"Kee" Points with Jim Kee, PhD.

In the US, fourth quarter 2016 GDP growth came in at 1.9%, resulting in 1.6% growth for the full year (Bureau of Economic Analysis). That’s respectable by other developed-market standards (i.e. Europe, Japan) but subpar by normal US standards. Expectations are that there will be stronger US growth in 2017, due mainly to (1) stronger consumer spending (end of deleveraging), (2) stronger government spending (e.g. some increase in infrastructure spending), and (3) stronger business investment spending (less taxes/regulation). Overall expectations are for stronger global growth as well in 2017, with Japan holding steady at low but positive growth and Europe accelerating slightly. Data from the UK continues to hold up better than many economists (like me) expected.


In China, the world’s second largest economy, I would say the opposite seems likely. Fourth quarter GDP growth numbers in China showed a slight acceleration (6.7%), due largely to temporary stimulus efforts that are expected to phase out by mid-2017. China’s official growth target for 2017 is 6.5%, which is below last year’s 6.5%-7.0% growth target. China has a growing corporate/government debt problem to contend with, and a domestic dearth of consumption relative to income (i.e. high personal savings rate) which makes transitioning to a consumer economy from an export-led economy difficult. It is not surprising to see official growth targets there come down.


I would be wary of investing in many Chinese companies. A former colleague of mine, Joel Litman of Valens Research (one of the brightest accounting minds I’ve ever met), has calculated the returns-on-investment (ROIs) for over 800 non-financial companies in China (listed on the Hong Kong, Shanghai, and Shenzhen stock exchanges). He found that 70% are generating negative economic profits when measured using the Uniform Adjusted Financial Reporting Standard (which Litman claims has fewer distortions than GAAP or IFRS-International Financial Reporting Standards).


That has been one of Japan’s problems for over two decades: their companies were able to get access to capital from the government whether they were profitable or not, creating so-called zombie companies that destroy wealth rather than create it. I’ve been watching for that in China for over a decade now, and Litman’s work suggests it may be becoming a reality. Anyway, a trade-war with the US is something I would bet the Chinese will try very hard to avoid. By the way, a conservative view of China should moderate enthusiasm (currently running high) for emerging market investments, which tend to correlate with Chinese growth and with commodity prices (which themselves have correlated with Chinese growth for the past 15 years). Some of that enthusiasm is based upon relative valuation measures (i.e. emerging market stocks look “cheap” relative to other markets), but it may be that they are cheap because of slower expected growth in China.


And speaking of trade, your guess is as good as mine as to why President Trump engaged Mexican President Enrique Peña Nieto last week in a manner that ensured a deepening rift. With regard to international trade in general, there has been a lot of discussion lately of “border tax adjustments,” which many Republicans favor but which Trump feels are too complicated. The idea of a border tax adjustment is to reduce taxes on exporters and raise taxes on importers - or at least on imported goods that companies here use to make their final products - all of this ostensibly to level the playing field relative to other countries whose international tax systems differ from ours. Legally, it is not clear what form a border tax adjustment could take that would keep the US in compliance with international law (i.e. the World Trade Organization and the General Agreement on Trade and Tariffs that it subsumed). Also, the economic incidence is difficult to determine, as taxing companies on imports from Mexico (or not allowing them to deduct them as a part of their cost-of-goods sold) could cause Mexican firms to pass the tax backwards by paying their workers less (which is why Mexican workers are upset). Or, US firms could pass it forward in the way of higher prices to US customers (in which case we’re paying for The Wall, as the press has noted). And if border taxes cause us to import less globally, then that puts upward pressure on the dollar (fewer dollars supplied globally to buy foreign goods). So does exporting more globally, because of stronger demand for US dollars by foreign buyers. A stronger dollar in turn would negate the negative impact on US importers (because their dollars now buy more) and it would hurt exporters because their goods would cost more in international markets. These points just really scratch the surface, but I hope they illustrate the complexities involved with border-tax adjustments.


The US’ biggest trading partners, by the way, are Europe, Canada, China, and Mexico, in that order (but they’re all pretty close in dollar volume). For what it’s worth, I would rather, in the words of Canadian economist Reuven Brenner, see the government “get back to basics and negotiate an international agreement to stabilize currencies.” Brenner (following Nobel Laureate Robert Mundell, another Canadian economist) points out that currency fluctuations wreak havoc with contract values, and contracts are the “essence of commercial societies.” Trade agreements, renegotiations, and “updates” (as proposed NAFTA changes are often called) are important, but so are exchange rate policies, which deserve more attention than they are getting at the moment.