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Mix-Ansicht- Stephen Roach: Canary in the Coal Mine - CRASH_GURU, 09.10.2004, 10:19
Stephen Roach: Canary in the Coal Mine
-->Global: Canary in the Coal Mine
Stephen Roach (New York)
While financial markets have been relatively blasΓΒ© about the unrelenting surge in oil prices, the global economy is not. Activity now seems to be sputtering in many segments of the world. That's true in Asia and Europe, although the US economy remains something of an outlier for now. But with oil prices at a flash point, resilience is likely to become an increasingly scarce commodity in a still-unbalanced and vulnerable global economy. The outlook for 2005 continues to darken.
Korea could be the"canary in the coal mine" β an early warning sign of what lies ahead for an increasingly vulnerable Asian economy and an increasingly unbalanced global economy. The recent Korean data flow simply looks terrible. External demand support is rolling over: Export comparisons (Y-o-Y) have decelerated by 13 percentage points in two months β from 36% in July to 23% in September. At the same time, domestic demand has weakened appreciably: Wholesale and retail sales, combined, were down 1.5% in August, and capital spending declined sequentially in August; moreover, a broad gauge of Korean service-industry production was down -1.7% in August (Y-o-Y). With demand conditions deteriorating, inventories are piling up (+3.5% Y-o-Y in August) β leading to cutbacks in industrial production (-0.6% sequentially in August) and declining employment (down 1.6% sequentially in August following a 0.3% drop in July). All this smacks of a Korean economy that is now on the brink of outright cyclical contraction. β underscoring significant downside risks to our 3.8% GDP growth forecast for 2005. For the Korean stock market, which is now up 22% from its early-August lows, this could come as a rude awakening.
Why dwell on Korea? For starters, Korea is Asia's third-largest economy behind Japan and China. It has long been one of Asia's most dynamic Tigers. Over the 1986 to 1995 interval, the Korean economy grew at an 8.5% average annual rate β more than three times average gains of 2.5% for the world's"advanced economies." While Korean growth slowed significantly to 4.6% over the 1996 to 2003 interval, even that relatively subdued pace was nearly double the 2.7% average growth rate of advanced economies over that period. Yet Korea now personifies all that's wrong with the Asian growth model. For starters, it suffers from an increasingly chronic weakness in private consumption β a by-product of a rapidly aging population that faces the twin pressures of unrelenting job insecurity and a huge pension problem. Lacking in domestic demand growth, Korea continues to rely on an export-oriented growth strategy. And now it has hooked its export machine to the fortunes of China; in 2003, the growth of Korean exports to China accounted for fully 45% of the total increase in Korean exports. What's especially interesting about the downturn in Korean exports is that it has yet to reflect the impacts of the China slowdown; the first leg of the export weakness appears to be driven more by the decline in semiconductor pricing. To the extent that the China slowdown gathers force, additional weakening of Korean exports is likely. And that will only tip the risks of this externally dependent economy further to the downside.
Could the rest of Asia follow suit? While it's always risky to paint any region with one brush, most other Asian economies have a good deal in common with Korea: in large part, they are also deficient in consumption support and driven increasingly by China-led export growth. Japan is a case in point. Over the past two years, exports have accounted for about 44% of the cumulative growth in Japanese GDP. Surging exports to China have been the driver at the margin. In 2003, more than 40% of the total growth in Japanese exports can be traced to the"China factor." Like Korea, as China slows, Japan is likely to follow suit. Hints of that response are now evident: Export comparisons have already flattened out, and industrial production seems set to decline for the first quarter since the spring of 2003.
While the latest Tankan survey of business confidence came in above consensus expectations, our Japan team interprets this as a weak report; recent trends in business activity were boosted by strength in the materials sector, which masked a sharper-than-expected deterioration in the forward-looking expectations data. Meanwhile, Japan's private consumption growth has softened appreciably; although consumer demand rebounded in August following three consecutive months of decline, workers' consumption in real terms was still down -0.2% Y-o-Y β underscoring the renewed consolidation of Japanese domestic demand. After a four-quarter growth spurt that ended in 1Q04, the Japanese economy has moved to a decidedly slower growth path. Our 1.3% growth forecast for 2005 suggests that Japan is likely to remain in that rut for some time to come. Throw in an oil shock and the risk is that it could be even weaker than that.
