from Follow the Money

Frederick Kempe of the Wall Street Journal gets an awful lot of things wrong

February 21, 2006

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As, I suspect, does Joseph Quinlan of the Bank of America- the source of much of Kempe's analysis.  

Kempe's core argument: consumers in emerging markets are driving global demand.  

His evidence: imports from emerging markets constitute a rising share of global imports.

The problem with his argument: he only looks at half the equation - imports - and ignore exports.

Emerging markets are importing more because they are exporting more.  China, obviously.    The oil and commodity exporters too.

But emerging markets in aggregate are not yet driving global demand growth. 

After all, consumption is the opposite of savings (not exactly - investment figures in too), and if there is a global savings glut, it pretty clearly is in emerging markets. 

Remember, many emerging economies have surging savings surpluses.   Current account surpluses are rising even as investment is rising - which implies savings is growing even faster than investment.  China's current account surplus rose substantially in 2005 despite strong investment growth.   The oil exporter's current account surplus soared even more.

Kempe's argument works for Eastern Europe - which does have a large current account deficit, and has been supporting demand growth in the rest of Europe.  It works for India.

But not for China.  And not for emerging markets as a whole.

Yes, their consumption is growing.  But their income is growing even faster.  So consumption/ income is falling.  In China.  And in the oil exporters.    The savings glut, remember.

The next stage of globalization may be characterized by the spending of the Shanghai factory workers and the Bratislava machinist.     But we aren't there yet.

The current state of globalization is characterized by the savings of the Shanghai factory worker, the savings of Russian tycoons (and the Russian state) and the savings of the Saudi, Abu Dhabi, Dubai and Kuwaiti royal families - and by an absolutely phenomenal surge in reserve accumulation in emerging economies.

Adjusting for valuation and counting all the foreign assets of the Saudi royal family, reserve accumulation by emerging economies set a record in 2005 - and it looks to be accelerating in 2006.

Basically, there is one simple way of fact checking Kempe's overall thesis - the overall current account balance of the emerging world.  The IMF conveniently does the calculations for any economist who cares to look.   And it is moving in the wrong direction.  Demand growth has been slower than income growth in the emerging world (and faster than income growth in the US).

An aside: for a nice overview of the investment drought/ savings glut debate, see Gilles Moec and Laure Frey of the Banque de France.

Other key facts Kempe leaves out:

  • Chinese exports to Europe have absolutely exploded since 2002.  That has contributed to global growth.  Europe has offset a growing deficit with China in part by exporting more to Eastern Europe, the Middle East and the real engine of global demand growth, the US (Richard Berner calculates that US consumption surged 10% in the November-January period ) . Europe's overall trade certainly remains far more balanced than that of the US.  But there is no doubt that the Euro's rise against the dollar since 2002 has contributed to increased global demand for Asian manufactures - and thus helped to spur growth in emerging Asia.  The fact that Chinese exports to Europe grew faster (in dollar terms) than Chinese exports to the US in 2003 and 200 doesn't fit the story Kempe (or Quinlan) wants to tell.  But facts are still facts.
  • In 2005, US exports to Europe grew faster than US exports to "emerging asia" - 9% v. 8%.   US exports to old Europe - the eurozone - grew as fast as US exports to emerging asia (8% v 8%).  For emerging asia, I am using the Pacific Rim - Japan.
  • Germany is not Europe.  Sure, German demand growth has been weak.  All that corporate restructuring and wage restraint to make Germany competitive.  But not Spanish or even French demand growth. 
  • As I constantly add, the exchange rate matters as well as the growth rate.  Chinese exports to Europe started to surge when the dollar-renminbi depreciated significantly against the euro, making sourcing production for the European market in China rather profitable (China's membership in the WTO helped as well).  Europe's contribution to demand demand for imports is a function of domestic growth and the exchange rate.  Europe has lagged on one aspect, but led on the other.

Finally, complaints about China's massive intervention in the foreign exchange market are a bit more than just protectionism.  China's government after all, is actively impeding market pressures for its exchange rate to appreciate - market pressures that just might help to make China into the force for global demand growth that Kempe postulates.   Joseph Quinlan of Bank America has long thought that trade deficits do not matter (so long as US firms are producing and selling abroad through their affliates).   The markets seem to agree, at least so far. 

But it is pretty hard to argue that China's peg (along has not been an impediment to global adjustment.  Not the only impediment to be sure.  but an still an impediment.

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