Have the Seeds for Decoupling Been Sown?

The decoupling theory – Asia and Asian markets (sans Japan) decoupling from the rest of the world – keeps surfacing from time to time – specially when the markets in Asia tend to perform better than those of US and Europe. It happened in the first two weeks of February when the Chinese and Indian markets seem to have started outperforming the US and European markets. However as the US market indices have started to challenge the November 08 lows the perception seems to be altering again. So is decoupling a possibility at all?

Prima facie it appears to be a difficult proposition. The reasoning is very sound:

Basically, there are two stories to tell here about the sudden downturn in the global economy.

The easiest to understand is the collapse of industrial production in East Asia, where the supply chain starts in places like Taiwan and Vietnam and moves through places like China and Japan before cars, shoes, computers and flat-panel TVs arrive at stores in the United States, Western Europe and everywhere else...

The 40 percent decline in Taiwan's industrial production at the end of last year was the "canary in the coal mine" of Team Asia's formidable export machine. At about the same time, Japan's exports fell 35 percent, Korea's 17 percent, and China's fourth-quarter gross domestic product was essentially flat -- no economic growth at all…

Never seen declines this fast and this steep, even during the Asian economic crisis ... It all reflects not only the sharp pullback in discretionary consumer spending around the world but also an equally sharp pullback in the flow of foreign investment that was used to build factories and shopping centers and has been an important driver of growth in the region.

Demand for Asian exports will pick up again before too long, but it will be a long time before they reach the levels attained at the height of the bubble economy. And it will be longer still before foreigners will be eager to invest in expanding capacity again.

Ideally, Asians would respond to this challenge by reducing their heavy reliance on exports and foreign investment and reorienting their economy more toward domestic consumption. But … that's not as simple as it sounds.

For starters, the things Asians might want to consume aren't necessarily the things they produce to export, so production would need to be reoriented and workers retrained and redeployed. And to replace the foreign investment, these economies would need to develop financial institutions that can raise and invest risk capital, which right now they don't really have. Most significantly, Asian governments would have to create safety-net programs like Social Security so people don't save so much and spend so little.

In short, the Asian downturn is probably manageable, particularly now that the Chinese government has responded with a massive stimulus package. But it will take time for the region to make the necessary adjustments to get the region humming again.

As I see the lessons learnt/being learnt during this severe downturn will have a lasting impact as these Asian countries now re-orient their industrial and fiscal policies to ensure that over dependence on exports is reduced in the years to come. Also trade within the region will now be a much greater focus as two of the most populous countries in the region ‘Chindia’ look to push their growth with policies that are much more domestic investment and consumption oriented. India always was domestic consumption story (save the IT and IT enabled services and Generic Pharmaceutical industry) and now can be regarded as a great advantage.

As the quote above points out - the reorientation will be challenging and will take time – a decade or so. But as the US and European consumption story sees its twilight in years to come it is the Asian and some of the resource rich countries such as Brazil that will need to fill-in. And as this re-orientation sees initial success foreign capital (US and European savings) will start seeking these countries and the capital required to sustain a reasonable growth rate will find its way. The seeds for this shift – possibly a power shift too - appears to have been sown.

Disclosure - No Positions.

Comments

[Steven Hansen:]

with globalization, it is unlikely decoupling will ever occur. my thoughts are the chinese stimulus was meant only to keep the economy afloat until the world came out of the recession.

Feb 23 07:32 AM

[William Gamble:]

The author correctly points out that the Asian countries should "now re-orient their industrial and fiscal policies to ensure that over dependence on exports is reduced in the years to come." But will they?

In the US to reorient our policies has taken a major political shift and a dramatic change of leadership. To reorient the policies and strategies of a corporation often requires a dramatic change of leadership most often forced by a takeover, shareholder revolt or even bankruptcy.

Asia unfortunately is not all that good at change. The Chinese Communist party has been in power for over 60 years. The LDP in Japan has been in power for over 50, Japan has been pursuing the same mercantilist policies for years. They can't just stop. Like China and other Asian counties there is a vast legal infrastructure which gears the economy to export. You can't just dismantle it over night. In the last recession they got rid of the keiretsu only to rebuild them during their short expansion.

Just because the policy is correct does not mean that anyone will follow it. In the US we had four years of disastrous policies under George Bush and we still reelected him. His advisers like Cheney and Rove still can't admit that they are wrong. The problem has to do with cognitive biases. We all have them and they prevent us from being good investors and good policy makers.

Feb 23 09:24 AM

[sunsetlover:]

"the things Asians might want to consume aren't necessarily the things they produce to export,..."

The problem is not that they don't want to consume what they produce to export, it's just that they can't afford them. In many Asian countries (except Japan and Korea) the purchasing power parity of the vast majority of the population is 1/10 of that in the US and European Union. Anyone who has traveled in Asia knows, or should know, that what a Westerner spends for 4 nights in a 4 or 5-star hotel there equals an average office worker local monthly salary. Which brings us to the other problem Asia faces: declining dollar reserves and revenue due to rapidly declining tourism.

Mar 02 05:53 PM