The Myth Of Decoupling

[dhukka]

An oft repeated mantra of the argument for a continuation of the bullmarket goes something like this: Despite a slowdown in US growth the world economy will pick up the slack as they are less dependent on the US economy. It all sounds nice but it is based on sound reasoning?

Governor of the Bank of England, Mervyn King, issued a grim warning last week about the state of the UK economy and by implication a large part of Europe:

He (Mervyn King) said the Bank's "central outlook for the UK economy is, in the near term, one of slowing growth and rising inflation. But further ahead that outlook is for a return of growth to its average rate and inflation to target...."

"With house price inflation easing and commercial property prices falling, residential and commercial property investment are likely to moderate, possibly quite sharply. And with tighter credit conditions in the future, the personal saving rate is likely to rise, bearing down on consumer spending...."

How about Asia and the other 'BRIC' economies? Even the Chinese government is warning that a US slowdown could have significant knock-on effects on Chinese growth. from the Financial TImes

US slowdown threatens Chinese export growth
China’s commerce ministry warned on Thursday that a slowing US economy would trigger a drop in Chinese exports that would mark a “turning point” for China’s rapid economic growth.

A global economic slowdown stemming from problems in the US subprime mortgage market and the resulting credit squeeze “will be the biggest challenge to China’s economy next year”, a report from the ministry’s policy research department said.

The report is Beijing’s first public comment on what repercussions it expects from the global credit crisis and a sign that the government does not support the view that Asian growth has “decoupled” from the US. “If demand in the US drops further, Chinese exporters will be devastated by a rapid and continuous fall in orders,” the report said....

Exports to the US have slowed significantly since the start of the year, dropping from a 20.4 per cent year-on-year rise in the first quarter to a 15.6 per cent increase in the second. Growth fell to 12.4 per cent in the third quarter following the eruption of subprime loan problems.

You don't need to read between the lines here. The Chinese government don't believe the decoupling thesis and in a still largely centralized economy they should have the best idea. The chart at the bottom comes from Morgan Stanley Asia's Steve Roach which shows that Asian economies are more dependent than ever on export led growth.

Also picked up this story from the Wall Street Journal, although you need to subscribe to read the full article. However the following blog has kindly reproduced it, from immobilienblasen.blogspot.com:

China Freezes Lending to Curb Investing Frenzy
Chinese authorities are slamming the brakes on bank lending, in their latest attempt to curb the runaway investment threatening to overheat what is soon to be the world's third-largest economy.

In recent weeks, regulators have quietly ordered China's commercial banks to freeze lending through the end of the year, according to bankers in several cities. The bankers say that to comply, they are canceling loans and credit lines with businesses and individuals.

A China Banking Regulatory Commission official here confirmed that local and Chinese subsidiaries of foreign banks have been asked to ensure that loans at the end of the year don't exceed the total outstanding on Oct. 31. The official described the request as "guidance aimed at supporting the macro-control measures being implemented."

Over the past few years, Chinese authorities have repeatedly sought to rein in investment in sectors such as property development, where they deemed it was becoming excessive. But even in China a blanket edict to halt lending growth is unusual.

Click on the link above for the full article. You have to give the Chinese government some credit for trying to reign in excesses however the horse has bolted. It is inevitable given the rapid pace of growth in China and the relative immaturity of it's financial system that there will be some train wrecks in the wake of a global economic slowdown.

No doubt there will be a decoupling from the US economy but we are still a couple of decades away from that reality IMHO. The health of the US economy is still of vital importance to the rest of the world and thus the theory that Europe and China will carry the global economy is little more than wishful thinking.

 

[Temjin]

It's all interesting because I have been reading competing articles on the decoupling side and the myth side of it. Yes, the myth part is from Morgan Stanley and the decoupling side is from Merrill Lynch.

http://www.ml.com/index.asp?id=7695_7696_8149_74412_79272_79274

http://www.morganstanley.com/views/gef/archive/2006/20061030-Mon.html

Another interesting radio I heard (lost the link) is about the last 5 years of Chinese GDP growth was averaging 10% p.a and that a large percentage of it (8-9%) is dependant on export. If the growth in export slows down, then the GDP growth rate for China will suffer.

So my opinion? The decoupling thesis could be a myth after all. I never have faith to believe that if US suffer a recession (not a soft landing), it would not AFFECT any part of the world and the global stock exhange market will start exhibiting low to zero correlation to the US market.

 

[RichKid]

Thanks for the great material and discussion, would have been interesting to see the relevant export figures for India in that last table, it might be the subject of greater focus amongst the general investment community if China's growth slows.

