The Recession’s Exit

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The theory of decoupling was discredited last fall when China followed the rest of the world into the recession’s abyss. But hold on. Writing in Newsweek magazine this week, Goldman Sachs chief economist Jim O’Neill argued that emerging-market economies – with China in the lead – are enduring the US-led global recession far better than the developed world due to rising consumption rates and low indebtedness. Far from arriving stillborn, Mr. O’Neill writes, decoupling is alive and well.

If recent data from Beijing is anything to go by, O’Neill may be right. According to a World Bank report, China’s economic slowdown will bottom out by the summer and end the year with a respectable 6.5 percent growth rate – well below the 9 percent expansion it achieved in 2008 but above East Asia’s regional average of 5.3 percent. The report praised the 4 trillion renminbi ($587 billion) economic stimulus Beijing administered in November as a timely and apparently successful attempt to keep Asia’s economic engine from stalling.

That was two weeks ago. Since then, Beijing has announced a first-quarter growth estimate of 6.1 percent. Export revenues continued to fall in March but at a slower rate while industrial output grew to 8.3 percent, up from 3.8 percent in the first two months of the year. Significantly in an economy known for a high savings rate, China’s consumers are exploiting a surge in bank lending enabled by the stimulus package. Auto sales in March rose 10 percent over year-ago levels and major urban property markets are showing signs of bottoming out. In contrast to rocky equity prices in the West, the Shanghai Composite Index has been rising steadily since November.

So liquid is the Chinese economy – the broad M2 measure of money supply rose to a record 25.5 percent last month – the central bank recently warned it might be forced to ration credit, despite the World Bank’s estimate that consumer prices in China were likely to remain low for the rest of 2009.

China is hardly out of the hole. It remains an export-led economy dependent on the appetites of consumers in the developed world – Americans first and foremost – at a time when global commerce is contracting and protectionism is on the rise. The country needs to manage at least 7 percent growth to keep people employed and off the streets. But the bullish indicators from Beijing suggests that the recession, far from retarding the process of decoupling, may end up accelerating it along with the equilibrium between debtor and creditor states considered vital for stable commerce.

Decoupling implies a shift from a unipolar global economy to a multipolar one and its attendant shifts in trade and capital flows. As emerging markets evolve in wealth and sophistication they are as likely to trade with and invest in each other as they are with the developed world. This process is well underway in Asia, where intra-regional trade and investment is worth as least as much as the commerce it generates with the West. Eventually, as Asian states draw down their huge foreign exchange reserves to meet the growing demands of their own consumers, they will – gradually, it is hoped – unwind their large positions in US sovereign debt. That, in turn, will promote higher savings and more stable interest rates in the US. The payoff of decoupling comes when a healthy node in a decentralized and syncopated global economy can limit the impact of an ailing one.

China is at the epicenter of this seismic shift, owing to its position as America’s largest creditor – World Bank President Robert Zoellick has cannily referred to the Sino-American relationship as the “G-2” – and no small amount of good luck. Currency controls, the last of which Beijing lifted in mid 2007, spared Chinese investors exposure to the toxic financial derivatives that did in so much of the developed world. Despite a costly affair with private equity – its central bank shelled out $3 billion for a stake in investment giant Blackstone at the top of the market in May 2007 – Beijing has parked most of its estimated $2 trillion in foreign exchange reserves in US Treasuries. Yields may be at historically low levels, but China, cash rich a debt free, can easily afford another stimulus package if necessary. The same can be said about Japan and Germany, which run ample trade surpluses and high savings rates.

Now consider what Washington and US President Barak Obama have to look forward to. It is still too early to expect measurable progress from the many trillions of dollars in government bail-outs, stimulus plans, and budget proposals the White House has thrown at an inert US economy. Inventories have declined in volume but remain high relative to sales. American consumers are silent – retail sales declined by 1.1 percent in March, defying expectations of a turnaround from the vertiginous declines of late 2008 – and retailers are sliding into bankruptcy. Even creditworthy borrowers are having a hard time getting bank loans, so anxious are lenders about adding additional non-performing debt to their books.

To make matters worse, the supply of home mortgage delinquencies and foreclosures – the debris of a housing bubble that did so much to destabilize the US economy – is hovering at a staggering 12 percent. At least the depths of that crisis is known, however. The default rate on commercial properties is rising dramatically, and a growing number of economists and investors fear that sector will become the next bad-debt calamity. Some $20 billion in commercial mortgages – on everything from hotels to shopping malls – is expected to fall due this year, with an even higher level projected through 2010 and 2011.

What’s held the market up until now? Congress has eased accounting regulations that require banks to value their assets consistent with market prices and to capitalize accordingly. As a result, lenders would rather keep so-called “legacy loans” on their books while awaiting a turnaround. In doing so, they are arresting the painful but redemptive process that only comes through large-scale liquidation.

So concerned are investors about the US commercial property market that the Abu Dhabi Investment Authority, perhaps the world’s largest sovereign wealth fund with an estimated $1 trillion in assets, is avoiding the sector for at least the next ten months, according to a Washington-based investment adviser.

Given so much uncertainty, the US economy will likely still be struggling when East Asia, led by China, will be well into recovery. That would guarantee at least one source of demand for an economy that up until now has been synchronized in debility, the very condition decoupling would hopefully prevent. This assumes, however, that the world can avoid the perils of protectionism.

It was an indirect form of trade manipulation – China’s policy of devaluating its currency by selling RMB for dollars – that kept US interest rates low and fueled American over-consumption. Now that the US bubble has burst, there is a race to the bottom among trading nations to protect local industry. Washington triggered this scramble by inserting a “Buy American” provision in its stimulus package and other governments have followed suit. If the trend continues, it could undermine China’s recovery while prolonging recession in the developed world.

Even before the credit crunch hit, China was subsidizing its steel and textile exporters with tax rebates, obliging its East Asian competitors to move in lockstep. France opened a fund to protect its companies from foreign takeovers and Indonesia imposed restrictions on imported products in the form of special licenses and fees. Germany offers its companies discounted loans through state-invested banks. Trade officials also note a disturbing rise in tit-for-tat “anti-dumping” measures, as governments accused of subsidizing domestic manufacturers are increasingly embracing the tactic as a retaliatory measure.

Campaigning for president last year, Mr. Obama gave decidedly mixed signals on trade in an attempt to appease both fiscal conservatives and trade unions. He is now under great pressure to renegotiate commercial treaties like the North American Free Trade Agreement. Last month, Beijing blocked Coca-Cola’s $2.4 billion bid for local drinks producer Huijuan Juice even as Chinese investors helped themselves to huge stakes in overseas companies like Australian mining giant Rio Tinto.

The world is paying a stiff price for a generation of American overindulgence. In crisis, however, there is opportunity, and the recession could well accelerate a process akin to cellular fission, in which the world economy’s center of gravity multiplies. It would be a pity if global leaders allowed the rank impulse of protectionism to derail decoupling just as it was gaining momentum.

Stephen Glain - Washington based journalist and author who covered Asia and the Middle East for the Wall Street Journal before returning to the US in 2001. 

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