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decoupling

Page history last edited by Brian D Butler 15 years ago


 

 

see also:  credit crisis of 2007 

 

"The second reason, she added, was “the international ramifications.” Through the summer, many people thought that while “the U.S. went down,” the rest of the world would not. That turned out to be wrong….We didn’t realize how interconnected our financial institutions were, but I think that’s probably the main source of the surprise.” In other words, that once much-vaunted decoupling between the United States and the rest of the world fed what proved to be a dangerous complacency."  source:  http://www.cnbc.com/id/29720337/page/3/

 

 

 

Decoupling:

 

No, I dont think so: 

 

"A third of the collateralised debt obligations (CDOs) and other financial instruments based on US residential mortgage-backed securities (RMBS) that are tied to sub-prime markets have moved offshore, mainly to Europe, the OECD said."

 

In early 2008, it became fashionable to claim that a recession in the USA would not cause emerging markets such as Brazil to slow down.  The theory of decoupling states that these emerging markets are no longer direcly correlated with the US economy: they have been "decoupled", and now depend more on China, and on Europe, and on their own internal growth.

 

My take on this:

 

The reason that the emerging markets such as Brazil, and China have not yet been adversly effected by the US bursting of the credit bubble is because our connections with those countries is not related as much with credit.  Our connections with China is that we buy their products.  Consumer demand of products is more important to the Chinese economy that a collapse of banking credit in the USA.  We were never "coupled" in the credit markets, so the idea that we have been "decoupled" is rediculous.   In fact, the countries are still very much tied through trade and through globalization, we are more tied together than ever before.   Its just that the connections are through consumer purchases of goods and services, and not on the availability of credit.

 

But, what is going to happen?   My predictions:

 

Credit contraction in the US, if it causes the consumers to cut back spending (buying of Chinese made goods), then that could cause a slowdown in China.  With a slowdown in China, there would be less demand for commodities, and countries in Latin America (and other big raw material suppliers) would feel the hurt.  The key is the consumer consumption....that is where the correlation (coupling exisits). 

 

What you should do?

 

Pay very close attention to the health of the US consumer....does he keep spending?  If not, then be careful, and take defensive positions out of commodities, and emerging markets. ...because the idea of "decoupling" will come undone.

 

 

Effects of the (USA) credit crunch:

 

see our discussion on the credit crisis of 2007 

 

Global effects

 

One of the biggest effects is that companies in emerging markets that need to raise new money will find it more difficult to do so.   Per the Financial Times (09/2008): "Of the $111bn in bonds that will mature between now and the end of 2009, $24bn worth are held by junk-rated groups that have almost no hope of tapping a market that has become averse to risk."

 

 

Global effects

 

Other than countries that were direct buyers of US asset-backed securities (mortgages), I don't see much of a contraction of credit in emerging markets

 

Let's look at Brazil for example;  In May of 2008 (6+ months into the "credit crisis of 2007"), I see no contraction of credit conditions at all.  In fact, there is an ongoing explosion of credit available to consumers in Brazil (even if the industrial credit markets are still as tight as ever).  On the consumer side, however, it appears as if Brazil is swimming in available credit, in spite of the so-called "credit crisis".  Maybe the troubles are not as global as some analysts are predicting.  Not directly anyways.

 

Mexico is another example.  According to a recent article from the Economist magazine, lending in Mexico "has ballooned.  Credit to the private sector has nearly tripled since 2001, while consumer credit has increased by around seven times."  This is hardy a global credit crisis.  Again, it seems to be localized just to banks that were buyers of mortgage backed securities, or other financial innovations.    But, in Mexico, the article goes on to explain that there has been an increase in the sophistication of the credit markets, as there has also been a massive growth of mortgage-backed securities markets, and improved credit ratings systems.  But, in contrast with the US, there has been a very minimal housing price increase (even less than inflation). 

 

So, in spite of a credit crunch, it appears as if the phenomenon is mostly US-based one. 

