The drivers of the U.S. economic expansion in the first half of this year — factors such as supply chain localization, advancements in AI technologies, a post-pandemic export resurgence and fiscal incentives — have ignited a significant surge of investment within the U.S. manufacturing sector. This growth is particularly evident in the development and application of cutting-edge products, such as semiconductor chips, computers and artificial intelligence.
Notably, the high-tech sector in the U.S. saw consistent monthly growth throughout the year. However, it is crucial to acknowledge the accumulation of certain risk factors. The future trajectory of the U.S. economy will depend on the relative development of these economic growth drivers and potential risks.
• Escalation of trade tensions. Friction between the U.S. and its major trading partners may have a negative impact on the U.S. economy. In particular, it should be noted that the geopolitical tensions between the U.S. and China could further intensify trade competition between the two. The mitigation of rapid inflation may embolden the Biden administration to strengthen already firm stance on China’s technology competition, trade disputes and potential future financial conflicts.
Such unwavering resolve could entail the retention of high tariffs and the possible introduction of more restrictive export policies. These actions are likely to provoke discontent from China. Should the U.S. and China continue to intensify controls and prohibitive measures pertaining to matters involving Taiwan, the South China Sea, and high-tech exports, the repercussions could restrain trade and investment activities between the two nations. This, in turn, could adversely affect U.S. export-oriented enterprises and industries closely linked to China.
• Tight U.S. dollar liquidity. In June, an agreement regarding the debt ceiling was reached between the two major political parties in the United States. The U.S. Treasury Department will engage in market debt issuance, as authorized by the Fiscal Responsibility Act of 2023. The net borrowing estimate for the Treasury Department during the July-September quarter has been revised upward to $1 trillion, substantially exceeding the initial projection of $733 billion in early May. Furthermore, to maintain a cash balance exceeding $750 billion in its accounts by year-end, the department will need to issue $852 billion in debt from October to December. In the short term, the issuance of Treasury securities will deplete U.S. dollar liquidity in the market, potentially resulting in short-term liquidity shortages, elevated financing costs and a stronger U.S. dollar. Additionally, the Federal Reserve will persist in reducing its balance sheet during the latter half of the year, which will further reduce U.S. dollar liquidity.
• Reduction in accumulated savings by U.S. residents. Over the past three years, the U.S. government has undertaken extensive cash distribution operations. As a consequence, U.S. residents have substantially accumulated surplus savings. The impact of these transfer payments extends not only to households but also to the corporate sector. Comprehensive legislation, including the CARES Act, Coronavirus Tax Relief, American Rescue Plan, Infrastructure Investment and Jobs Act, CHIPS and Science Act and Inflation Reduction Act, resulted in the transfer of over $2.3 trillion to U.S. households and the corporate sector between 2020 and 2022, constituting 9.6 percent of U.S. GDP in 2021.
But these policy-driven fiscal injections are tapering off. Credit card delinquency rates are rising persistently, and mounting evidence suggests that consumers are feeling the financial strain of elevated prices and reduced savings relative to previous years. Further, wage growth for U.S. workers, which peaked in June, began to wane in July. This decline in income growth is poised to induce greater financial caution among U.S. consumers.
• Slowing of revival in U.S. manufacturing. Over the past 18 months, foreign investment in U.S. computer and electronics sector manufacturing has risen continuously, surging from a mere $17 million in 2021 to $54 billion in 2022, constituting 66 percent of the total new foreign direct investment for the year.
However, the sustainability of this trend warrants scrutiny. Although the Biden administration has robustly championed the resurgence of manufacturing, the number of manufacturing jobs has barely increased since January, hovering at approximately 13 million and showing only marginal growth since early 2020. Consequently, the sustainability of the revival of U.S. manufacturing remains uncertain. In fact, indications of this trend’s fragility have recently emerged in Texas, a prominent manufacturing hub in the U.S. Factory activity in Texas regressed again in August, with the production index plunging to -11.2, the lowest level since May 2020. Multiple indicators gauging manufacturing activity have also contracted.
