Decoupling: too soon to count the US out!

Decoupling: too soon to count the US out!

Decoupling, the notion that the rest of the world can weather the effects of a slowing US economy, had all the attributes of a successful advertising campaign. The message was clear and succinct. One problem: It doesn’t fly, or at least, not yet. It could even be argued that the powerful forces of globalization make decoupling impossible.

“Global growth will decouple from the US growth to a greater extent than in the past," Goldman Sachs Group Inc. said in a September 2006 report by Jim O’Neill, head of economic research. The US is now a less important destination for world exports, the firm said.

“Domestic demand is on solid footing in Europe, Japan and key emerging markets," Goldman said. “The underlying shock driving the US slowdown is not global in nature, but is linked to a slowing US housing market."

“A sharp slowdown in the US economy in 2007 is unlikely to drag the rest of the global economy down with it," Merrill Lynch & Co. said last year. “The good news is that there are strong sources of growth outside the US that should prove resilient to a consumer-led US slowdown." The firm dismissed the potential fallout from a US housing downturn with a simple, “The world doesn’t build US houses."

Goldman Sachs and Merrill Lynch were bullish on Japan. Calling Asia’s largest economy, “global star," Merrill said, “Japan appears better able to withstand a US slowdown than an other country." On the 13-nation euro area, Merrill said, “The region has a good chance of avoiding the worst effects of a US slowdown."

Japan contraction

Now for the reality check. Japan’s gross domestic product (GDP) contracted an annualized 1.2% in the second quarter, down from 3% in the first quarter and 5.6% in the fourth quarter of 2006. The euro-area GDP growth was a weak 0.3% in the second quarter, down from an average of 0.8% for each of the preceding two quarters and the lowest since the last three months of 2004. Among the area’s bigger economies, German GDP slowed to 0.3% in the April-June period, down from 0.5% in Q1. French GDP was also 0.3%, while Italy grew a measly 0.1%.

Elsewhere, the UK housing boom is ending, and the Mexican peso is set to weaken as remittances from Mexicans abroad—especially the US—slow down, London-based Lombard Street Research Ltd predicted earlier this month. Central bankers have been no more accurate than their private sector brethren in reading the economic tea leaves.

Deflation risks

“Strong money supply, driven by buoyant credit demand, adds to concerns that consumer price increases in the euro area will stay on average significantly above 2% in coming years," Germany’s Bundesbank said in its monthly bulletin on 17 August. Duh! That was after central banks had pumped $350 billion (Rs14.1 trillion) of emergency funding into global money markets and just hours before the Federal Reserve cut its discount rate. For months, the return of inflation and the need for central banks to resist it with higher interest rates were a concern. The real risk, though, is deflation, compliments of the US subprime mortgage mess and tightening credit standards.

“Amid all the fear generated by the US subprime meltdown, one key argument against the ‘sky-is-falling’ camp rested with the assumption that while the US economy may be vulnerable to a credit shock, the rest of the world was doing just fine," says Joseph Quinlan, New York-based chief market strategist at Bank of America Capital Management.

Global rate pause

Well, last week, concerns that the market turmoil may spread persuaded central banks in Europe, the UK, Australia, Canada and South Korea to hold off raising rates. On 10 September, Morgan Stanley economists lowered their 2008 US growth forecast to 2% from 2.6% and, also, cut their projection of 2008 euro-area GDP growth to 2% from 2.4%. “The US economy is and should continue to be weaker than we had expected, as the housing market downturn starts to spill over on the economy at large," says Eric Chaney, the firm’s London-based chief European economist.

Decoupling proponents back their claims with data. Yet ,markets were overcome by banks’ hesitancy to extend credit to anybody they didn’t trust, which for a while was just about everybody.

Merrill optimist

Not all decoupling advocates are giving up. Asian countries’ dependence on the US consumer has declined “dramatically" since the technology bubble burst, says Silvia Liu, a Hong Kong-based economist at Merrill Lynch. Exports of consumer goods to the US declined to 6% of total Asian exports in 2006 from 8% in 2001, she says.

Goldman Sachs economists reiterated their confidence in decoupling in a 12 September report, using the same arguments as a year ago, adding that the so-called Bric countries—Brazil, Russia, India and China—remain “key to global decoupling." The day will come when the rest of the world can escape the pull of the $13.3 trillion US economy, especially when the Bric nations mature.

For the time being, though, it’s too soon to count the Americans out.

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