“A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him,” said economist John Maynard Keynes.
The banking industry has done nothing to prove him wrong over the past 18 months. But the same urge to herd can be seen in almost every part of the finance industry – it just tends to have less obviously devastating consequences when it goes wrong.
Take a look at analysts’ forecasts – say for a company’s earnings a year from now. Too often, they end up clustering closer to each other than they do to the eventual outcome. There’s a very good reason for this: like sound bankers, it’s better to be wrong together than be conspicuously wrong with a far-out estimate.
Once a consensus is established, it’s hard to shift away from it. That explains why most forecasts for Asia’s growth over the next year are so implausibly high. For example, the consensus still thinks that China will grow by around 8% through 2009, despite strong evidence that growth could already be well below that and is clearly decelerating…
Global trade is collapsing
Take the latest trade data. November’s exports fell by 2.2% year-on-year, down from growth of 19.2% year-on-year in October and the first decline since June 2001. It wasn’t just China. Other countries have shown even worse numbers: South Korea’s was down 18% and Taiwan 23%, as you can see in the chart below from Capital Economics.
Some analysts argue that the refusal of banks to provide trade finance to exporters is having a big impact on these numbers. But I think the jury is out on that – if there really is unfilled demand because exporters can’t ship goods to buyers, then we should see shortages and rising prices in these goods. So far, there’s no sign of that.
Given how much the global economy has deteriorated in the last few weeks, it’s not unexpected to see a big drop-off in trade. But I’ll confess that a move from +19% to -2% in one month has taken me by surprise – although perhaps in hindsight it shouldn’t have.
When economies slip into recession, things deteriorate very quickly. Indicators tend to tick down for a short while before plummeting. But this time has been a little unusual. It looked as if the US was heading into recession in early 2007 – yet the plunge hadn’t come.
The domestic economy was clearly weak. But it looked as if ultra-loose monetary policy, tax cuts and the promise of huge fiscal stimulus to come meant that the US was merely slipping into a Japan-style malaise, without the usual Wile E. Coyote moment where the ground drops away under the economy’s feet.
With US GDP likely to shrink by 5% or so at an annualised rate this quarter, it’s now clear that this wasn’t the case. Events were merely delayed by relative strength in Europe and in the cash-rich commodity exporters; now with Europe in recession and commodities in freefall, things are taking their usual course. The US, the consumer of last resort, is in severe recession and everywhere else is following it down. “Things fall apart; the centre cannot hold; mere anarchy is loosed upon the world,” as Yeats put it.
Other signs of a slowdown
The fact that I’m quoting a poem called The Second Coming should not be taken to mean that I think that Armageddon is at hand. But the outlook for next year is getting worse and Asia will not be spared.
Apart from exports, there are other signs of a pronounced slowdown in China. Imports were down 17.9% year-on-year. Falling commodity prices and lower demand for goods for re-export undoubtedly played a part, but this could also point to weaker domestic demand (although retail sales still remain strong at present).
Meanwhile, electricity production, which is usually closely correlated to growth, was down 4% year-on-year in October, as you can see on the chart below from CLSA.
That drop overstates the slowdown, since it reflects power-intensive industries such as steelmakers and aluminium smelters cutting back on production in the fall of collapsing global commodity prices. But there are plenty more warning signs, such as weaker car sales or the still-floundering property market, where residential sales to individuals are now down 18% year-on-year (see chart below).
China is slowing down – and so is the rest of Asia. And growth will come down far more than most analysts are yet predicting. The forecasts below are the bull, baseline and bear scenarios from Morgan Stanley’s Asia economics team. ‘Baseline’ is the one that they think is most likely, but to me the bear case looks more realistic for many countries, at least for 2009. For some, even that could be optimistic; Thailand’s political upheaval has damaged confidence and badly hurt the tourism industry, suggesting that an outright fall in GDP is more likely.
This optimism doesn’t only apply to economists. Many equity strategists are talking of a 20% fall in earnings as a baseline scenario. But as we’ve mentioned before (click here to read this article: It’s not time to buy into the Asian rally just yet), a 50% fall would be more typical in a recession.
A handful of economists, such as Jim Walker of Asianomics and Andy Xie, formerly of Morgan Stanley, are making the case for a much more abrupt slowdown in China next year: Walker forecasts growth of 0-4% next year (which for an economy with a growth trend like China’s is a recession). Some of the more independent-minded outfits such as Capital Economics and CLSA are expecting recessions across most of Asia. These forecasts could be too bearish – but they’re likely to be closer to reality than the consensus, at least when it comes to the first half of the year.
China’s spending spree will take time to work
Of course, China has considerable scope to boost the economy. The central government has already announced a stimulus package, while interest rates are being slashed and loan quotas have been removed. Provincial governments have taken this as a green light to raise spending and have submitted RMB13trn-RMB20trn (estimates vary) in investment plans for central government approval, although it’s far from clear how much of this will be okayed or find funding – especially given that the property slump is hammering provincial government tax revenues. Most recently, central government announced measures to boost consumer spending, announcing discounts for rural residents on electronic goods.
