Money Morning Mailbag: China Needs to Boost Domestic Demand to Continue Economic Recovery

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China released data this week showing its economy grew 9.6% in the third quarter from a year earlier, slower than years past but still significantly ahead of other countries that are struggling to stabilize their economies.

A slight dip in growth is what China wanted. Its gross domestic product (GDP) has grown on average more than 10% annually since 2006. The country's central bank lifted rates this week by 0.25 percentage points for the first time since 2007 to further cool the risk of overheating.

While working to maintain a healthy level of growth, China now has to contend with other countries devaluing their currencies to compete against a cheap yuan that is fueling an export-driven recovery. However, the whole world can't depend on exports – somewhere along the line there must be growth in demand.

The following reader question asked how emerging markets like China will continue selling goods while other economies' consumers find themselves with less valuable currency, and what this means for investors.

With the developed countries -- who have been buying the emerging economies goods at very low cost -- going down the drain with the dollar and unemployment, who will be buying from the emerging economies? Why run off to China to invest when they see that the American market is dying and they are building huge additional reserves to go on after the dollar collapses?

The Chinese see that they will have to dump the dollar and the markets of the developed economies, which they have destroyed. They know that their people can take what will be a hard recession or depression better than Westerners who are used to having it all and think it will go on forever. All of these investment ideas in the face of world economic disaster make no sense other than the possession of gold and silver, food, and farmland.

-- Peter M.

Developed economies clearly cannot support emerging economies on export needs, so there needs to be a global shift toward emerging market demand. China for more than five years has attempted to boost domestic consumption, but domestic consumption accounted for just 35.1% of the country's GDP last year.

A recent article in The Economist pinpointed China's reliance on heavy industry as a reason domestic consumption has not picked up as needed. Capital-intensive heavy industries of steel, cement and aluminum create few chances for job growth and keep wages low.

But there are signs of a shift in policy.

Deputy central bank governor Yi Gang said earlier this month that the government would help promote domestic consumption by reducing income inequality, improving social security and education, and improving infrastructure in rural areas.

"To emphasize domestic demand is a firm policy of the Chinese government, and this is a comprehensive policy from all directions," Gang said at the International Monetary Fund's (IMF) annual meeting.

A consumer-driven economy would grow more slowly than an economy reliant on exports, but it would be more resilient against global financial crises that affect other countries' imports and demand levels.

Developed nations like the United States support a stronger Chinese consumer, hoping the shift would give a boost to U.S. exports. The United States continues to be the most vocal about wanting China to allow its currency to appreciate and has made threatening tariff proposals. Other nations like Germany, Japan and Brazil also have started speaking out.

"We have to take care that the currency war doesn't become a trade war," German Economy Minister Rainer Bruederle told German business paper Handelsblatt. "China bears a lot of responsibility for ensuring that it doesn't come to an escalation."

But no changes will be made without significant progress at the next Group of 20 (G20) meeting in Seoul, South Korea early next month. Policymakers are slated to discuss how to prevent the global currency war from spiraling into a paralyzing trade war - something that will take multilateral cooperation.

Until more progress is made, the currency disputes mean investors will continue to turn to commodities as portfolio safety measures against a weakening U.S. dollar and slow economic recovery.

"Against this backdrop, one of the smartest things for investors to do is buy those things that not only appreciate amidst failing fundamentals, but which preserve their wealth at the same time - case in point gold and other precious metals," says Money Morning's Chief Investment Strategist Keith Fitz-Gerald. "I continue to believe that we're in a long-term commodities bull market no question about it. Commodities may drop in the short term, but any such moves will likely be reviewed in history's rearview mirrors as buying opportunities, for at least the next ten years."

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