roubini: no decoupling

[jk]

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.
In my view this debate on decoupling (this writer argued against the decoupling hypothesis already in mid 2006) is partly semantic: those who argued for a decoupling always did so conditional on the view that the US would experience a soft landing; and I would myself agree that, conditional on the US having a soft landing (i.e. growth below potential and ranging 1.5%-2.5% for a few quarters), there was enough growth momentum in Europe, Asia, BRICs and other emerging markets that such US slowdown would not lead to much of a slowdown in the rest of the world. But, conditional on a US hard landing, almost no one believes that the rest of the world would decouple from such a hard landing: this does not mean that the rest of the world would experience, like the US, a recession; it rather means that a US recession will lead to a significant and serious slowdown of growth in the rest of the world.
A typical example of how there is recoupling rather than decoupling is Europe. The old argument that, since only 3% of European output is exported to the US, European growth is unrelated to a US slowdown proved wrong in 2001-2002 and will be proven wrong in 2008. Europe is already slowing down given that booming – or bubbly – housing markets in some European economies – US, Spain, Ireland especially – are now starting to turn down. Also, measures of forward looking manufacturing activity and business confidence are slowing down.
But recoupling is also related to a variety of other factors: the euro strengthening relative to the US dollar is leading to a sharp fall in external competitiveness of European exports, not just in the Club Med countries (Spain, Portugal, Italy, and Greece) but now even in Germany. And since the RMB and other BW2 currencies have shadowed the US dollar downward the euro has sharply appreciated relative to the RMB and such other currencies. Thus, the Eurozone has experienced a double whammy: loss of competitiveness relative to the US dollar and other dollar-zone currencies. Indeed, Chinese exports to Europe are rising at a faster rate than Chinese exports to the US even if the bilateral trade balance of China relative to Europe is not yet as imbalanced as that relative to the US.
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. Thus, based on recent European loan officer surveys, the credit crunch – especially towards corporate lending – is now more severe in Europe than in the US. This is no surprise as the relatively more bank-based financial system of continental Europe – relative to the capital markets-based financial system of the US and UK – is more vulnerable to credit crunches when there is a seizure of liquidity and credit that flows to the corporate sector.
Recoupling occurs not only in credit and debt markets but also in equity markets; there is a high correlation between equities and US equities. So downward pressures on US stock prices are rapidly reflected in similar pressures on European equities.
Europe is also hit by common global shocks that hit the US: higher risk aversion, cycles in housing that – with a lag- are now hitting Europe; shocks to oil prices and energy prices that are now hurting all oil importers, Europe as much a the US, Japan and other oil importers. Global shocks to other commodity prices – food, metals, minerals, etc. - also affect Europe as much as the US.
Recoupling is also occurring as the ECB – in a repeat of the 2001-2003 – is deluding itself that the Eurozone can decouple from the US slowdown and – unlike the Fed – is holding rates and arguing that – once the credit turmoil is passed (as if it would pass any time soon) - it would raise further policy rates. This delusion means that the Eurozone slowdown will become – like 2001-2003 – deeper and more protracted than the US one. At least the Fed is aggressively cutting rates now; the ECB is still in the dream mode that this is a temporary shock and that policy rates should be going up; in reality – as in 2001-2003 – the ECB will end up cutting rates but doing that too little too late.
Other macro policy tools are now not available to prevent recoupling: not only monetary policy is not helping but, with large structural fiscal deficits, the Eurozone can ill afford the fiscal easings that occurred after 2001; if anything tighter fiscal policy is needed in most of the Eurozone. Tight monetary policy, no leeway for fiscal policy, stronger and stronger euro: this is the macro mix that exacerbates the Eurozone slowdown.
Recoupling also occurs through confidence channels: Eurozone corporations and households have never been particularly confident during many years of slow EU growth; but the US slowdown and financial turmoil has dented again such confidence. And the prospect of a US hard landing, strong euro, higher risk aversion, credit crunch, and investors’ uncertainty means that capex spending by the European corporate sector will also slow down sharply in the quarters ahead. Large global corporations that are cutting on investment spending in the US and never spent much in capex in Europe will not start now to spend more in Europe given the global slowdown.
And the wealth effects of international portfolio diversification become another channel of recoupling. Home bias in much less now than it was a decade ago and European have large exposure – of the order of trillions of dollars – to US dollar assets. The negative wealth effects comes from two sources: a falling dollar reduced the euro value of European assets in the US; the fall in the market value of dollar assets – housing, RMBS, CDOs, US equities, etc. – is another negative wealth effect. Add to these losses the reduction in the profits/earnings of European firms - that have done FDI in the US - via the fall in such dollar earnings once the US hard landing occur and via the fall in the euro value of such earnings given the slide of the US dollar.
Similar recoupling channels from the US hard landing to global economic slowdown are relevant – even more than for Europe – for China, Asia, other emerging market economies, Latin America. And we will flesh out in more detail such channels in future writings. And just to be clear: I am not arguing that a US recession will cause a global recession; I rather argue that a US recession will lead to a serious and significant slowdown of growth in the rest of the world, i.e. absence of decoupling.
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. Certainly credit and financial markets have already suffered from such contagion; the dollar weakness is sending shivers to non-US investors, policy makers and exporters; and daily shocks to US equities are transmitted to Asia and Europe. It will take only a little longer – once the US consumer falters – for the US real hard landing to affect the growth rate of Europe, Asia and emerging market economies. 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.


