Now is the time to start talking about decoupling. No, I am not mad. Well, not certified yet. Decoupling talk was rife in 2006-07. We remained sceptical and even wrote against it. The world was one leveraged bet on the US consumer. That has been borne out by reality. As the US consumer cuts back on his spending, export growth of Asian countries plumbs new depths. So, in this cycle, there is no decoupling, or there was no decoupling. What about future cycles? There is scope for hope.
Delivering the inaugural speeches at the World Economic Forum in Davos, both Vladimir Putin and Wen Jiabao had taken to criticizing the US macroeconomic growth model and held it chiefly responsible for the global financial crisis. They are not wrong, but they were clearly exaggerating the US role and underplaying their own culpability in fanning the flames of the global debt binge. Nonetheless, their outburst against the American model suggests that they are not going to walk down that path again, much as American policymakers are hoping to persuade or pressure them into buying US treasury debt again.
Notice how the US Federal Reserve signalled its intention to hold the federal funds rate at zero per cent for a long time to come and promising to buy US treasurys so that treasury yields could be brought down further. This promises alluring returns to treasury holders—chiefly foreign central banks. Certainly, low interest rates do little to encourage savings and investment in America. It is an attempt to beat back deflation through imprudent lending and eventual inflation. As a perceptive writer of letters to the Financial Times noted recently, inflation punishes the prudent while deflation punishes the imprudent. No prizes for guessing which path the US is or will be taking.
Asian and other developing nations have to avoid falling into that trap. Putin and Wen’s rhetoric suggests that they are thinking. They have to desist from investing in US treasurys at low nominal rates of return, for eventually inflation and dollar debasement will erode their returns. Further, they have to think of interest rates as not just a lever for managing the income side of households, but also that of the nation’s savings and investment balance.
For too long—until now—interest rates have been adjusted down or up—mainly in response to inflation. But interest rates equilibrate savings and investment. Hence, too much of investment and interest rates have to rise; too much of savings and they have to drop. Most Asian nations have high domestic savings. They need to use that to stimulate domestic consumption and investment.
However, if the economic performance of the developing world is to decouple from that of the US, economic thought has to do so first. Right now, it appears convenient for these nations to blame the US for all their troubles. They have to do more. They must take steps to move decisively away from the monetary policy framework set by Western economists that ignores credit and asset prices, as George Cooper advocates in his book, reviewed in these pages recently.
Even if they take their time to think differently, the case for decoupling remains strong. Asian banks and financial institutions—on the whole—are in better shape. Bloomberg produced a very nice chart showing the superior relative performance of stocks of Asian financial institutions in the Morgan Stanley Asian financial index, compared with those in the indices for American and European financials. The contrast has been more noticeable since the collapse of Lehman Brothers in mid-September last year.
This is grounded in fundamentals. Fifty-six per cent of the global write-offs and write-downs by financial institutions have come from the US, 36% from Europe and only 8% from Asia. Based on the conduct of English and continental European institutions, there is reason to believe that their write-downs will be accelerating this year.
Perhaps Chinese banks are slightly more vulnerable, for the country was high on confidence, had institutional structure that facilitated directed lending and had enough global cheerleaders to take them down that path. Korean institutions and households are genetically hardcoded to assume leverage of Western proportions. Indian banks would have walked down that path gladly but daddy (the Reserve Bank of India) effectively forbade them from doing so. So, Asian banks are in considerably better shape. Their credit intermediation has been disrupted not by the state of (ill) health of their and their clients’ balance sheets, but by the economic cycle.
Further, a survey conducted by the Duke University on the cash levels of financially constrained and unconstrained non-financial firms, their credit availability and their investment plans for the future, shows that Asian firms are much better placed than their Western counterparts. This suggests that economic growth will be both relatively and absolutely better in Asia.
Lastly, if there is one reason to take decoupling seriously, it is that no one is talking about it now. In the next column, we will do some cherry picking in Asia.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org