• Relatively high inflation. Persistent inflation has continued to be a pressing concern in the U.S. during the second half of the year. While the U.S. core CPI exhibited a gradual descent, dropping from 5.3 percent in June to 4.8 percent in July and 4.7 percent in August, overall inflation levels rose from 3 percent in June to 3.2 percent in July, primarily due to surging food prices. The persistence of inflation will ensure the continuation of the Federal Reserve’s tight monetary policy.
Financial market perils
• Risk of elevated interest rates. As the Treasury Department reduces market liquidity through debt issuance and the Federal Reserve sustains its monetary tightening, interest rates remain at elevated levels. The deleterious effects of high-interest rates on the economy will progressively manifest themselves. Since the Federal Reserve once again raised interest rates in July to a range of 5.25 percent to 5.5 percent, the highest in nearly 22 years, the broad money supply (M2) has contracted by over $1 trillion. During the global central bank governors’ meeting in Wyoming in late August, Federal Reserve Chairman Jerome Powell confirmed the U.S. economy’s brisk growth, ongoing robust consumer spending and enduring inflationary pressures. Consequently, Powell reiterated the Federal Reserve’s commitment to sustaining benchmark interest rates at elevated levels until inflation subsides to the 2 percent target, a decision that will perpetually impact the U.S. economy and, notably, influence Asian economies. High interest rates and a restrictive monetary milieu will raise financing costs for both businesses and consumers, thereby exerting pressure on financial markets.
Moreover, the impact of interest rate hikes on the Eurozone is increasingly apparent, given Europe’s susceptibility to interest rates relative to the United States. Japan’s economic outlook is similarly bleak, as it is plagued by geopolitical pressures and exhibits marked growth disparities.
• Deterioration of global stock markets. Owing to the confluence of tighter U.S. monetary policy and high interest rates, global stock markets have displayed signs of fatigue. Concerns over the Federal Reserve’s potentially expedited interest rate hikes loom large, precipitating apprehension over an impending market correction. The Tokyo Stock Price Index (TOPIX) in Japan has recorded marked declines since June, while the Hang Seng Index in Hong Kong has also experienced contractions. The performance of U.S. stock markets, despite the Federal Reserve's monetary stance, falls short of expectations, primarily because of elevated valuations and worries about the sustainability of corporate profitability. Should inflation and interest rates persistently ascend, global stock markets, including U.S. stock markets, may encounter substantial challenges.
• Disruptions in supply chains. The acceleration of supply chain localization, driven by geopolitical tensions, trade disputes and the lingering pandemic, has not alleviated the threat of supply chain disruptions. Natural calamities, labor disputes and logistical bottlenecks can disrupt the production and distribution of goods, culminating in augmented costs and diminished operational efficiency for businesses.
• Escalating operational costs for enterprises. The persistent presence of inflation, elevated interest rates and recurring supply chain disruptions amplify operational costs for businesses. Enterprises may find themselves compelled to transfer these heightened expenses to consumers in the form of higher prices, potentially curtailing consumer spending and reducing corporate profitability.
• Labor market challenges. The labor market is grappling with several challenges, including labor shortages, wage pressures and skill shortages. These hurdles can render the task of identifying and retaining qualified employees arduous for enterprises, thereby potentially hampering their capacity for expansion and growth.
• Cybersecurity vulnerabilities. Cyberattacks and data breaches continue to pose a formidable threat to businesses and the broader economy. A significant cybersecurity incident has the capacity to disrupt operations, tarnish corporate reputations, and result in financial losses.
Spillover effects on China
The risks confronting the U.S. economy possess the latent potential to spill over into the global economic arena. The interconnectivity of financial markets and supply chains underscores the reality that disturbances within the U.S. can trigger far-reaching repercussions across the globe. For instance, a correction in U.S. markets could precipitate declines in global stock markets. Similarly, disruptions in U.S. supply chains can imperil businesses and industries on a global scale. The implications of these trends on China are intricate and multifaceted.
Economic growth. The trajectory of the U.S. economy has a substantial influence on China’s economic expansion. Sustained growth in the U.S. economy would bode well for China’s export demand and foreign investment inflows. However, any risks and uncertainties faced by the U.S. economy may lead to diminished import demand from China, thereby affecting China’s exports to the U.S. and its overall economic growth.