China, of course, is the main event in Asia. To date, the fabled China slowdown has been limited, at best β a 3.5-percentage-point deceleration in industrial output growth from peak rates early this year (+19.5% Y-o-Y in January and February down to 15.9% in August, with September data due out next week ). This slowing, however, stops well short of the 10-percentage-point downshift that an overheated Chinese economy needs. Yet the markets are rife with rumors that the Chinese authorities are backing off from the administrative restraints that have been in place since last spring. While I am not in the business of commenting on rumors, I find this story implausible. Premier Wen Jiabao has led the way in expressing serious concerns over an overheated Chinese economy. With inflation still accelerating, the investment cycle still frothy, and property bubbles building in coastal China, I am hard-pressed to believe that China's new Premier has lost his nerve. I am on record in expressing a preference for interest-rate adjustments over the administrative edicts of quantity restrictions (see my 1 October dispatch,"China Meets the G-7").
If China were shifting the mix of its policy restraint in that direction, I would applaud that. But a premature easing at this point seems totally out of character with the determination of the new leadership. It also raises the possibility that an overheated Chinese economy would quickly come to a boil, setting the stage for the dreaded hard landing. That's the last thing China, the rest of Asia, or the world at large needs. A further moderation in Chinese economic growth still seems like the best case to me. For the rest of externally dependent Asia, such an outcome would spell further deceleration in the months ahead.
Meanwhile, trends elsewhere in the world economy are hardly comforting. Germany, long the weak link in the Euroland growth chain, has taken yet another worrisome turn for the worst. Manufacturing orders fell back sharply in August (-1.5% M-o-M) after a 2.8% surge in July, leaving such booking broadly flat when compared with the 2Q04 pace. The August decline was led by weakness in foreign orders, suggesting that Germany, too, may be on the cusp of feeling the first-round impacts of the China slowdown. That shouldn't be surprising β surging exports to China accounted for fully 28% of the total growth in German exports in 2003. With orders weakening, the surprising rise in German unemployment in September hardly looks to be a statistical accident. Even the United Kingdom now seems to be slowing. On the heels of a third consecutive monthly decline in manufacturing output, overall industrial production fell sharply in August (-0.8%).
At the same time, there was a deceleration in average UK earnings growth, as well as a marked weakening in the UK services PMI in September β the latter trend mirrored by an equally weak report for the Eurozone services PMI. Finally, in the US, while the GDP seems OK β our latest 3Q04 estimate is tracking a 4.6% 3Q04 increase β the quality of the increase does not. That's especially the case for the increasingly beleaguered and oil-shocked American consumer (see Dick Berner's dispatch in today's Forum,"Taxing the Consumer"). With chain store sales just reported to have held on the soft side in September for a third month in a row, consumer resilience may already be starting to waver.
Noise or signal? That's always the question when the oft-volatile data flow lists one way or another. But I don't think it's a coincidence that signs of weakness are now popping up all over the world. With oil prices having sliced through the $50 WTI threshold without any difficulty, the possibility of a full-blown oil shock needs to be given increasingly serious consideration. I continue to hold the view that the oil price has to remain around $50 for at least three months to qualify as a legitimate shock; so far, it's been only about two weeks. But the combination of an oil shock and a vulnerable global economy is worrisome, in my view β underscoring the growing possibility of recession in 2005. I would currently place a 40% probability on such an outcome. I will raise that probability the longer the oil price stays around its current level. Meanwhile, the early warning signs of a cyclical downturn in the global economy are increasingly evident. A China-centric Asian economy is leading the way, and Korea appears to be first in line. With oil prices surging and the China slowing likely to gather force, I suspect this canary in the coal mine is providing a strong hint of what lies ahead for the rest of Asia and the broader global economy.
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