Reasons to Be Bullish?

Nouriel Roubini ("The Coming Financial Pandemic," March/April 2008) offers a useful exploration of the limits of the U.S. financial crisis. Just as during the Asian financial crisis in the late 1990s, the China-specific version of the question "will they, or won’t they?" is central today. Then, the question referred to whether China would join the opportunistic currency-devaluation crowd and throw gasoline on the fire. It did not. Now, the question is asked in terms of how vulnerable China is to a slowdown. But if China maintains even 9 percent growth in 2008 — down from 11.4 percent in 2007 — its marginal contribution to the world economy will still be $300 billion or more, handily contributing more than the United States.

Roubini is rightly concerned about whether this new engine of global growth will sputter out. But his China scenarios are too pessimistic. He asserts that China relies on exports to sustain its high growth. Four fifths of China’s gains, however, stem from consumption and investment growth at home. Additionally, if Beijing loses a full percentage point of growth from an export slowdown, China will arguably be in better shape than if it keeps it up; last year’s $550 billion in net foreign exchange inflows, foremost from its trade surplus, is more of a headache than comfort today. Only a few specific industries in China, such as apparel and consumer electronics, are severely sensitive to the U.S. market. Further, China’s export growth rates to the rest of Asia and Europe now top its export growth rates to the United States.

Finally, though Roubini notes that the declining demand for natural resources may hurt some developing countries, he fails to score this phenomenon as a mitigating bonus for China. If copper prices — or those of bauxite, iron, chrome ores, oil, and grains — fall, so too will inflation in China. Beijing would probably be happy to trade some export surplus for a commodities price cut right about now.

— Daniel Rosen
Visiting Fellow
Peterson Institute for International Economics
Washington, D.C.

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Roubini outlines a dark scenario for the global economy, and it is difficult to argue with his conclusion that "no one can claim to be immune" from the aftershocks of the U.S. financial crisis.

But, though the United States faces a challenging road ahead, an even partial decoupling of global economic activity, supported by effective monetary and fiscal policies, would dampen the global impact of a U.S. slowdown and help avert the worst outcomes. Moreover, a moderate slowdown in global growth could even offer a long-term benefit: a similar curbing of global commodity prices, whose recent growth has fed higher inflation in many countries.

Roubini claims that a monetary-policy response to the financial crisis is limited by the fear of inflation. But if inflation is truly a global concern, then it merely reflects excessive demand growth that could be tempered by a U.S. import slowdown. The global economy may well have more room than many analysts expect to cushion the blow of a U.S. downturn.

Roubini’s discussion of the available policy options places too much focus on sustaining economic growth in the United States and other major economies. This view is excessively U.S.-centric. Emerging markets can support the transition from U.S.-led growth by reducing their reliance on exports as an economic growth engine. Rather than continuing to support the massive global imbalance represented by the United States’ current-account deficit, policymakers can view the current crisis as an opportunity to achieve a more balanced pattern of global growth in the future.

— Tim Duy
Adjunct Assistant Professor
Department of Economics
University of Oregon
Eugene, Ore.

Roubini raises the very important and timely issue of interdependence between national economies and financial markets. Today, the linkages are particularly visible in capital markets, where events in the United States spill over into other economies. Roubini’s article concludes with a virtually indisputable sentence: "Not every country will follow the United States into an outright recession, but no one can claim to be immune." But it is the relative immunity that is the key issue.

The macroeconomic linkages to which Roubini alludes are complex and difficult to quantify. Indeed, a severe and prolonged recession in the United States could conceivably reduce demand for imported goods and thus dampen the health of those economies that rely on exports to the United States. Nonetheless, countries now reliant on those exports may still be able to diversify their clientele and retain decent growth.

The jury is still out on how severely a U.S. recession will hurt China, which in recent years has focused on building its domestic economy and diversifying its exports away from the United States. China is likely to feel some pain in the short term, but in the long term, these trends will only strengthen its economy.

Other large emerging economies are more insulated from a U.S. slowdown. India’s exports to the United States and other developed countries account for only roughly 5 percent of its GDP. In addition, Russia has embarked on an investment spree that will contribute significantly to GDP growth in coming years — and it benefits from high commodity prices. Roubini also overlooks the global wealth shift that is most dramatically represented by the growth of sovereign wealth funds in emerging economies. These funds hardly registered a decade ago, but their $3 trillion value today is larger than the Russian and Indian economies combined.

Roubini claims that a U.S. slowdown will drive down commodity prices from the demand side. I disagree. A commodities "correction" was one of the first predictions when the U.S. housing sector began grinding to a halt. But high prices for copper, oil, steel, coal, and other resources have endured. The primary reason is global demographics: The world’s population is pushing 7 billion, and urbanization is occurring at a frantic pace. New city dwellers demand more and better infrastructure that governments have committed to building. Given the profound demographic changes driving emerging-market growth, it is doubtful that commodity prices will decline in any meaningful way in the near future.

— Jack Dzierwa
Global Investment Strategist
U.S. Global Investors, Inc.
San Antonio, Texas

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Nouriel Roubini replies:

Daniel Rosen, Tim Duy, and Jack Dzierwa present some interesting observations. Rosen wonders whether the Chinese growth slowdown will be severe. In my view, the sharper the American consumer-led recession is, the greater the risk of a more pronounced Chinese growth slowdown. It is also important to note that the contribution of trade to Chinese growth is not limited to the 40 percent of aggregate demand due to exports. Of the 40 percent of GDP that goes into investment, a good fraction represents the increase in the production capacity of exportable goods. So a severe recession would affect both exports and firms’ capital spending. A fall in commodity prices may be beneficial to China, but that fall in prices would be the product of a painful U.S. recession that leads to a sharp slowdown in Chinese growth. Thus, it would be a mixed blessing at best.

Duy is correct that a side effect of a severe landing in the United States would be a reduction in global inflationary pressures via a reduction in commodity prices. That reduction in global inflationary pressures, however, would be the result of a fall in U.S. and global demand relative to the supply of goods and services; that is, global recoupling rather than decoupling. Moreover, even though domestic demand in emerging markets could, in principle, dampen the negative effects that a reduction in net exports would have on growth, it is not clear how fast domestic demand can grow in such countries. Net exports have been a crucial engine of growth, whereas domestic demand growth has been less dynamic.

Dzierwa also argues that emerging-market economies can decouple from a U.S. economic downturn. Granted, India is less dependent on trade than China. But given its current-account deficit, India is more at risk of a sudden drop in capital inflows. Russia’s success is due primarily to high commodity prices that could dip in a cyclical global downturn. Although one can be bullish about commodity prices during a medium-term horizon as growth of demand may outstrip the growth of supply, in the short run a severe U.S. recession and a significant global economic slowdown could mean a sharp fall in commodity prices that would hurt exporters. America has sneezed, and make no mistake: The world is catching a cold.