Export Dependence

Nigel Aitkins - Thu 25 Nov, 2004

"...Asia needs US consumers to keep borrowing and spending...Britain needs the US to keep buying its financial and business services. What happens when America hits recession?..."

Asian countries are getting worried because their export growth is waning, and countries in that region are highly dependent on exports. Exports account for more than half the GDP in a number of smaller ones, such as Vietnam (52%) and Thailand (55%). In Singapore, Malaysia and Hong Kong, the ratios exceed 100%, as their airports and harbours turn imports into exports.

These countries worry that high-energy prices and other forces are cooling the US and European economies and, hence, demand for their exports. They also worry about the effects of high-energy costs on Asia and, more broadly, exports within the region.

Asian countries are also concerned about the strength of their own currencies against the dollar and the resulting negative effects on their exports—specifically, their exports to the United States since the lion’s share of their exports, directly or indirectly, end up in America. US consumers need 70% of the world’s savings to fund their spending.

Nevertheless, currency values and real imports have almost no correlation; the same is true of real exports and currencies. So if currency movements don’t alter trade flows very much, what does? Economic activity. When an economy is growing, consumers and businesses buy more of everything, especially imported goods and services. There is a close correlation between real imports and GDP in the United States. Statistical work shows that US imports rise 2.9% for each one percent increase in GDP, but only 0.2% for each one percent rise in the dollar. Other major countries have similar relationships.

Asian concern over dollar weakness, then, is overblown, but worries over US growth and American imports are well founded. The immense fiscal stimuli from earlier tax cuts and jumps in defence and Homeland Security spending are now fully absorbed. So, too, are the effects of the decline in interest rates, which spurred housing activity and cash-out mortgage refinancing.

With further big leaps in US housing and consumer spending unlikely, many hoped that business outlays would surge and seamlessly continue robust US economic growth. But those hopes have not been fulfilled. So, the US economy lacks meaningful growth stimuli. At the same time, three negative forces are at work: First, the recent jump in crude oil prices is cutting about 1% off US GDP growth. And it’s sobering to note that the last five oil price spikes were associated with recessions...and not just in the US, but in Britain and Europe, too.

Second, the Fed is in the midst of a rate-raising campaign. And it’s true that Fed rate hike efforts almost always end in recessions.

And lastly, there is also the US election year cycle. In the postwar era, a recession occurred in the first or second year after 10 of the 15 presidential elections.

So if the United States is no longer the destination for much of the world’s exports, who will be able to step in? According to Stephen Roach at Morgan Stanley, the US...with its debt-fuelled consumption and E-Z credit bubbles...accounted for 98% of world GDP growth in the 10 years to 2002. This imbalance will only have worsened since in the two years since. Who can pick up the slack?

China has become a big player on the global stage, and therefore important to the worldwide economic outlook. The concentration of global manufacturing in China has made her a huge consumer of raw materials and promoted rapid economic growth and leaping exports. But now China is trying to cool her overheated economy, and last month the central bank raised its benchmark interest rate for the first time in nine years. More increases are likely since that interest rate is still below China’s inflation rate.

The likelihood that China can let the superheated air out of her soaring economic balloon without a crash-landing is very low. In the United States, the Fed, with all its sophisticated monetary tools and experience, has tried to affect soft landings in the post-World War II era eleven times...but has only succeeded once, in the mid-90s. How can China succeed with her crude monetary and fiscal tools in an economy with only partly free markets?

A recession in China would wreak havoc on the rest of Asia, even Japan, which is just emerging from over a decade of deflationary depression and remains dependent on exports for growth. While America continues to be Japan’s prime market, exports are increasingly headed for China. Japan is increasingly dependent on capital spending in China, and her exports to China accounted for 79% of Japanese export growth last year. The bottom line is that Japan’s recovery is export-led, much of it due to China. So, if the Chinese economic balloon makes the hard landing I expect, Japan’s may fall back to earth without even having gained much altitude. And if the United States, China and Japan have weak economies, so does the rest of the world.

In the near future, the world will continue to depend on the United States to buy its excess goods and services, and the outlook for the US economy and American imports isn’t rosy. Most countries are running merchandise trade surpluses, the counterparts of the huge American deficit of more than $600 billion. In the longer run, however, the US trade gap may reverse gears and shrink, but in a way that damages foreign exporters.

So, will another country replace the United States as the economic engine that absorbs the globe’s excess goods and services? Maybe, but none have yet volunteered for the job. It’s unlikely to be Continental Europe, with its traditional disdain for imports in favour of job-sustaining local production. Ironically, though, the even more import-wary Japan may end up being the world’s next big importer. All major countries have rapidly aging populations, but Japan’s is the most extreme. One reason for this is the long life spans of the Japanese. In future years, Japan, like the United States, Canada and European nations, will face a dwindling number of workers to support retirees.

But due to decades of saving more than was needed for domestic investment, Japan has been exporting capital. Those outflows have cumulated into huge holdings of US Treasury obligations, foreign real estate and other assets around the globe. Japan, in the decades ahead, can simply sell those piles of foreign assets and use the money to buy the imports needed to supply her retirees. No other major developed country that faces an aging population has that horde of foreign assets to cash in.

While Japan may replace the United States as the globe’s importer, developing countries like China are unlikely to fill that role. Sure, we know all the stories about big domestic spending in China on mobile phones, cars and TV sets. But I suspect that that spending comes from export revenues and the direct foreign investment that continues to pour into China to build production facilities. With the next US recession and global downturn, both Chinese exports and direct foreign investment there will dry up. So too will domestic spending - if I’m right.

More fundamentally, I believe that China, India, the Asian Tigers, Latin American lands and other developing countries are not yet industrialised enough to have the vast middle classes needed to create economies that are led by domestic spending. Today’s array of developing countries are probably decades away from achieving big enough middle classes to eliminate their dependence on exports for growth.

Many see the growing US trade and current account deficits as menacing problems. I see the reverse, the dependence of the rest of the world on America to buy its excess goods and services, which can only be good for us in the long run.


Regards,

Gary Shilling
for The Daily Reckoning