By Michael R Sesit/Bloomberg
As the $13.3 trillion US economy slows, will the rest of the world pick up the slack?
It’s a question that has bedeviled economists. The debate over whether global growth can weather a steep US slowdown has the earmarks of a number-crunching exercise, and is already having an effect on stock prices in Asia and Europe.
The US economy is slowing. Gross domestic product expanded at 2.2% in the fourth quarter, against 5.6% in the first three months of 2006. US growth will average 2.5% in 2007, according to the median forecast of 73 economists in a Bloomberg survey published 8 March. It was 3.3% last year.
ING Groep NV last week lowered its 2007 US GDP forecast to 2.1% from 2.3% as the decline in housing purchases risks undermining consumer sentiment and as weakening corporate earnings threaten business confidence.
Goldman Sachs Group Inc.’s prediction of 2.1% came before this month’s announcement that US service industries expanded in February at their slowest pace in almost four years.
“We see some downside risks to our own US forecast, which is below consensus,” says Jim O’Neill, Goldman Sachs’s global head of economic research in London.
O’Neill says the world economy can “decouple” from the US “The evidence is pretty strongly in our favour.”
The 13-country euro area, Japan, the UK and the four BRIC countries — Brazil, Russia, India and China — all reported stronger growth in the fourth quarter than the US, he says. “It appears the US has stopped being the ‘engine’ of world growth.”
Goldman Sachs predicts Japan and the euro area will grow 2.4% this year, the UK by 2.9%. The investment bank sees Brazil expanding 3.5%, Russia 7%, India 8% and China 9.8%. Its projection for world GDP is 4.2%, down from 4.8% in 2006.
Emerging markets’ high growth rates are to be expected. Germany and Japan are more questionable.
Germany, Europe’s largest economy, grew 3.7% in the fourth quarter from a year earlier, the fastest since three months through June 2000. The risks to continued growth include a rise in value-added tax and union wage demands. IG Metall, Germany’s largest trade union, seeks 6.5% more pay for its 3.4 million workers.
Japan may yet stumble on its road to economic recovery. January industrial production fell the most in almost three years. And zero inflation in January signaled that deflation still haunts the world’s No. 2 economy.
Goldman Sachs’s O’Neill expects Japanese economic growth to slow to 1.5% in the current quarter before accelerating for the rest of the year and into 2008.
The ability of other countries to emerge from the US economy’s long shadow may reflect more wishful thinking than logic. No doubt, it will eventually happen, especially as some of the bigger emerging countries mature. Right now, the world still needs the US consumer.
The global economy is too dependent on exports to the US, whose trade deficit was $765.3 billion in 2006, while Asia and Europe lack sufficient domestic demand to offset reduced US spending on overseas goods, says Stephen Roach, chief economist at Morgan Stanley in New York.
The US accounts for 24% of Japan’s total exports, 84% of Canada’s, 86% of Mexico’s and about 40% of China’s, he says.
Just as China is dependent on the US, other countries rely on Asia’s second-largest economy. So a US slowdown that hurts China will reverberate in Japan, Taiwan, South Korea and commodity producers such as Russia, Australia, New Zealand, Canada and Brazil.
From 2001 through 2006, the US and China combined contributed an average of 43% to global growth, measured on the basis of purchasing-power parity, according to Roach. And there may be more fallout from a US decline.
“Allowing for trade linkages, the total effects could be larger than 60%,” he says. “Globalization makes decoupling from such a concentrated growth dynamic especially difficult.”
As the US economy faltered in early 2001, many Wall Street gurus predicted that Europe would outpace the U.S.
“It didn’t happen — a lesson investors should bear in mind today,” says Joseph Quinlan, chief market strategist at Bank of America Capital Management in New York. Even though only about 8% of European exports go to the US, Europe is vulnerable to a US slowdown through its businesses abroad.
The earnings of European companies’ US units plunged 64% in 2001, according to Quinlan. Those declines in the biggest and most-profitable market for many German, UK, French and Dutch enterprises resulted in reduced orders, lower profit, slower job growth and weak business confidence. After expanding 3.9% in 2000, euro-area growth shrank to 1.9% in 2001, 0.9% in 2002 and 0.8% in 2003.
“As the US economy decelerates and as the dollar continues its slide, Europe will sink or swim with the US in 2007,” Quinlan says. Affiliates of European Union companies generate 42% of their non-EU earnings in the US, he says.
If the naysayers are wrong about decoupling and Goldman Sachs is right, the world may even help the US economy through its slowdown, O’Neill says.
“If the US has a massive housing correction, what better time to do it than when the rest of the world can help pick up the slack.”
“Happy Slowdown” is his motto.
The US will be hoping O’Neill is right.
(Michael R. Sesit is a Bloomberg News columnist. The opinions expressed are his own.)