The end of decoupling

For the past week, I’ve been participating in conferences in Singapore, Nanning, and Hong Kong on the future of China and the Asian economies in which I have been subjected to endless repetition of a mantra. Speaker after speaker has risen to declare that China is her or her country’s largest trading partner. Left unspoken but understood by all is the fact that just a few years ago the largest trading partner of all these countries was either the United States or the EU. So the clear understanding is that China has displaced America and Europe as the main customer and engine of growth.

The declaration is often made with a certain air of excitement, almost as if many of the speakers can’t quite believe what they are saying. And the truth is that they shouldn’t.

Even as we discussed these trade numbers at the Pan Beibu Gulf conference in Nanning, the Chinese government released its latest growth figures showing a dramatic slowdown to 7.6 percent of GDP which was somewhat below the already lowered target. This slowdown is occurring in large part because China’s exports are performing poorly in the face of the Euro crisis and a relentlessly slowing U.S. economy. China’s growth is also slowing because the enormous stimulus spending the country undertook to offset the impact of the recent Great Recession created its own inflationary and excess debt and capacity problems that Beijing has been trying to control by cutting  back on the stimulus. This is the subject of a second mantra which is that China is rebalancing by shifting away from investment and export led growth to domestic consumption led growth. So the hope has been that structural reform will make China a major end consumer and that consumption led growth will take up the slack of relatively declining export led growth.

Well, none of it is happening. Or, at least, it’s not happening fast enough. The truth is that China is only the largest trading partner of many Asian countries in the sense that they ship goods to China. But China is merely a stop on the supply chain that eventually ends in the United States or Europe or, sometimes, in Japan. It is not usually the end customer unless the goods being shipped are raw materials, oil, and agricultural commodities. Most of what is happening is the shipment of parts and components from an Asian country  to China where they are assembled into final products and then shipped on to the final U.S. and European customers.

The weaknesses of the whole global system are now becoming excruciatingly apparent. China has been urged by the G-20 and has committed to rebalancing and focusing on domestic consumption led growth. But consumption accounts for only 35 percent of China’s GDP and is not large enough to be an engine of growth in the short term. As growth has slowed dramatically, Chinese officials are talking more and more of another round of investment and infra-structure stimulus. Understandable as a short run measure, this only threatens to exacerbate the longer run problems. Moreover, another round is unlikely to be as effective as the first round was because of the unresolved distortions remaining from that effort. In any case, reform looks like it will not happen quickly if at all. Further, China has backed away from allowing the yuan to strengthen and has put renewed effort behind exports, but the crisis in Europe and the slowing of the U.S. economy are having a huge negative impact and belying all the happy talk of decoupling.

Meanwhile, Europe seems determined to commit suicide by austerity and the death of a thousand all night Brussels summits. The Euro-zone needs some kind of growth agreement to complement the new fiscal pact as well as a banking union and some degree of common debt sharing through Eurobonds. But all this is unlikely, and certainly unlikely in the required time frame in the face of German opposition.

The U.S. situation is objectively the least dire in that its enormous trade deficit gives it the potential to grow by importing relatively less and producing and exporting relatively more. But no serious effort is being made in this direction, and political gridlock and the looming debt cliff are likely to continue to erode confidence and U.S. growth prospects.

The consequences of all this are that there is not going to be a global growth engine in the foreseeable future. China is not likely to rebalance by making the shift from investment and export led growth to consumption led growth, and the collapse of the euro and break-up of the EU is becoming a reasonable bet.

Aside from that, everything’s okay. Have a good day.