Friday, December 07, 2007

We Interrupt This Blog To Announce the End of the World


China Matters will be on hiatus until December 16.

Meanwhile, here’s some economic news to chew on.

That might involve the end of the world.

Economics’ premier bear, Nouriel Roubini, is in clover right now, having correctly predicted the subprime/housing crunch, the looming U.S. recession, and global credit/liquidity woes.

Beyond the revelation that we are about to experience a Minsky Moment, titillating to the non-economists who know Minsky’s only as a burlesque house, Roubini’s thesis as I understand it is that the bursting of the U.S. real estate bubble has revealed fundamental flaws in how the markets evaluated and traded non-transparent, risky investments; that the already-spooked international financial markets are going to have to deal not only with bad paper but huge insolvent institutions thanks to the upcoming U.S. recession; and the current situation where the international system is afraid to lend money will turn into one where there isn’t much money available to lend for real world investment as well as Wall Street derring-do.

Prognosis: not good.

On his blog he quotes the mordant wit of a commenter:

“Gold is for optimists. I’m diversifying into canned goods.”

Roubini’s current priority is beating anybody who believes in decoupling—the ability of Europe and/or Asia to ride out the U.S. recession or even make things better for everybody by stepping up and replacing weakening U.S. demand with their own domestic demand--around the ears with a rolled-up newspaper.

Roubini believes that China is in for some rough times:

Paradoxically China is the one country that has, so far, decouple the most – both in real and financial terms from the U.S. but it will also be the first and most serious victim of a U.S. led recession. ... China is mostly exporting low-priced consumer goods to the U.S. and the recoupling of China will occur soon once the US consumer recession is in full swing. Thus, the biggest victim of a US consumer led recession will be the country – China - that, so far, has decoupled the most from the US. And for China a fall in its growth rate from 11% towards 6-7% would be the equivalent of a "hard landing" as China – to maintain its social and political stability given its widening income and wealth inequality – needs to grow at least 10% a year in order to move about 15 millions poor farmers from the rural to the urban and industrial sector every year. No wonder that Chinese officials have started to express serious concerns about the current sharp slowdown in Chinese exports to the US, from an annualized growth rate of over 20% in Q1 to a rate of 12.4% in Q3 of this year ("If demand in the US drops further, Chinese exporters will be devastated by a rapid and continuous fall in orders," a Chinese official report said).
And once there is a sharp growth slowdown in China the next victims of this recoupling will be East Asia and commodity exporters. There is a current myth among some analysts that the increased amount of trade between East Asian economies shelters them from a US slowdown. But in spite of the growing intra-Asian trade the cyclical and structural dependence of East Asia on US growth is now larger than five or ten years ago. The reason – as analyzed in detail in recent work by, for example,
the Asian Development Bank – is as follows: it used to be the case a decade ago that East Asian economies tended to export directly final goods to the US. But the rise of China has radically changed the Asian global production and supply chain: now East Asian countries tend more to produce inputs and intermediate goods and raw materials that are exported to China; in turn China, given its lower labor cost, processes these inputs and assembles them into final goods that are exported to the US. Thus, in spite of growing intra-Asian trade the dependence of Asia on US growth is now larger than any time before, both structurally and cyclically. So the argument that Asia can decouple from the US because of this greater intra-Asian trade is altogether flawed. Rather, once China slows down the Chinese demand for these Asian intermediate inputs and its demand for raw materials from Asia, Latin America and Africa will fall. Thus, you will observe both a slowdown in Asian growth and a sharp fall in commodity prices that will hurt all commodity exporters.

Some argue that, while a US hard landing may hurt China and Asian economies, there is wide room for domestic demand and non-US demand to maintain the growth of Asia. But this is another myth that has little basis. The role of domestic demand in China’s growth is very modest. You have an economy where exports are 40% of GDP; where investment is 50% of GDP and, leaving aside housing investment, most of such investment is directed towards the productions of more exportable goods; where the current account surplus has gone from $20b in 2002 (2% of GDP) to an expected $300 billion plus this year (12% of GDP). China and Asia strongly depend on trade and on trade to the US. And, as recent research by Morgan Stanley shows, there is a very low probability of major improvements in domestic demand or non-US external demand. [emph. added]

I think the outlook for the United States is a symbolic bailout for borrowers, and then some more meaningful help for lenders to help them get some of the portfolio of atrocious loans off their books.

But it doesn’t seem like this will solve the fundamental problem: that hundreds of billions of dollars worth of loans were written on the assumption that they could be securitized and passed along in the “there’s always a higher price and/or a greater fool” exuberance of a bubble market.

One thing I think we can look forward to is low interest rates, as the U.S. government hopes against hope that cutting the prime will suck more borrowers and lenders in the market and keep the economy from slipping into a deeper recession.

Low interest rates means a weak dollar and weaker imports.

Roubini believes that fish gotta swim, birds gotta fly, and the Chinese economy has to grow--or else.

I dunno.

Well, if the leadership of China's mixed economy can't handle a slowdown in growth and maintain social stability, they really have no reason to keep their jobs.

I think they'll be working double time to mitigate the social and political fallout.

My layman’s take is that the Chinese government will not be happy with the loss of value of their colossal dollar portfolio but, hey that’s what reserves are for. And they’ll probably have to expend some more of that rainy day reserve dealing with the economic and social consequences of an economic downturn.

At least in the past, the main macro-economic concern of China's Joe Sixpack was averting the erosion of savings through inflation and expecting government programs or forebearance for assistance in getting through hard times.

Since most of China's economy is non-state, the traditional channels for handouts don't exist anymore, but that doesn't mean that the Chinese government won't find a way to keep income and employment from dropping below crisis levels.

Meanwhile, as China tries to look more like the United States, the U.S. banking system may end up looking more like China.

It would be rather ironic if the United States joined Japan and China in the club of countries trying to work out from under a mountain of bad loans that drag down the financial sector and, with it, the economy.

The tragedy is, even if it won’t take decades, like is happening in China and Japan, it will take years.

And that means Chinese exporters are in for some rough sledding.