 

[rederob]

An oft repeated mantra of the argument for a continuation of the bullmarket goes something like this: Despite a slowdown in US growth the world economy will pick up the slack as they are less dependent on the US economy. It all sounds nice but it is based on sound reasoning?
......
No doubt there will be a decoupling from the US economy but we are still a couple of decades away from that reality IMHO. The health of the US economy is still of vital importance to the rest of the world and thus the theory that Europe and China will carry the global economy is little more than wishful thinking.

dhukka
I think there are some important distinctions to make.
First, that of a "recession" in the US versus a "slowdown".
The world has weathered well the US slowdown over the past 12 months - with the DOW breaking over 14000 points.
But now we have the real spectre of "recession" in the world's predominant economy, with its "reserve currency" status making the scene doubly bad.
It would be foolish to suggest a global bull could run against this tide.
Next is the commodity consumption argument versus value of goods argument.
The BRIC economies have no choice: They will continue to grow internally (albeit at a lesser pace) irrespective of how much money they are earning - ie. the export dollars numbers. For example, to get water and electricity from China's 3 Gorges dam project to the masses is not going to stop overnight - or at all for that matter. It's a nation building project that will steamroll on to completion (a poor metaphor, I know).
A curious observation from a fundamental perspective is the very slow build of metal inventories after many years of galloping supply and capacity expansions. Indeed, iron ore is not tipped to come off the boil yet, and nickel prices have been holding around $30k for months as market players are unwilling to concede the steel sector will be meaningfully impacted.
That may well change - I quit all my nickel holdings this week, as I suspect it could!

There are two other themes that I think will be important in 2008.
First, I believe energy prices are going to spike substantially on fundamental grounds, which might be exacerbated should the USD continue to weaken.
Secondly, the cost of money will increase. Reduced borrowings, higher interest/loan costs and a tight money supply will be a huge burden on business.

My strategy for now is to go heavily into cash, and keep it there until the storm clouds have well and truly disappeared.

 

[dhukka]

dhukka
I think there are some important distinctions to make.
First, that of a "recession" in the US versus a "slowdown".
The world has weathered well the US slowdown over the past 12 months - with the DOW breaking over 14000 points.
But now we have the real spectre of "recession" in the world's predominant economy, with its "reserve currency" status making the scene doubly bad.
It would be foolish to suggest a global bull could run against this tide.
Next is the commodity consumption argument versus value of goods argument.
The BRIC economies have no choice: They will continue to grow internally (albeit at a lesser pace) irrespective of how much money they are earning - ie. the export dollars numbers. For example, to get water and electricity from China's 3 Gorges dam project to the masses is not going to stop overnight - or at all for that matter. It's a nation building project that will steamroll on to completion (a poor metaphor, I know).
A curious observation from a fundamental perspective is the very slow build of metal inventories after many years of galloping supply and capacity expansions. Indeed, iron ore is not tipped to come off the boil yet, and nickel prices have been holding around $30k for months as market players are unwilling to concede the steel sector will be meaningfully impacted.
That may well change - I quit all my nickel holdings this week, as I suspect it could!

There are two other themes that I think will be important in 2008.
First, I believe energy prices are going to spike substantially on fundamental grounds, which might be exacerbated should the USD continue to weaken.
Secondly, the cost of money will increase. Reduced borrowings, higher interest/loan costs and a tight money supply will be a huge burden on business.

My strategy for now is to go heavily into cash, and keep it there until the storm clouds have well and truly disappeared.

Rederob,

I agree mostly with what you have said. Even with a US hard landing scenario a slowdown in the Chinese economy would be growth of around 6 -7%. still high by any standards but would be considered a growth recession given China's current growth levels.

The cost of money is already rising despite the Fed having lowered interest rates 75 bps. Mortgage rates are still higher now in the US than they were before August. Credit standards are tightening and as we see more subprime related bodies float to the surface the ability of some institutions to lend will be impacted.

I think the drop in various metal prices copper, zinc, etc. is giving us a signal about the likely direction of these over the near term.

Interesting call on oil, I notice a lot of economists and market commentators think oil will come off into 2008 significantly, I don't know enough about oil to comment.

I suspect cash it not a bad place to be. I'm quite happy holding a decent wad of yen at the moment.

 

[Uncle Festivus]

Global Recoupling Rather than Decoupling as the US Heads towards a Recession

Nouriel Roubini | Nov 20, 2007
Now that the risk of a US hard landing – recession – has become very high the debate on whether the rest of the world can decouple from this US hard landing is returning.


http://www.rgemonitor.com/blog/roubini/227885

 

[rederob]