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

[DemonD]

Re: roubini: no decoupling

And just to be clear: I am not arguing that a US recession will cause a global recession; I rather argue that a US recession will lead to a serious and significant slowdown of growth in the rest of the world, i.e. absence of decoupling.

To me that would be decoupling, if the US goes into recession and the rest of the world doesn't.

I agree with the title (us recession will lead a worldwide one, no decoupling), but the quoted statement doesn't fit with the title.

[jk]

Re: roubini: no decoupling

roubini returns to the theme:

Recoupling rather than Decoupling: the Forthcoming Contagion to China, East Asia and Emerging Markets
Nouriel Roubini | Nov 23, 2007

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?

[bart]

Re: roubini: no decoupling

"The four most dangerous words in investing are, 'It's different this time.'"
-- Sir John Templeton

[metalman]

Re: roubini: no decoupling

"The four most dangerous words in investing are, 'It's different this time.'"
-- Sir John Templeton

doesn't this chart from the redburn thing say it all? we've been here before. "peace: a period of cheating between two periods of fighting".


and this is a picture of an economy quickly flushed down the commode...



i was "Wealthy as an Argentine".

globologna

[bart]

Re: roubini: no decoupling

doesn't this chart from the redburn thing say it all? we've been here before. "peace: a period of cheating between two periods of fighting".



and this is a picture of an economy quickly flushed down the commode...



i was "Wealthy as an Argentine".

globologna

That'll get you at least one rimshot!
http://www.nowandfutures.com/grins/rimshot.mp3

[touchring]

Re: roubini: no decoupling

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.

I beg to differ. China will be a serious victim, but not the most serious victim, for a simple reason that low priced junks as trex describe here are price inelastic - first lesson in Economics. :p

Capital and luxury goods like airplanes, cars, holidays, gucci bags, military goods, are first to be sacrificed in a world recession, not the $3 teddy bear or 15 cents apple (you can't get this in the US).

A world recession might in fact boost some chinese producers with their low price advantage.

A US recession may also benefit india as companies outsource more software, customer service tasks to India.

I suspect that Japan will be most severely affected by a US recession.

[GRG55]

Re: roubini: no decoupling

I beg to differ. China will be a serious victim, but not the most serious victim, for a simple reason that low priced junks as trex describe here are price inelastic - first lesson in Economics. :p

Capital and luxury goods like airplanes, cars, holidays, gucci bags, military goods, are first to be sacrificed in a world recession, not the $3 teddy bear or 15 cents apple (you can't get this in the US).

