Will Asia’s downturn be worse than America’s?

Below is an article that has been syndicated on a number of sites in the Indian press (hat tip Ravin) which challenges the common wisdom that Asia, and particularly China, will weather the downturn better than the U.S.  While the articles conclusions are contentious, its analysis bears noting, making those conclusions an outcome to not dismiss.

Yves Smith of naked capitalism recently coined the phrase Alpha Creditor to denote the country with the highest net exports and largest current account surplus. In the 1930s that country was the United States. Today, China is the Alpha Creditor. Therefore, it makes sense to compare China to the America of the 1930s, and America – as the Alpha Debtor – to the U.K. of the 1930s.

Here is what the article has to say. I have bolded the areas to note:

China is in danger of repeating the mistakes that the US made in the 1930s in the downward spiral of the Great Depression, and as a result China might end up bearing a large part of the painful adjustments from today’s global economic downturn.

In fact, Moody’s Economy.com associate economist Alaistair Chan takes the contrarian view that the global downturn may hurt Asia more than it will hurt the US. “This seems counterintuitive,” acknowledges Chan, “but Asian countries are mostly net producers, while the US is a net consumer. A reduction in global demand means a reduction in global supply… And so although the US downturn will trigger a reduced global demand, Asia could bear the brunt of the problem through reduced global supply.

By way of historical parallel, Chan points to one “overlooked reason” for why the US was so badly hurt during the Great Depression of the 1930s: the US was at that time the world’s largest exporter and ran the world’s largest current account surplus. Europe in the 1930s was in much the same state as the US is today: it was running a trade deficit and consuming American goods.

“When demand collapsed in the 1930s, there was overcapacity, mostly in the US,” Chan recalls. “And rather than boost domestic demand to absorb the excess production, the government imposed import tariffs… This led other countries to retaliate, further blocking off markets for American goods.” That downward spiral resulted in a painful adjustment period, when production had to fall to the level of consumption, which was ultimately corrected with the onset of government spending for the Second World War, says Chan.

The US, Chan points out, is now undergoing another period of adjustment in which consumption and investment relative to GDP are falling while saving is increasing.

“Among other things, this implies a reduction in the US current account deficit and, hence, a reduction in Asian current account and trade surpluses.” Given that China is the US’s second-biggest import supplier and the country with which the US has the largest bilateral trade deficit, China is likely to bear a large part of the adjustment, he argues.

For Asia to “solve the problem” by stimulating domestic demand isn’t as easy as many commentators make it out to be, says Chan. “If the process were so straightforward, governments would likely have done so already.” It’s of course true that Asian economies have no other choice: with demand shrinking in Western markets, either domestic demand must compensate, or supply must shrink.

The period of adjusting could be prolonged and painful, observes Chan. “If the adjustment in consumption and saving in the US is part of a long-term correction, there will be major implications for Asia. Entire export industries will have to be retooled to serve domestic sectors. Retooling, say, factories in Shenzhen from assembling iPods and mobile phones towards products that Chinese consumers would buy would require a long process of reconfiguring supply chains across Asia, affecting, among other things, semiconductor production in Taiwan, memory production in Korea, and hard drive production in Singapore.”

The process, he reckons, will likely take decades. Government policy must be directed at boosting domestic consumption and discouraging saving. Governments may have to ramp up deficit spending and improve social safety nets such as unemployment benefits and healthcare.

However, China is in danger of repeating some of the mistakes that the US made in the 1930s, which accentuated its downward spiral during the Great Depression.

Pointing out that the Chinese government had announced tax rebates on exports for a range of goods, Chan said, “In an economic sense, there is little difference between import tariffs and export subsidies.”

A planned depreciation of the yuan, about which there is intense speculation, would have a similar effect. And the announcement of the 4 trillion yuan fiscal stimulus package seemed designed partly to encourage American policymakers to come up with a larger package.

In sum, although policymakers around Asia insist that the region is well-placed to withstand financial instability around the world, the risks of a deeper downturn are rising, cautions Chan.