Global Recoupling Rather than Decoupling as the US Heads towards a Recession

http://www.rgemonitor.com/blog/roubini/227885

Nice link, Uncle.
If there is to be a recession, we can hardly claim it "crept upon us"!!!
For over a year the US economy has swaggered its way towards oblivion.
Yet the helmsman is oblivious, seemingly, and the tiller is firmed into the storm.
I say incredulous.
Yet his track record suggests I am the moron for not earlier seeing his stupidity.
Nevertheless, somewhere ahead a light will shine - probably after the Democrats have worked out that a bit more pain is needed, so they can steel their way into a second term as the saviours of the stars and stripes.
I had a suspicion a "soft landing" could be manufactured.
I now have a suspicion a hard landing is essential.
Afterwards, and I believe it will be a very soon afterwards, the global economy will pick up again at a very rapid pace.
Oddly enough, the stymieing of US economic consumption will recoil strongly, and the differential effect of US demand on global growth rates will be immediately strong, albeit, I suspect, relatively brief.
So I am preparing myself for a re-entry in the latter half of 2008: It may be earlier, but I doubt it.
Ordinarily I would have said the chart action can't sustain such a rapid turnaround. But I think economies nowadays are a bit like the computer industry where Mohr's law can be extrapolated to other spheres.
I'm tipping the shortest recession in history.
But I'm preparing for worse, and refuse to be hoodwinked by false breaks.
If it gets worser I'll get readier.

 

[MS+Tradesim]

I find a great deal of economic commentary confusing as there are very different opinions around and I don't have a background in economics so is very hard determine what is dribble and what is significant.

But let's say a likely scenario is US recession and global slowdown and rising energy costs.

What are opinions of what this would mean for both traditional and green energy companies? Would the energy sector fall along with the main indices, or hold, or rise?

Dhukka especially, I read your blog occasionally and would welcome your opinion.

 

[Uncle Festivus]

In my nearly 30 years of investing & trading I have never seen the global economy in such a precarius state & worse still, the apparent inability of the people in control to do much about it because the usual safety mechanisms (interest rates) are having no effect.

The rising oil price and the biggest housing bust in history (after the biggest housing boom in history) will or is tipping the US into a recession, and that's the best case scenario!

The US is bankrupt and there are signs that the rest of the world is no longer willing to subsidise them! China is adjusting, both from internal mechanisms and offshore influences form the US. Australia will be dealt a harsh blow soon, so be prepared.

The coupling chain around the globe is stronger than ever, so this coming event will be a global financial shock of huge proportions once the commodity hedge funds start bleeding like the mortgage derivatives holders.

Co-ordinated derivatives melt down.

 

[dhukka]

I find a great deal of economic commentary confusing as there are very different opinions around and I don't have a background in economics so is very hard determine what is dribble and what is significant.

But let's say a likely scenario is US recession and global slowdown and rising energy costs.

What are opinions of what this would mean for both traditional and green energy companies? Would the energy sector fall along with the main indices, or hold, or rise?

Dhukka especially, I read your blog occasionally and would welcome your opinion.

MS+Tradesim、

Agreed, sorting the wheat from the chaff is tough when it comes to economics. When it comes down to it common sense goes a long way. Common sense tells me that the largest housing and credit bubbles in history can't end well either for the economy or the stock market. Earnings have turned negative and from history we know that that is rarely a one quarter occurrence.

If the US falls into a deep recession and the global economy slows I would expect energy prices to subside not rise, however commodities and energy are not my strong points. rederob knows more about that stuff and he thinks energy prices will sky rocket next year.

 

[Uncle Festivus]

Decoupling dies as half the globe hits crunch

The rising economies of Asia are too small and deformed to rescue world growth as America, Britain, Australia, and Club Med face their day of debt reckoning. China may make matters worse, not better.

http://www.telegraph.co.uk/money/ma.../12/10/bcnambrose11.xml&CMP=ILC-mostviewedbox

 

[numbercruncher]

'The US is a US$9.5 trillion consumer. China is a US$1 trillion consumer. India's a US$650 billion consumer. Mathematically, it is almost impossible for the young dynamic consumers of China and India to fill the void that would be left by what is likely to be a significant shortfall of US consumer demand.'

http://www2.skynews.com.au/business/article.aspx?id=206846

 

[Real1ty]

I find the Rising oil prices theory an interesting one.

Imo a lot of the price is speculative money.

Obviously in the booming economic times we have been experiencing, demand has been strong but will this continue at an above average rate amongst a slowing World demand?

China and lack of supply will ensure that demand will stay at reasonable levels but i believe that when the speculators come out of the market that oil will retreat to sensible levels, with their new levels to be decided by rational supply and demand without the massive money jumping in every time there are harsh words spoken in the middle east or US inventory drops slightly.

There has been massive amounts of easy money made in recent years and hedge funds and speculators left right and centre have been plowing this money into speculative futures, with oil being a big favourite.

I will be betting that oil will drop significantly but i am the first to admit i have a lot to learn on economic matters.

rederob, could you please explain briefly why you believe energy prices will spike substantially?

Is it only related to the falling US dollar?

