Trouble in China

The real source of today’s stock market plunge is a collapse of China’s purchasing managers index, which fell to 40.9 in November from 45.2 in October, its fourth straight monthly drop. Inside the index, export orders fell significantly. All of this suggests big cuts in China production, employment, and investment, including infrastructure investment.

Over dinner last week, economic Nobelist Robert Mundell, who advises the Bank of China and travels there every other month, told me the Chinese economy is in bad shape. As a bulwark for the global economy, the China card is fast turning unreliable. Not only are stocks falling everywhere else in response to this disappointing China news, but commodity prices like palladium, silver, gasoline, oil, and gold are all plummeting today. I’ve only seen one news story that reported on this China economic decline, but I’m convinced it’s the main factor behind the U.S. stock drop.

Meanwhile, China’s yuan is starting to depreciate, a development that may be a function of their weakening economy, but also may be a policy change by the Bank of China toward devaluation, rather then appreciation.

I’d like to reiterate my support for Mr. Mundell’s idea for a 1-year tax holiday on U.S. corporate profits, then segueing to a 20 percent marginal tax rate on U.S. business from the current 35 percent rate. It is business, not government, that creates economy-growing jobs. Although U.S. profits have slipped (IRS/NIPA profits after tax have dropped 9 percent from their peak in late 2006), they still totaled $1.5 trillion thru the end of the 3rd quarter. After tax, that’s $1.1 trillion.

So, with roughly a $400 billion tax bill at stake, a tax-free holiday would provide a big pool of cash for U.S. business recovery. And a lower marginal tax rate after that would make it pay more after tax to invest in businesses. The Mundell tax cut recovery plan is especially important now that the NBER has just officially declared a recession beginning in January.

Once again, I repeat, government cannot spend our way into prosperity. However, strengthening incentive rewards would boost the animal spirit of investors and businesses to put risk money back to work. This would produce economic recovery.