I do believe that the severity of the slowdown in China has been underestimated. Given the bursting of a housing and stock market bubble, it seems unlikely that domestic demand can replace export demand given the low relative per capita income in China. The required increase in domestic demand is much greater in China due to the lower relative income per capita. In my view domestic demand will not increase, it will decrease. Only government spending can fill the gap. And that cannot nearly be enough to reflate the Chinese economy.

China ‘repeating US mistakes of 1930s’ – Sify.com, India
Coinage of the evening – naked capitalism

  1. Denis says

    Excellent find, I never thought about it this way. It makes a lot of sense.

    On a related note I was recently thinking about Chinese stimulus program. It seems that if Chinese government gives money to their own people, they are likely to hoard rather than spend. In that sense it might be better to give the money to the Americans who are more likely to spend than the Chinese. And then it occured to me that this is exactly what was going on for the last 30 years or so – Chinese and Japanese governments were stimulating consumption in the US via purchse of US treasuries to stimulate manufacturing in their home land.

  2. John Creighton says

    I always questioned the emerging markets/decoupling theory. I herd a few days ago on BNN that they actually admitted that the decoupling theory has proved to be wrong. I think that emerging markets are still trading at a much higher price to earnings then first world countries. I bet their is an opportunity to make money on the spread as emerging markets correct their price to earnings valuations with companies in north America. The problem though is the famous quote about markets remaining irrational longer then a person can remain solvent. The other problem is that emerging markets well now overvalued still have more long term growth potential.

  3. Edward Harrison says

    I would be bullish on emerging markets if it weren’t for the nasty downturn they are about to work through. Mark Mobius has turned bullish again and is actively buying shares in the emerging markets. I remain more skeptical. Denis, I can’t fault the logic of your thinking about the Chinese NOT spending any stimulus given to them by their government. That is why the Chinese are subsidizing exports. I will be writing a lot more about this shortly, but the U.S. has already filed a complaint with the WTO saying that the export subsidy is tantamount to a tariff. It looks like we may have Smoot-Hawley in another form here. In my mind, this is big news.

    Stephen Roach has always said decoupling was a crock and he has been proved right. The question is whether the emerging markets/Asia will rebound quicker. I am making the case here to not assume this is the case as I might have previously. Watch for more on this in the coming weeks, especially the export subsidy stuff. I’ll post when I get more info.

    Cheers, guys.


  4. tokyo joe says

    What concerns me most about China is the possibility of social unrest. The populace not only expects the government to provide or at least fine tune everything, they also expect to be driving a Mercedes in the near future. Unfortunately, the economy has yet to meet the expectations of about 750,000,000 peasant farmers, and of those gainfully employed, approximately 140,000,000 have stock accounts, most of which have an average cost around 4000 SSE. It is slowly sinking in to all parties that Uncle Wen and Uncle Ho cannot provide everything to everyone. Dashed expectations can lead to unbecoming behavior, particularly when the populace has no recourse against the self-appointed officialdom.

  5. Jing says

    Tokyo Joe has everything backwards. He isn’t describing China so much as the United States. The Chinese people already have little enough faith in their own government and their savings reflects their wariness about government nannyism. The only expectations that the average Zhou has of the government is that bureaucrats will try to steal from them. Stock ownership is relegated only to a minority of the total population unlike in the U.S. American’s are the real dopes thinking that they can dig their way out of a credit collapse with more debt and government cheese. You will be hard pressed to find actual Chinese expecting to be driving a mercedes, but the legions of yuppies driving BMW-3 series (the quintessential mark of middle class conspicuous consumption, the yuppie-mobile if you will) will suddenly find themselves late on their payments. They will be in for a shock as a whole generation enters retirement only to find their homes, 401ks, pensions, etc worth far less than they had thought.

    1. Edward Harrison says

      Jing, for a more pro-China growth analysis, take a look at what Marshall Auerback had to say. I disagree with him regarding the likely severity of a Chinese downturn, but we both agree that China is still the growth story to watch.

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