Global: Hardly a Global Soft Patch
Stephen Roach (New York)
Many of the major economies of the world have suddenly slowed. First came the US and China, but then Japan, Korea, and Germany have followed in short order. In my view, this is not a coincidence but yet another important example of the interrelated perils of an unbalanced US-centric global economy. When the US and China flinch, the rest of the world -- lacking in autonomous domestic demand -- is quick to follow. Barring a spontaneous reacceleration in the world’s two major growth engines, risks are mounting that 2005 could be a surprisingly tough year.
Recent slowdowns in the US and China have been well documented (see my dispatches of 9 August, “ The Mythical Recovery” and 13 August, “Razor’s Edge”). On the back of an unusually anemic 1.6% increase in real personal consumption expenditures in 2Q04, a consumer-led US economy slowed to a downwardly-revised 2.8% annualized growth rate in the spring quarter -- fully 45% below the 5.1% average pace of the preceding four quarters. Without additional policy stimulus and lacking in organic job and wage income growth, there is good reason to believe that the saving-short, overly-indebted American consumer will remain under pressure for some time to come. The impacts of high and volatile energy prices only increase this likelihood, in my view.
In China, industrial output growth decelerated to 15.5% in July -- still rapid by most standards but fully four percentage points slower than peak growth rates of close to 19.5% earlier this year. Foreign trade and bank lending comparisons have also decelerated, although there was a surprising reacceleration of fixed investment in July. As I see it, a soft landing comes when the industrial output comparisons have moderated into the 8-10% range; to date, China has completed only about 40% of this journey. With CPI-based inflation now above the 5% threshold and only partial progress on the cooling front, I remain convinced that the Chinese leadership will stay the course of its recent campaign of policy restraint.
The world economy, in my view, remains very much dominated by developments in the US and China. The American consumer has long been the driver on the demand side of the global equation. US private consumption growth averaged 3.9% in real terms over the 1996 to 2003 period, slightly more than 75% faster than average gains of just 2.2% elsewhere in the developed, or “advanced,” economies of the world. At the margin, the Chinese producer now wields equally impressive influence on the supply side. China’s 40% surge of imports in 2003 accounted for a highly disproportionate share of export growth in externally-driven economies such as Japan, Korea, Taiwan, and Germany. Moreover, China’s rapid growth in industrial production claimed an outsize share of industrial materials consumption, a key factor pushing up global commodity prices and shipping rates. The world has very much become a two-engine growth machine. And with both of those engines now slowing, spillover effects on other economies should not be surprising.
That’s exactly what now seems to be occurring. Japan, the world’s second largest economy, is an important case in point. Japanese economic growth slowed to a 1.7% annual rate in 2Q04, well below the surprisingly vigorous 5% gain over the preceding four quarters. When the second quarter number was released, there were widespread expectations that this was nothing more than a temporary setback likely to be followed by a solid rebound. With the data flow out of Japan continuing to be weak, that interpretation can now be drawn into serious question. Just-released household consumption statistics are especially worrisome in that regard -- underscoring Japan’s lack of autonomous domestic demand. Real consumption plunged 2.5% on a sequential monthly basis in July -- the third consecutive sharp drop following a now seemingly aberrational 9.7% spike in April; as a result, year-over year Japanese consumption gains slowed to just +2.9% in July -- only half consensus expectations of 5.7%.
Meanwhile, there was also a sharp rise in Japan’s unemployment rate in July back to 4.9% in April -- essentially retracing the labor market improvement of the previous four months. While July’s rise in joblessness was influenced by a sharp increase in the labor force, there can be no mistaking the worrisome sign conveyed by a marked run-up in the male unemployment rate from 4.7% in May to 5.3% in July. At the same time, Japanese export volumes fell 0.5% in July, with weakness concentrated in shipments to China -- especially office equipment and construction and mining machinery. The impacts of the “China factor” on an externally-dependent Japanese economy should not be surprising; in 2003, surging sales to China accounted for about 43% of total growth in Japan’s exports. Taking all these considerations into account, our Japan team now believes that real GDP growth is tracking at about a 2% annual rate in the current quarter -- consistent with sluggish gains in the spring period but far from the imminent rebound widely expected and quite consistent with our below-consensus 1.3% GDP forecast for 2005.
