The theory of decoupling grew in popularity during the 2000s. In its simplest form, it said that the United States would no longer be the driver of the global economy. Rather, emerging markets would become an economic force in their own right and develop at their own pace, regardless of the U.S. economic condition.
Instead of decoupling, emerging markets are unhinged. Most developing countries export manufactured goods to the developed markets or export raw materials to the manufacturing countries. The developed world, led by America, Japan, and Europe, has cut back on spending and may not surpass its bubble consumption rates for a generation or more. A combination of debt deflation, excessive government spending, and deficits coupled with demographic decline means that there will be fewer people to pay ever-growing bills.
A slow transition from high consumption rates to lower consumption rates would have been easier to handle, but the flood of spending and debt over the past few years created an unsustainable trend that has totally imploded. Japan’s export-dependent economy contracted at a 12.7 percent annualized rate in the fourth quarter of 2008, for instance, and the decline for emerging markets could be worse when all is said and done. Below, I’ll take a look at several regions and some major countries to give readers an idea of what’s happening.
Korea reported more than a 30 percent drop in exports in January and 17 percent in February. Taiwan reported greater than 40 percent declines in exports and industrial production in January; exports fell 28.6 percent last month. China said exports fell 17.5 percent in January and 25.7 in February while imports fell a whopping 43.1 percent in January and 24.1 percent last month. Many Japanese and Korean firms export unfinished goods to China, where they are completed and then exported around the globe. That China’s decline in imports matches the drop in exports from Korea and Japan indicates that the Middle Kingdom’s exports may continue to fall in the next month or two.
Thailand’s economy shrank at a 4.3 percent pace in the fourth quarter, a swing of 8 percentage points from positive 4 percent growth in the third quarter. Singapore’s economy entered recession a quarter earlier, since it is a major financial center, while electronics and natural resources exporter Malaysia is expected to sink in the coming months.
Since many of these countries experienced a depression during the Asian Crisis, they avoided the excesses found in many bubble economies. As bad as the numbers above look, this is actually one of the better regions. The main weakness for most of these countries is their mercantilist development plans that rely on foreign consumption to drive growth. Economically, they are positioned well because domestic consumption could pick up much of the excess capacity, but their problem is political. Political parties are far more entrenched in Asia, even in democratic Japan. The outlier here is Singapore, which has by far the best political leadership and addressed the crisis quickly. Unfortunately, as a financial center and small city reliant on global trade flows, the country’s competent leaders cannot spark a global recovery.
Fourteen years. That’s the amount of commercial real estate supply available in Beijing following the Olympic construction frenzy, according to a businessman American investor quoted in the Los Angeles Times. China’s export-driven economy was brought to a relative standstill in the southern light-manufacturing regions, with various figures in the range of 20 million being used to describe the number of migrant jobs lost throughout the country. China suffers from misdirected investments in other sectors due to export subsidies and the government’s push for infrastructure projects; its currency may also be devalued slightly to aid the exporters.
China’s position is very similar to that of America in the 1920s. It is a major exporter with an undervalued currency and overcapacity in many sectors. People are migrating from the agrarian sector in rural areas to the manufacturing and service sectors in the urban areas. One important difference, however, is that whereas the United States abandoned the free market for protectionism and central government control, China is sticking to free trade and continues to open its markets.
The country’s stock markets have shown the best performance among major markets this year, up 22.1 percent through March 18. However, one explanation for the rise was the huge increase in bank loans. Unlike American banks that refuse to loan in the face of a bad economy, China’s state-owned banks have followed the central government’s directive to make new loans. In fact, loans increased 19 percent year over year in December and more than 20 percent in January, and as much as one-third of the money flowed into the equity market, according to one China-based analyst.
India reported 5.3 percent growth in its third quarter, which corresponds to the fourth quarter for most of the world. The country cut excise taxes by 25 percent and services taxes by 17 percent at the end of February to boost the economy, one of the few nations implementing this historically successful tactic. S&P may lower India’s bond rating to junk due to high deficits, but the tax cuts are unlikely to cost much if economic activity slumps. The Economist still predicts growth of more than 5 percent for the next two years, an impressive feat if the country can manage it.
As one of the petrol states, Russia experienced a nose-diving economy in 2008, and its central bank burned through about one-third of its currency reserves. In December, Bloomberg reported Russians were hoarding gold and dollars while the ruble collapsed, but this has slowed as the currency stabilized. Russia recently received a $25 billion loan from China in exchange for delivering oil for the next 20 years, but industrial production numbers here aren’t much better than in the rest of Asia. Vladimir Putin made ambitious speeches at Davos about replacing the U.S. dollar, but unless he’s planning to back the ruble with gold, this will not be possible.
In January, Argentina reported a 4.4 percent drop in industrial production, while Mexico reported a 6.7 percent slide. Mexican automotive production fell 51 percent in January as the largest export market for Mexican cars, the United States, reduced car purchases. Brazil’s economy is expected to slow, but Brazil hasn’t grabbed headlines like the other nations have. Meanwhile, Chile may be Latin America’s answer to Singapore. The country built up reserves while commodity prices were high and is widely regarded as the best-managed economy in the region.
Now we come to the region that stands the greatest risk of bringing pain to the global economy. The Economist published an article titled “Argentina on the Danube?” In the first paragraph, the author describes the crisis in Eastern Europe as a mix between the Asian Crisis and the Argentinean currency crisis. Western European banks are on the hook for massive amounts of loans to countries that are watching their economies implode and their currencies collapse. The Economist reports, “Austria’s lending to Eastern Europe is equivalent to about 80% of its GDP.” Ambrose Evans-Pritchard has stayed on top of the topic for the U.K.’s Telegraph. He reported that 60 percent of Polish mortgages are in Swiss francs, but the Polish currency fell from two zloty to one franc in September to more than three today, a loss of more than 50 percent.
The currency declines in Eastern Europe are similar to what was seen in Asia during the Asian Crisis, but European banks have the greatest exposure by far. Western European banks face far greater losses if their loans to Eastern Europe fail, possibly dwarfing subprime losses in the United States. For this reason, the dollar has been able to hold its ground versus the euro before Bernanke implemented quantitative easing. The E.U. will watch the region implode like East Asia in 1997, or it will end up having to follow the policy of the Federal Reserve in the United States and flood the banking system with liquidity.
The performance of international ETFs through March 18 basically reflects the trends discussed above. There’s no Mainland China ETF, but year to date, closed-end Morgan Stanley China (CAF) gained 35.6 percent; iShares FTSE/Xinhua China 25 (FXI) fell 4.78 percent as Hong Kong listed shares underperform the Mainland. PowerShares India (PIN) fell 9.71 percent; Market Vectors Russia (RSX) climbed 8.95 percent as the ruble stabilized. Latin America, which has mainly kept itself out of the headlines, moved higher. iShares S&P Latin America 40 Index (ILF) is up 2.36 percent; iShares MSCI Brazil (EWZ) gained 9.23 percent; iShares Chile (ECH) added 13.82 percent. iShares MSCI Austria (EWO) lost 11.37 percent.
Decoupling is a dead theory, but this may be the moment when economies actually exhibit some signs of decoupling, in the sense that countries move from over-reliance on a few sectors or export markets to a more balanced economic structure. The United States and Europe will have a lot to do with this as well. A push for greater globalization will open more markets and bring economies closer together, while a move toward protectionism will close markets to developing countries and isolate the developed nations. In the short run, protectionism means more jobs at home due to the imbalanced global economy, but in the long run it may create the decoupling that so many economists expected.