 

 

Not safe yet - my "titanic" theory, and the danger I see ahead

 

Emerging markets are not out of the woods yet.  see my "titanic theory" here...My skepticism about the “decoupling” argument:

 

In a recent article in the Economist; “The Bank of Japan consensus seems to be that the worst of America’s financial turmoil is now over, but that uncertainty now hangs over its real economy, with risks for Japan. Export volumes to the United States are falling, while the growth in exports to Asia and Europe is slowing. A stronger yen is beginning to squeeze company profits.”

 

In other words, the initial shock of the impact may be over, but the real trouble may be just about to begin. Think about the initial financial crisis in the USA as the moment when the Titanic first struck the ice berg. At that moment, serious damage was done, but the real life effects were not felt until much later. As the real economy in the US slows, and as the credit conditions contract, we should expect to see a slowdown in the US consumer market (who are big consumers of imported Japanese, and Chinese goods, for example).

 

Then, in order to spur the US economy out of the doldrums, the Fed has cut interest rates, which has only increased the downward pressure on the value of the US dollar. With a weaker US dollar, we have seen the benefit in the US of increased exports, which is helping to narrow the current account deficit (a good thing).

 

But the reduced value of the USD has led to reduced imports. Slower consumer demand mixed with a weaker US dollar, and its clear that China and in other SE Asian “tigers” that focus on “export oriented growth” models, will suffer. Maybe the suffering wont be as deep as it would have been in the past due to diversification, but if you take away the significant export market of the USA, then many countries around the world will surely see reduced exports of consumer goods to the US (it will take as long as it takes for global supply chains to be re-configured). The impact? No longer can emerging markets focus on exporting to the US, but instead are forced to compete with the US producers in the global marketplace.

 

But, amid the financial crisis affecting the developed world, we are seeing a bull market run in countries such as Brazil. Why?

 

Business in Brazil is booming because the world is demanding more and more commodities. Right? Yes, partly this is true, but at the same time, there is also a boom in the commodities markets that is partly fueled by speculation, and partly fueled by a global capital flight to “safety” as investors flee the wreckage in the US market, and hope that they can find “safety” in the commodities markets.

 

This displacement and speculation may be effecting the commodities markets positively for now, but like all bubble markets, you should be careful if it bursts.

 

If the US market is like the “titanic” ship that is sinking, and the “iceberg” impact was the initial financial crisis in the US, then commodities countries such as Brazil can be thought of as the dry-spot on the boat where passengers congregate in order not to get wet in the other parts of the ship. Remember the scene in the movie where the musicians continued to play, in spite of the rising waters, and in spite of the clear personal dangers lurking?

 

As investors flock to the commodities markets in hopes of finding “safe haven”, it is wise to be wary of analysts that predict that this time is different because of the rise of middle classes in India and China that will always need more raw materials to feed the booms that are going on there. Although there is some very strong logic involved in these arguments, it is also a bit of wishful thinking by those who hope that the Titanic isnt really sinking, and that hope that global speculation in commodities markets is justified. While it may be true that the global demand for commodities will only increase over time, it is also foolish to ignore the influx of speculators and displaced global investors that are rushing to “dry land” in hopes that they wont get wet.

 

Remember, when the Titanic goes down, everyone gets wet! It’s best to be in a life boat, wearing a life vest, and not joining in with the band to enjoy the party.

 

read more about  decoupling

 

 

 

 

 

More skepticism on "Decoupling"?

 

According to the IMF’s Global Financial Stability Report, published yesterday, “the widening and deepening fallout from the U.S. subprime lending crisis could have profound financial system and macroeconomic implications”. The IMF estimates that losses from this financial crisis may be almost as high as $1 trillion.  As emphasized in the Global Financial Stability Report, “the market turmoil has exacerbated vulnerabilities in a number of emerging markets notably in some countries in emerging Europe that had relied excessively on foreign bank credit or wholesale funding to finance rapid domestic credit expansion”.  Check out: “Fast Growth in CEE Area: Will It Continue In 2008?", “Credit Growth in CEE Countries: Catching Up or Going Too Fast?

 

 

Emerging Markets "Decoupled"?

 

Even as financial contagion into Asian emerging markets has weakened the decoupling argument, the World Bank, Asian Development Bank and UN have lowered their growth forecast for the Asian economies.