Korea is also back in the danger zone -- hardly a trivial consideration for the fourth largest economy in Asia. The July data were uniformly weak, driven by a sequential decline in factory output, renewed weakness in private consumption, and a worrisome fall-off in business capital spending. Sharply moderating year-over-year comparisons in Korea are all the more disappointing, given that trends a year ago were adversely impacted by widespread labor stoppages; business investment trends are especially disconcerting in that regard, as the year-over-year comparison slipped from 7.7% in June to 2.5% in July. Export growth (+39% Y-o-Y) remains the only real source of support for the Korean economy; however, with exports to China having accounted for 45% of total Korean export growth in 2003, it seems inevitable that the China slowdown would also take a serious toll on this economy’s externally-driven growth dynamic. We recently downgraded our 2005 Korean GDP growth forecast to 3.8%, about two percentage points below gains elsewhere in the region. Risks remain very much on the downside of our increasingly cautious prognosis.
Finally, there’s the seemingly never-ending saga of growth disappointments in Germany -- Europe’s biggest economy and the world’s third largest. The latest Ifo survey of German business sentiment pointed to further slippage in August -- continuing the general downtrend that has been evident since late 2003. The August falloff was concentrated in the retail sector -- underscoring lingering weakness in German domestic demand, which has contracted for the past six quarters. Improving export expectations were the only source of support in the manufacturing piece of this survey; however, the China slowdown could also take its toll on this important prop to German activity -- shipments to China accounted for fully 28% of total German export growth in 2003.
My colleague Eric Chaney constantly warns me from making too much of Germany’s weakness. In his “two-track” view of Europe, Germany is the outlier, no longer the dominant force shaping the region. That may well be the case, but the offsets outside of Germany are only “powerful” enough to generate 2% GDP growth for Euroland as a whole over the 2004-05 period, according to our latest forecasts. While that represents a doubling of the anemic 1% average gains over the 2001-03 interval, it still leaves Europe as the weakest link in the industrial world growth chain. To the extent that Europe, in general, and Germany, in particular, remain heavily dependent on conditions in external markets, the recent global slowdown hardly comes as welcome news.
The operative view in policy circles and financial markets is that all this is nothing more than a “soft patch” -- a temporary lull in an otherwise solid and increasingly synchronous global growth dynamic. While that’s certainly possible, I continue to have my doubts. In my view, it all boils down to a key issue we’ve been debating for most of the past two and a half years -- the sustainability of recovery in a US-centric global economy. Without the organic support of job creation and income generation, US demand remains heavily dependent on policy stimulus, asset markets, and the willingness to push the envelope on debt -- both domestic and foreign -- in order to keep the magic alive. If policy stimulus fades, asset markets falter, or debt burdens become more onerous, sustainability becomes all the more problematic. Add a shock to this tenuous equation -- oil or anything else, for that matter -- and the recovery itself could quickly be at risk. Those are all very real possibilities, in my view.
As the US and China slow, prompt reverberations elsewhere around the world are telltale signs of a dysfunctional global economy. The world suffers from a major shortage of autonomous private consumption growth. When the American consumer falters, there is really no one else to fill the void. The same is the case when the Chinese production machine slows -- China’s cross-border supply chain is quick to transmit the impacts elsewhere. That’s already having an influence on China’s trading partners in Asia, and should also affect the capital goods production complex in Germany and the United States.
This global recovery dynamic is very different from those of the past. In an effort to contain deflation, the extraordinary reflationary policy gambit of 2003 succeeded in providing a temporary burst of vigorous growth. But that resurgence came at a cost -- it exacerbated already serious global imbalances and, therefore, borrowed heavily from gains that would otherwise have occurred in the future. In my view, 2005 could well be payback time, and the current global soft patch could be but a hint of what lies ahead.
morganstanley.com |
