Although Russia is part of the G8, it is also one of the BRICS.  Putin’s Russia has been looking East while still maintaining relations with the West.  What do these new and growing connections with developing and emerging markets mean?  Read “Is Russia An Alternative to the West for Developing Countries?”  

 

One instant reaction to this note came from some market participants who called me and asked me: "Do these South-South trade and financial links imply that emerging markets will decouple from the US slowdown and recession?" I.e. can the growing role of China in emerging markets (Asia, Latin America, Africa) lead to a decoupling of the emerging markets from the coming US recession? My answer to this question is a clear NO.

 

Before I discuss why my answer is no, let me notice that some recent macro news this week only confirm my recession call: today's consumer confidence figures - in a free fall - are matched by this week's housing starts figures - also in free fall together with all sort of other housing indicators. So, I am even more convinced now than before about my recession call. And the few indicators this week and last suggesting some robustness in the economy (retail sales, industrial production) are much weaker than their headline figures once you scratch their surface (I will discuss this in a separate blog).

 

Going back to the decoupling issue, I have already discussed several times (here and here and here) the reasons why the world will not decouple from the US. But this market reaction suggests that I may want to elaborate a little more this issue. Indeed, some recent market analysis - such as a recent JP Morgan research piece - makes the following argument: even if the US will slow down, there is so much economic momentum in China, that emerging markets - especially those trading with China, such as the Latin American commodity exporters - will be sheltered from the US slowdown. Steve Roach would have called this reasoning as the fallacy of partial equilibrium analysis when you need a general equilibrium approach.

 

Indeed, the more sensible general equilibrium argument is that a US recession will lead to a sharp growth slowdown in China and, in turn, this slowdown in China will sharply reduced the demand for commodities and thus hurt commodity exporters, especially those in Latin America that have significantly benefited from China's explosive demand for commodities. Note also that most analyses of the decoupling of China and the rest of the world from the US (such  as those by Goldman Sachs) assume that the US will experience only a slowdown, and even in that case such such studies implies that China's growth may fall by 1.5 to 2% percentage points in a US slowdown scenario. If, instead, I were to be right in my US recession call (with negative growth rather than just a 2% growth slowdown scenarios), such trade effects on China and other trading partners of the US would be much more severe than those estimates, i.e. a US recession may reduce Chinese growth by 3 to 4% percentage points.

 

Thus, a US slowdown hurts emerging markets (EMs) and commodity exporters via several channels: it directly reduces US demand for the commodities and manufactured goods exported by such EMs; it reduces the demand for commodities and for intermediate inputs via its negative effect on Chinese growth and on growth in the other G7 economies; it increases risk spreads for EMs as US and global slowdown will increase investors' risk aversion. Since EMs have benefited from high global growth, high commodity prices, low interest rates and low investors risk aversion, a US slowdown and recession can be only bad news for EMs, directly or indirectly via the South-South trade. In a globalized economy there is no way any country can escape the effects of a US slowdown: the lack of decoupling or the lack of a rotation in global growth will occur because it is still the case that when the US sneezes the rest of the world gets the cold, with or without South-South trade. And the latest figures on consumer confidence and housing, both in a free fall, make it clear that the US is not just sneezing or having a cold; it is on its wat to get a nasty pneumonia. And when the US gets its pneumonia, the rest of the world will...I will leave it to you to figure that out...