Economic and trade relations. Adjustments in U.S.-China trade policies can have profound ramifications for bilateral trade dynamics. Improved trade relations between the two nations, marked by reduced trade frictions and trade barriers, would facilitate trade and investment between them, consequently benefitting China’s exports and economic growth. Nonetheless, if the U.S. persists in tightening technology restrictions on China, restructuring supply chains under the Indo-Pacific Economic Framework and enforcing measures against unfair trade practices, it could compel China to adopt retaliatory measures. This could exacerbate economic and trade tensions, hasten economic decoupling and pivot China toward developing markets beyond the U.S.
Technological competition. Heightened U.S. support for technological innovation and industrial modernization may intensify technological competition between the U.S. and China. This could pose challenges for China’s technological advancement and technology-driven enterprises, particularly in areas such as artificial intelligence, 5G and semiconductors. Nevertheless, it may also catalyze greater investment in technological innovation by China.
Financial markets. Volatility and risks in U.S. financial markets can potentially spill over into China’s financial markets. Given the interdependence between the two nations’ financial markets, developments in U.S. financial markets can initiate global market fluctuations, which, in turn, can impact China’s financial stability and capital flows.
Such impacts are intertwined and intricate, influenced by additional factors, such as international politics and the global economic landscape. The extent and direction of the ultimate impact hinge upon the interplay and evolution of various factors.
Recommended responses from China
In response to the impacts, the following strategic approaches are recommended:
• Stabilization and enhancement of the domestic economy. While the stabilization and development of the domestic economy have always been focal points for the Chinese government, the divergence in GDP growth between China and the U.S. has recently expanded. Further, there have been indications of industrial relocations, underscoring the need for vigilance in preserving the stability and growth of the domestic industrial ecosystem. This becomes pivotal for upholding domestic economic stability and ensuring sustainable development.
• Formulation of crisis mitigation policies. At present, there exists a heightened probability of the U.S. economy descending into a soft recession by year’s end and into next year. China should therefore consider the formulation of crisis mitigation policies to preemptively address any secondary crisis stemming from a downturn in the U.S. economy. Furthermore, should the U.S. banking sector confront another crisis owing to liquidity constraints, China should explore responses and proactively take necessary actions.
• Adoption of multi-pronged measures to guard against contagion from turbulence in U.S. financial markets. China should reinforce monetary policy flexibility, preserve equilibrium in the current account and ascertain the sustainability of debt. Enhanced financial regulation, daily liquidity risk monitoring, exploration of tiered liquidity reserves and contingency plans and bolstered resilience in China's capital markets to withstand potential risks are imperative. Additionally, China should continue advancing the market-oriented reforms of the renminbi exchange rate and augment exchange rate flexibility to buffer against external financial risk impacts. China's overseas financial entities should augment their reserves of U.S. dollar liquidity.
• Augmentation of technological investments. The U.S. has enacted more extensive Western-imposed technology restrictions on China with the aim of maintaining China’s position in the lower echelons of the value chain and exerting pressure on China’s steady economic development. However, adversity often fuels innovation. China should seize this opportunity to bolster support for technological innovation through diverse means, encompassing financial incentives, tax reform, social security initiatives and more.
In 2022, U.S. research spending on scientific endeavors totaled $679.4 billion, surpassing China’s $551.1 billion. Per capita research spending in the U.S. is approximately five times greater than in China. Consequently, China still has ample room for expanding its technological investment. Concurrently, an emphasis on enhancing education and skills training is imperative. By delivering higher-quality education and skills training, starting with human capital development, China can enhance the alignment of its workforce with advanced technology.
• Adaptation of trade policies. China should strive to establish trade facilitation mechanisms with a broader spectrum of trade partners via novel dialogues and negotiations. By resolving trade disputes and diminishing trade barriers, China can mitigate the uncertainties emanating from trade frictions and spur the resurgence of trade and investment activities.
Full implementation of extant and effective free trade agreements remains pivotal. China should deepen foreign cooperation, utilize the outcomes of its free trade zone development, expedite the execution of existing trade agreements and enhance economic connectivity with neighboring nations, as well as with Central Europe and Latin America.