Interesting year in 2008

 

[dhukka]

I find the Rising oil prices theory an interesting one.

Imo a lot of the price is speculative money.

Obviously in the booming economic times we have been experiencing, demand has been strong but will this continue at an above average rate amongst a slowing World demand?

This is my thinking as well. In a slowing global economy how can oil prices rise unless there are severe shortages of supply? (Which we currently don't have and are less likely in a slowing economy). Whilst the US PPI and CPI numbers were through the roof in November most of this is related to oil prices. I think inflation worries are overdone. Everywhere else you look we see deflation in:

• Falling US home prices
  
• $400 billion of ABCP disappeared in 4 months.
  
• markets for LBO's, bonds securitization have dried up.
  
• Shrinking corporate balance sheets as financial institutions write down the value of assets.
  
• Tougher lending standards to both corporates and individuals
  
• Bans unwilling to lend to one another
  
• Base metal commodity prices have pulled back
  
• A recent rally in the USD
  
• Velocity of money sharply lower

All deflationary signs. IMHO in 6 - 9 months we will be hearing more about deflation than inflation.

 

[numbercruncher]

Yes im subscribing to deflation. ( But think well start with Stagflation)

To me evidence (less wildcards) points to downward pressure on Oil prices, Climate change going mainstream, Western nations swinging towards greater MPG on vehicles, US i understand just put through senate 35mpg target up from 25 ... swing to Biofuels etc etc , so many things , take out the futures speculators and whammo ... Take out some demand via a recession and whammo .... US actually seems very determined to at Min reduce its reliance on ME oil and at best eliminate it.

 

[numbercruncher]

Another blow for decoupling ?

China's economy overestimated by 40%: World Bank
18-December-07 by AAP

The size of China's economy is overestimated by some 40 per cent, but it remains the world's second largest using a ranking based on purchasing power, the World Bank said today.

In a report ranking the world's economies for 2005, the World Bank said its updated survey using "purchasing power parity" (PPP) shows a much smaller value for China than earlier estimates which the Bank called "less reliable".

The study carried out by the World Bank and other partners was "the most extensive and thorough effort" to measure the relative size of 146 economies using the PPP method which strips out the effect of exchange rates, a Bank statement said.

China participated in the survey for the first time and India for the first time since 1985.

While the economies of China and other developing countries appear larger using the PPP method compared to using market rates, the new estimates include more reliable data on goods and services in China.

The PPP method is still somewhat controversial among economists compared with the traditional market exchange rate methods.

http://www.wabusinessnews.com.au/en-story/1/59506/China-s-economy-overestimated-by-40-World-Bank

 

[Uncle Festivus]

Dr Doom doesn't buy it, but still likes the China story.

[FONT=Times New Roman, Times, serif]CAPE TOWN (ResourceInvestor.com) -- Ever the contrarian, Dr. Marc Faber had a plethora of opinions on the state of the global financial system in his keynote address “Will the First Synchronised Global Economic Boom in the History of Capitalism Lead to a Synchronised Bust?” at the Mining Indaba 2008.
Faber, editor and publisher of “The Gloom, Boom and Doom Report”, an economic and financial publication that promotes against the grain investments and cautions against widely accepted investment themes, said in his speech that he’s not a believer in economic decoupling: A recession in one country is likely to lead to a recession globally. If a country begins to slow in economic growth, you can bet that other countries will slow as a result, he said.

“If people are looking for a decoupling financially, they’re dreaming,” Faber told Resource Investor.
“Decoupling, in my opinion, is not in the cards,” he said during his speech. “If one country goes into a recession, it will affect other countries around the world.”

http://www.resourceinvestor.com/pebble.asp?relid=40174
[/FONT]

 

[dhukka]

Mr Containment himself, US Treasury Secretary Henry Paulson doesn't buy the Decoupling theory. From Bloomberg:

G-7 Growth Warning May Prompt Rate Cuts, Lower Taxes

Paulson Dismisses `Myth'

``The current financial turmoil is serious and persisting,'' Paulson said. ``I always thought that decoupling was a myth. What happens in any country, that's a major country, impacts what happens in the rest of the world.''

 

[ithatheekret]

Mr Containment himself, US Treasury Secretary Henry Paulson doesn't buy the Decoupling theory.

It's not for sale yet Hank , that's it I believe it .

 

[moses]

Decoupling may be a myth, but according to this article the effects of the global economy are quite the reverse; basically the author argues that the US economy is unlikely to go down the gurgler (a) because it isn't in the interests of the Arabs or the Chinese for the US dollar to collapse (essentially because the Arab and Chinese economies are tied to the dollar), and (b) because they will actively pump dollars back into the US banks to ensure the banks don't collapse, ah la Citibank.

http://www.investorsinsight.com/otb_va.aspx?EditionID=628

Interesting contrarian pov.