A world recession might in fact boost some chinese producers with their low price advantage.

A US recession may also benefit india as companies outsource more software, customer service tasks to India.

I suspect that Japan will be most severely affected by a US recession.

It makes sense for any mass produced product with commodity characteristics the low cost producer (presumably China) will be "the last one standing" in any downturn.

However, with the Rupee increasing against the US$, Indian outsourcing companies like Infosys are already finding it difficult to compete for contracts against US based competitors. Indian companies are now opening satellite offices in Mexico and the US to get their costs down.

[touchring]

Re: roubini: no decoupling

It makes sense for any mass produced product with commodity characteristics the low cost producer (presumably China) will be "the last one standing" in any downturn.

Yes, but i must point out that i've not factored in the implications of a domestic stock market and real estate bubble burst to the Chinese economy. The Chinese real estate and stock market can fall 60%-70% in a severe downturn*. This has the potential to inflict more damage on China than slowing exports.

*this is the estimation based on HK real estate, which fell 50% during the asian financial crisis.

IHowever, with the Rupee increasing against the US$, Indian outsourcing companies like Infosys are already finding it difficult to compete for contracts against US based competitors.

Being in the software industry, India is experiencing severe IT brain drain, the better Indian engineers don't live in india - they live in silicon Valley. So, i'm not surprised that Infosys has to open offices in Latin america.

Nonetheless, there are other parts of BPO like call center, legal, accounting and even medical services outsourcing which India continues to do well. Technically speaking, with broadband, IM, and high speed scanners, you could pretty much outsource everything that does not require face-to-face contact.

[c1ue]

Re: roubini: no decoupling

I beg to differ. China will be a serious victim, but not the most serious victim, for a simple reason that low priced junks as trex describe here are price inelastic - first lesson in Economics. :p

MSS speaking again.

China is cheaper than the US, but it is NOT cheaper than Bangladesh, Vietnam, Indonesia, or any of 2 dozen other countries with lower GDP per capita.

As for Japan being hurt - there will be negative impact on the car side of the equation, but the unspoken military manufacturing side won't be affected.

Japan also has significant internal consumption and likewise exports a great deal to Asia as the quality leader.

Thus overall Japan is less affected by an American consumer downturn.

Last item to note: one thing that you CANNOT outsource is votes - at least not yet.

As the economy continues its slide, we will see if the American voters will 'do the right thing', or act as they have historically: bread, circuses, and isolationism.

[touchring]

Re: roubini: no decoupling

You might be right about Japan. Toyotas are greatly sought after in China, despite import taxes. I'm a Toyota fan as well.

http://www.bloomberg.com/apps/news?p...K.k&refer=home

Japan's Exports Rise to Record on Asia, Europe Demand (Update4)

Nov. 21 (Bloomberg) -- Japan's exports rose to a record in October as companies shipped more cars and electronics to Asia and Europe, easing concern that a slowdown in the U.S. will cool the economy's expansion.
Exports climbed 13.9 percent from a year earlier, the Finance Ministry said in Tokyo today, double September's pace. That helped lift the trade surplus 66.1 percent to 1.02 trillion yen ($9.3 billion) as imports gained 8.6 percent.
Shipments to China and the European Union surged to the highest ever, cushioning a drop in exports to the U.S., where the worst housing recession since 1991 is crimping demand. Toyota Motor Corp.'s profit rose 11 percent last quarter, helped by sales of Camry sedans in Europe and Asia.

[metalman]

Re: roubini: no decoupling

You might be right about Japan. Toyotas are greatly sought after in China, despite import taxes. I'm a Toyota fan as well.

http://www.bloomberg.com/apps/news?p...K.k&refer=home

does roubini read bloomberg? guess not.

[touchring]

Re: roubini: no decoupling

does roubini read bloomberg? guess not.

Bloomberg isn;t the only one making such reports, but his doomsday predictions next year will mean that decoupling effect will reverse in a matter of time. I agree, its high time for the chinese bubble to burst or deflate.