Publié par : crise2007 | novembre 29, 2007

Recoupling rather than Decoupling: the Forthcoming Contagion to China, East Asia and Emerging Markets !

Recoupling rather than Decoupling: the Forthcoming Contagion to China, East Asia and Emerging Markets !


Nouriel Roubini

This analyst started arguing against the « decoupling » hypothesis in the summer 2006;  see 12 Reasons Why the World Will Not De-Couple From the Coming U.S. Growth Slowdown…Or “Why When the U.S. Sneezes the World Gets the Cold”…and The Fairy Tale that the World Will « Decouple » from the Coming U.S. Recession…

 I elaborated my views in the recent Global Recoupling Rather than Decoupling as the US Heads towards a Recession  While there I discussed how Europe will not decouple from the U.S. hard landing the argument holds a fortiori for China, Asia and other emerging market economies.

  Paradoxically China is the one country that has, so far, decouple the most – both in real and financial terms from the U.S. but it will also be the first and most serious victim of a U.S. led recession. The decoupling of China is clear as its growth rate has not decelerated, in spite of the U.S. slowdown, and its financial markets have – so far – blissfully avoided (thanks in part to its financial system partially isolated via capital controls from the global one)  the turmoil and volatility that hit the US and Europe since the summer. But the reason for the Chinese growth decoupling is that, until recently the US slowdown was still modest (short of the coming hard landing) and it was not concentrated in private consumption but rather housing: China is mostly exporting low-priced consumer goods to the U.S. and the recoupling of China will occur soon once the US consumer recession is in full swing. Thus, the biggest victim of a US consumer led recession will be the country – China – that, so far, has decoupled the most from the US.  And for China a fall in its growth rate from 11% towards 6-7% would be the equivalent of a « hard landing » as China – to maintain its social and political stability given its widening income and wealth inequality – needs to grow at least 10% a year in order to move about 15 millions poor farmers from the rural to the urban and industrial sector every year. No wonder that Chinese officials have started to express serious concerns about the current sharp slowdown in Chinese exports to the US, from an annualized growth rate of over 20% in Q1 to a rate of 12.4% in Q3 of this year (« If demand in the US drops further, Chinese exporters will be devastated by a rapid and continuous fall in orders, » a Chinese official report said).

And once there is a sharp growth slowdown in China the next victims of this recoupling will be East Asia and commodity exporters.   There is a current myth among some analysts that the increased amount of trade between East Asian economies shelters them from a US slowdown. But in spite of the growing intra-Asian trade the cyclical and structural dependence of East Asia on US growth is now larger than five or ten years ago. The reason – as analyzed in detail in recent work by, for example, the Asian Development Bank – is as follows: it used to be the case a decade ago that East Asian economies tended to export directly final goods to the US. But the rise of China has radically changed the Asian global production and supply chain: now East Asian countries tend more to produce inputs and intermediate goods and raw materials that are exported to China; in turn China, given its lower labor cost, processes these inputs and assembles them into final goods that are exported to the US. Thus, in spite of growing intra-Asian trade the dependence of Asia on US growth is now larger than any time before, both structurally and cyclically. So the argument that Asia can decouple from the US because of this greater intra-Asian trade is altogether flawed. Rather, once China slows down the Chinese demand for these Asian intermediate inputs and its demand for raw materials from Asia, Latin America and Africa will fall. Thus, you will observe both a slowdown in Asian growth and a sharp fall in commodity prices that will hurt all commodity exporters.

 Some argue that, while a US hard landing may hurt China and Asian economies, there is wide room for domestic demand and non-US demand to maintain the growth of Asia. But this is another myth that has little basis. The role of domestic demand in China’s growth is very modest. You have an economy where exports are 40% of GDP; where investment is 50% of GDP and, leaving aside housing investment, most of such investment is directed towards the productions of more exportable goods; where the current account surplus has gone from $20b in 2002  (2% of GDP) to an expected $300 billion plus this year (12% of GDP). China and Asia strongly depend on trade and on trade to the US. And, as recent research by Morgan Stanley shows, there is a very low probability of major improvements in domestic demand or non-US external demand.

This growing link between Asia and US growth – and growing correlation between equity returns in Asia and those in the US – has been confirmed by a recent Citigroup research piece.  This research piece came to the following conclusions about the decoupling myth being busted:

 Myth: Decoupling; Busted, for Now
Asia ex Japan Strategy Markus Rosgen, Elaine Chu, Chris W Leung October 24, 2007

Growing consensus that Asia can decouple. We find no supportive evidence – Correlations between Asian export growth & US/ G3 non-oil have risen 2.1x over the last 20 years to 0.7. The same series using intra-regional exports has shown a six-fold jump to 0.6.– Asian ROE’s fell more in the 2001 downturn than in the three prior US recessions – The 2001 downturn did not lead to a recession, yet ROE in Asia ex fell by 280 bps vs. an average of 150 bps in the prior three recessions. Hardest hit in the post-1990 recessions: tech, other financials, materials &industrials. ROEs actually rose for the utilities, telecoms and banks.

