad and China accounts for just 0.4 percent of all FDI in the U.S.

The bottom line is that slowing growth in China and the yuan devaluation could curb U.S. GDP growth but does not pose a significant risk given the steady improvements in U.S. consumer fundamentals over the past few years.

Economic Outlook
The proportion of AIER’s Business-Cycle Conditions (https://www.aier.org/BCM) leading indicators deemed to be expanding was 64 percent in August, down slightly from 67 percent in July. This marks the fourth consecutive month with the index in the mid-60s range following three months at the neutral 50 percent level from February through April. Each month, AIER calculates the percentage of its Twelve Leading Indicators that are judged to be cyclically expanding. A reading above 50 percent indicates that continued economic expansion is likely.

In our latest evaluation, 64 percent of our Leaders were on an upward trend, marking the 72nd consecutive month at or above 50 percent. Consistent readings above the midpoint suggest a low probability of recession over the next six to 12 months. Conversely, a drop below 50 percent indicates an increased chance of a future contraction.

However, before drawing conclusions, we look for confirmation from our cyclical score of Leaders. For August, it was 78, up just one point from a level of 77 but still well above neutral. With our Leaders index and our cyclical score both comfortably above neutral, we conclude that the probability of a recession occurring in the next six months to a year remains low.

The percentage of expanding coincident indicators increased to 100 percent in August, following three straight months at 83 percent. Those three results interrupted a run of 40 consecutive months with a perfect 100 score through April 2015. With the return to a 100 percent score, as expected, we have further evidence that the first-quarter weakness was indeed temporary. Among our Six Coinciding Indicators, four touched new cycle highs.

The proportion of lagging indicators judged to be expanding also returned to a perfect 100 reading in August following three months at 80 percent. Four of the Six Lagging Indicators reached new cycle highs, while two were indeterminate. Overall, the percentage expanding and the cyclical score for our leading indicators suggest an expanding economy and low probability of recession (Chart 3).

Charts

Click for interactive Indicators at a Glance (on mobile device turn to landscape)

Next/Previous Section:

1. Overview
2. Economy
3. Inflation
4. Policy
5. Investing
6. Pulling It All Together/Appendix

 

AIER Staff

Founded in 1933, The American Institute for Economic Research (AIER) educates people on the value of personal freedom, free enterprise, property rights, limited government, and sound money. AIER’s ongoing scientific research demonstrates the importance of these principles in advancing peace, prosperity, and human progress.

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