 

 

 

Other peoples definitions:  (read to understand the issue):

 

 

 

 

Decoupling holds that European and Asian economies, especially emerging ones, have broadened and deepened to the point that they no longer depend on the United States for growth, leaving them insulated from a severe slowdown there, even a fully fledged recession. Faith in the concept has generated strong outperformance for stocks outside the United States - until now.

 

see more:  http://www.iht.com/articles/2008/01/27/business/26delink.php

 

 

Exports make up especially large portions of economic activity in those places, but that was not supposed to matter anymore in a decoupled world because domestic activity was thought to be so robust.

 

 

France "decoupled"?

 

"Jean-Pierre Landau, second deputy governor of Banque de France, says there is no credit crunch in European hedge funds and private equity. He said he believed that the International Monetary Fund had been too pessimistic in its growth predictions for the area. Reuters (04/08)"

 

 

 

Emerging Markets "Decoupled"?

 

 

"Decoupling is yesterday's story," Stuart Schweitzer, a global strategist at JP Morgan Private Bank, said. "Last year, when the U.S. slowdown was driven almost entirely by housing, it made sense that the rest of the world kept right on going. Housing is a domestic story, plain and simple.   "The nature of the slowdown has changed in two key respects. The credit crunch that began in midsummer is not just a U.S. phenomenon; the rise in risk aversion is global and will have an impact on credit terms and availability everywhere. And we're finally seeing evidence that the U.S. job market is losing steam and consumer spending is slowing."

 

"The notion that the U.S. can go into recession with no negative knock-on effect in the rest of the world doesn't hold up."

 

Even as financial contagion into Asian emerging markets has weakened the decoupling argument, the World Bank, Asian Development Bank and UN have lowered their growth forecast for the Asian economies.

 

Asia will be vulnerable to slowing export demand in U.S., Europe and Japan, a weakening US dollar and contracting global liquidity.  Moreover, growing inflation from food and energy prices may prevent rate cuts and pose risks to growth.ChinaandIndia’s growth estimates have also been revised down due to slowing exports and rising global risk aversion respectively.

 

 

 

Stocks vs. Bonds

 

Bonds and equities have experienced sharply diverging fortunes recently. Many stock markets are more than 20 percent below their 2007 highs, while yields on government bonds have plummeted, sending their prices aloft.

 

 

 

 

Wikipedia Definition:

 

Economics

In economics, decouplingrefers to the lessening of correlation or dependency between variables. It is often used in the context of economic production and environmental quality. In this context, it refers to the ability of an economy to grow without corresponding increases in environmental pressure. In many economies increasing production (GDP) would involve increased pressure on the environment. An economy that is able to sustain GDP growth, without also experiencing a worsening of environmental conditions, is said to be decoupled. Exactly how, if, or to what extent this can be achieved is a subject of much debate.

 

Similarly, decoupling can refer to "breaking" the link between a dependent variable and its cause for a specific industry or activity. For instance, decoupling green house gas emissions from increasing electrical power generation.

 

 

 

 

Decoupling and the stock market declines of January 2008

 

Decoupling holds that European and Asian economies, especially emerging ones, have broadened and deepened to the point that they no longer depend on the United States for growth, leaving them insulated from a severe slowdown there, even a fully fledged recession. Faith in the concept has generated strong outperformance for stocks outside the United States. In January 2008 as fears of recession mounted in the United States, stocks declined heavily. Contrary to what the decouplers would have expected, the losses were greater outside the United States, with the worst experienced in emerging markets and developed economies like Germany and Japan. Exports make up especially large portions of economic activity in those places, but that was not supposed to matter anymore in a decoupled world because domestic activity was thought to be so robust.[1]

 

 

 

External Links:

 

 

 

   *Asia Plays With Trade Barriers to Contain Food and Energy Prices

   *Canada Recoupling? External Weakness To Infect Domestic Demand?

   *Russia's Economic Outlook: Growth Moderation, Higher Spending for 08?

   *Turkey Economic Outlook: Slowing Growth

   *Nordic Economic Outlook: Will Star Performance Continue Beyond 2007?

   *U.S. Subprime Crisis: Impact on Middle East

   *Will Latin Countries Be Affected By a U.S. Recession?

 

 

 

 

 

 

 

 

 

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