A common misconception: North Asia is more US growth sensitive -We have found that India, Korea and Taiwan have elasticities of less than 1 to US GDP growth, whilst ASEAN ranges from 1.3 to 1.7. Yet investors are overweight ASEAN on the belief that they are buying domestic consumption.

– Domestic consumption-to-GDP ratios have fallen in Asia; export ratios have risen – The ratio of consumption to GDP has fallen over the last five years to 59%. At the same time, the contribution of net exports to GDP growth is higher today than in the last 15 years. Nor have Asian consumers ever behaved count-cyclically.

Stock market correlations stand at 30-year highs – Never over last 30 years have market correlations been negative nor been as high as now, between Asia & the USA & Europe. Correlation coeff of 0.6 and above doesn’t make for decoupling.

  So much for the idea of Asia decoupling. And, as discussed in my current and previous analyses, the anti-decoupling arguments made by Citigroup for Asia hold even more strongly for Europe, Latin America and other emerging market economies.

  Finally, the Financial Times’ Alphaville presented yesterday the following commentary supporting the idea of recoupling, following my Recoupling blog:

Don’t count on decoupling to get you out of this one 

Put down the comfort blanket. Step away from the idea of decoupling. It may not be the thing to save the day after all.As Martin Wolf pointed out this week in the FT, we are in the midst of “the great unwinding” – the re-import by the US of the stimulus it imparted to the rest of the world between 1996 and 2004, when its domestic purchases grew faster than GDP and the current account deficit exploded.The US wants its stimulus back. And with an ever weaker dollar, it’s going to get it, dammit.This unwinding is a turning point, says Wolf. The rest of the world and the emerging markets in particular must now become the demand engines of the world economy. “Will they do so? This is the big macroeconomic question to be answered over the next few years,” he writes.So keep clinging to the decoupling life raft and praying that we all stay afloat, right?Wrong. The backlash has begun.

Melvyn Krauss, senior fellow at the Hoover Institution, Stanford University, this week was scathing of the European faith in decoupling to save their economic skins. Writing in the Japan Times he said: « Decoupling is an idea that is based on bad economics — and on some Europeans’ reluctance to accept the fact that Europe’s short but sweet economic expansion is also coming to an end.

« So what if the US has become less important for European exports, while Asia’s significance has grown, he asks? « The links between Europe and America are, frankly, much more complex than the advocates of decoupling appreciate.

« And the idea that a US recession has no effect on Asia is, says Krauss, nonsense. « So Europeans should not be tempted to think that they are somehow “decoupled” from America’s foibles and woes. Until recently, many Europeans thought they were insulated from the current US housing and mortgage crisis. But in what has been a truly malignant “export” from America to Europe, the US created “garbage debt” in the form of sub-prime mortgages, and Europeans — hungry for extra yield, and as reckless as Americans — bought it. Many European banks’ balance sheets are now as contaminated as those of American banks, and no one is sure who is holding — or hiding — the junk, and how to value it.

« The theory of decoupling then is not a panacea – it’s a curse, designed to deny the “very real threats” to the robustness of Europe’s economy. It’s very existence, says Krauss, should be a cause for concern.

And if we needed further convincing, FT Alphaville’s favourite bear Nouriel Roubini has also this week torched our decoupling succor.In a sense, the argument is now defunct, says Roubini. Even the most ardent proponents of decoupling would struggle to make the case that in the event of a US hard landing that Europe and the rest of the world could just keep on trucking.But in any case, he adds, what we have is recoupling, not decoupling. In fact, the eurozone has experienced a double whammy – loss of competitiveness relative to the US dollar and other dollar-zone currencies.

« Recoupling or contagion is also evident in financial markets. Certainly European financial markets did not decouple from the summer and fall financial turmoil in US financial markets; rather there was massive contagion: the ECB was forced to inject liquidity faster and more than the Fed. And the lingering liquidity and credit crunch has been as severe – if not more severe – in Europe than in the US.

« Equity markets have also recoupled with downward pressure in the US rapidly reflected in European equities, argues Roubini. And global shocks – higher risk aversion, the housing cycle, oil and energy prices, other commodity price shocks – will affect Europe as much as the US. Recoupling occurs through confidence channels – as European corporations pull sharply back on capex. A US recession says Roubini will lead to a “serious and significant” slowdown of growth in the rest of the world.In a repeat of 2001 to 2003, the delusion that the Eurozone can decouple from the US will delay the appropriate action, simply ensuring that, again, the slump is deeper and more protracted than the US version, he adds.

« For now it is clear that it is still the case that when the US sneezes the rest of the world gets the cold. And since the US will not just sneeze but is risking a serious case of protracted and severe pneumonia the rest of the world should start to worry about a serious viral contagion from this US sickness….There was never real decoupling; the perceived “decoupling” was only a side effect of the modest slowdown of US growth; now that the slowdown is turning into a hard landing contagion and recoupling is reestablishing itself with a vengeance. »

Thus, as the FT appears to agree, decoupling is out and recoupling is in. Finally, for more details, links and analyses on this decoupling/recoupling debate see RGE Monitor’s detailed coverage of  Can Asia Decouple from the U.S. Slowdown?

source :

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