More important than the detail of the plans so far is the signal they send – that China will act to keep the economy going and that more measures will follow if these don’t work. Given the relatively high degree of control that the government exerts on the economy, it has more tools at its disposal than the West. For example, apart from increasing government spending even further, it can direct banks to lend more and state-owned business to continue investing.
Nothing China or the rest of Asia does now will take effect overnight. But by late next year, the impact of the stimulus programmes in Asia and the West plus – hopefully – thawing credit markets should see the situation begin to stabilise. At that point, Asia’s low debt burden and high savings will see it in the strongest position for a recovery.
And as Christopher Wood of CLSA points out in the latest issue of Greed & Fear, there is a positive angle to the crisis. “The spectacular collapse in the export-processing industry centred on Guangdong is forcing policymakers to think hard and fast about measures to promote consumption and not just investment. This is a matter of urgency since there are an estimated 26m migrant labourers working in Guangdong… many of whom will now be returning to their rural homes.”
With the US consumer finally shopped-out, Asian economies will be forced to rebalance and strengthen domestic consumption, rather than focusing so heavily on exports. This will not be quick or easy, and we need to expect slower trend growth even when the economy rebounds – China’s overheated 11-12% rate of the last few years is likely to be a thing of the past. But it’s a necessary step, both for the next stage of Asia’s development as a financial power and the stability of the world economy.
Protectionism is the biggest threat
So long-term, the outcome of the crisis should be for the good, although there are risks. Many of them are overstated: comparisons between now and the Great Depression are proliferating in the news, yet there are huge differences between the two eras, ranging from the relative strength of the global economy (back then, the developed world was still recovering from the devastation of WWI) to the mistakes that were made in tackling the problem (it’s unlikely that many governments will tighten monetary policy and skimp on public spending this time).
But it’s not impossible to imagine governments trying to protect their domestic industries, like a modern day rerun of the ill-conceived Smoot-Hawley tariff act that crippled global trade and did so much to make the depression worse. These measures could include China devaluing the renminbi to protect its exporters, a move that would invite retaliation and risk starting a trade war – the last thing we need at this juncture.
That’s probably the biggest threat to the global economy – but it’s unlikely. There was a lot of agitation about a drop in the renminbi two weeks ago, but that move has now been largely undone. It’s clear there are Chinese policymakers who think a renminbi devaluation would be a good idea – but it’s equally clear that there are many who realise that since the problem is a collapse of demand, a cheaper currency would achieve little.
Given that the drop occurred just before US treasury secretary Hank Paulson visited Beijing for talks, it’s likely it was political point-making rather than anything else. That said, if we say substantial protectionist moves – either in China or elsewhere – I would become more worried about the outlook for the whole world over the next few years.
This is the last MoneyWeek Asia of 2008 – I’ll be back at the start of January with the next issue. I’d like to thank you for all your emails and feedback over the last few months, and wish you a good holiday and a happy and prosperous new year.
Turning to the markets…
| Market | Close | 5-day change |
| China (CSI 300) | 1,960 | -2.6% |
| Hong Kong (Hang Seng) | 14,758 | +6.6% |
| India (Sensex) | 9,690 | +5.0% |
| Indonesia (JCI) | 1,263 | +4.8% |
| Japan (Topix) | 813 | +3.5% |
| Malaysia (KLCI) | 852 | +0.6% |
| Philippines(PSEi) | 1,894 | +0.3% |
| Singapore (Straits Times) | 1,740 | +5.9% |
| South Korea (KOSPI) | 1,103 | +7.4% |
| Taiwan (Taiex) | 4,481 | +6.1% |
| Thailand (SET) | 424 | +8.1% |
| Vietnam (VN Index) | 300 | 0% |
| MSCI Asia | 81 | +11.0% |
| MSCI Asia ex-Japan | 291 | +14.0% |
Asian markets rose last week on growing optimism about the likelihood of a large US government spending programme and a bailout for Detroit’s doomed automakers. China was the only major market to buck the trend, sliding on November’s very weak export data.
In Thailand, it seemed increasingly likely that the opposition Democrat party would succeed in forming a new government as factions of the dissolved PPP-led coalition began defecting to them. Optimism that the country’s political crisis would soon be over helped make Bangkok the strongest performing Asian market over the week. But given that this looks like a return to Thailand’s long tradition of political heavyweights selling their loyalties to whichever group can do most for them in the short-term, it’s not clear that the resulting government would be very stable or an advance for Thai democracy.
Credit markets remained largely unchanged and still highly stressed. Credit default swap indices – which measure the cost of insuring against a borrower defaulting on their debt – barely moved and remain at very high levels. And in Japan, interest rates on three-month yen interbank loans stayed above 0.9% for a second week, the highest level since 1998. Rates on commercial paper – short-term borrowing by companies for working capital purposes – also remained very high; as a result, banks are reporting increasing demand for corporate loans from firms who would previously have tapped the commercial paper market.
However, sentiment seemed to be improving in the currency markets. Most Asian currencies gained against the dollar, led by the South Korean won (up 7.5%) and the Indonesian rupiah (up 5.6%). Contracts on the value of these currencies in a year’s time also strengthened, although markets are still pricing in a 12% devaluation for the rupiah and 15% for the Vietnamese dong over the next twelve months.