SERIOUS MONEY:Eastern economies have now found they are not immune to the worlwide fiscal malaise
WORLD STOCK markets have advanced sharply in recent months as economic data confirm that the rate of deterioration in the global economy has slowed. This has led many to conclude that the worst economic recession since the second World War is close to an end, while some have declared confidently that it is a developing Asia which will lead the global economy out of its current malaise.
Proponents of the latter view are among the same commentators who argued just 18 months ago that the developing world would prove largely immune to an economic downturn in the West. That view proved embarrassingly wide of the mark.
The latest reformulation of the same thesis conveniently overlooks the fact that a vibrant Asia is almost certain to exacerbate the very same global imbalances that contributed greatly to economic instability.
The world economy enjoyed the strongest and most sustained boom since the early-1970s from the end of 2002 through the summer of 2007, with average growth rates in GDP close to 5 per cent. The prolonged expansion however, was centred on excess production in the East – notably China – satisfying excess consumption in the West, particularly the United States. The recycling of eastern current account surpluses kept exports competitive and placed downward pressure on world interest rates that served to push asset prices higher and enabled overstretched western consumers to accommodate higher debt loads.
The production-driven economic model of developing Asia saw the export share of pan-regional GDP jump by more than 10 percentage points in less than a decade to a record 47 per cent in 2007.
Although there was a sharp rise in intra-regional trade, dependence on consumers in the developed world increased as the growth was concentrated primarily in intermediate goods, with roughly 80 per cent of the final demand stemming from the world’s largest economies.
The dependence on the West was compounded by the high investment rates in recent years, which were geared towards the satisfaction of export demand and not domestic consumption. Indeed, the region’s consumption share of GDP dropped eight percentage points in just eight years to a record low of 47 per cent in 2008.
The US consumer was the driving force behind the global economic expansion and Asia’s export boom from the mid-1990s through 2007. It continued to be the world’s “consumer of last resort” during the current cycle, in spite of modest income gains arising from sub-par employment growth and lacklustre increases in private sector labour compensation. The gains in household income fell more than $800 billion in real terms below the trajectory of the four previous economic expansions.
Sluggish income gains did not curtail American households’ free spending ways as they increasingly turned to the wealth gains on their rapidly-appreciating homes in order to keep their binge alive.
Mortgage equity withdrawals soared to more than $700 billion in 2005 or almost 9 per cent of disposable personal income. This more than compensated for the dismal increase in real labour compensation.
The increasing reliance on asset price gains saw household debt jump more than 29 percentage points relative to GDP in just seven years to 100 per cent in 2007, a level that was higher than the comparable figure on the eve of the Great Depression.
America’s worst housing recession in modern history brought an end to the asset-dependent spending binge, and real consumption expenditures contracted at an average annual rate of more than 3.5 per cent during the final two quarters of last year. Declining consumer demand in the US wrought havoc on the world economy and export-driven Asia proved particularly vulnerable with the economies of Hong Kong, Japan, South Korea, Taiwan and even China all coming to a standstill over the past six months. Exports collapsed and have remained weak through the first four months of 2009, with Chinese exports falling 23 per cent year-on-year in April as against gains of 25 per cent 12 months earlier.
Economic growth in China slowed to 6 per cent during the first three months of the year as against almost 7 per cent during the final quarter of 2008, and with more than 15 per cent of the total migrant labour pool unemployed, the Middle Kingdom responded with a tried-and-tested formula of increased infrastructure spending and credit lending, the success of which ultimately depends on an increase in the demand for Chinese goods by American consumers.
However, the rebalancing of the US economy has barely begun with the consumption share of GDP jumping to a record of more than 72 per cent in the first quarter.
America’s consumption share of GDP is clearly unsustainable given households’ overstretched balance sheets. Deleveraging by households means that consumption growth is likely to lag increases in GDP for several years – at the very least until the GDP share returns to its pre-bubble level of roughly 65 per cent. This means that China’s current economic policies could prove self-defeating as excess capacity leads to a spike in non-performing loans, which would act as a constraint on Chinese consumption – the only genuine replacement for soft US demand.
Investors are confident that the worst of the global economic downturn is over, which is hardly surprising given the magnitude of the declines in real activity over the past six months.
However, the emerging confidence has now morphed into the idea that Asia will lead the world out of its current malaise. This new formulation of the now defunct global decoupling thesis doesn’t stand up to scrutiny just like its predecessor and astute investors would be well served to ignore the dubious logic.
charliefell@sequoia.ie
