from Follow the Money

A large, truly global slump

February 13, 2009

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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China’s GDP growth stalled in the fourth quarter, which represents an enormous deceleration from its typical fast growth.

US GDP fell at a close to 4% annualized rate in the fourth quarter. The decline would have been steeper but for a big buildup in inventories. That will subtract from growth in q1.

Japanese GDP growth fell by around 10%. Some estimates are now even putting the q4 fall, annualized, at close to 12%. The fall in smaller Asian economies was often even larger.

And now we know that Europe’s GDP fell by 1.5% q/q, or 6% annualized. Germany, until recently Europe’s strongest economy, contracted at an 8% annual rate.

According to the European Union’s statistics office, the economy of the 16 countries sharing the euro currency declined by 1.5 percent in the fourth quarter. On an annualized basis, that would indicate a contraction of 6 percent — considerably deeper than the 3.8 percent annual rate of decline in the American economy in the same quarter. The performance was worse than many economists had expected, and it was even more pronounced in Germany, the euro zone’s most important economy. There, the economy shrank by 2.1 percent from the third quarter, when it had already contracted by 0.5 percent.

There is a lot of spare capacity in the global economy now.

Back in the 1990s, the vogue was to talk of capital account crises. A "sudden stop" in capital flows to an emerging economy triggered big fall in output; countries that relied on capital inflows to cover their external deficits had to bring their imports down suddenly -- and that usually meant a sharp economic contraction.

It consequently is striking to me that the countries with the steepest falls in output in q4 have been the countries that are known for relying heavily on exports for growth --

They in effect are suffering from a sudden stop in global demand, which has given rise to a sudden stop in trade flows. Or perhaps a sudden stop in finance led to a sudden stop in demand, a sudden stop in trade and sharp falls in output.

Last summer -- in Sovereign Wealth and Sovereign Power -- I worried about the risk that China, or another major sovereign creditor, might stop financing the US if the US adopted policies its creditors opposed. As a borrower, the US was vulnerable to a sudden interruption in capital flows. I was implicitly drawing on the analogy of the emerging market crises of the 1990s.

It turns out though that -- with a big enough shock -- the volatility in output that can arise from a current account shock can be almost as big as the volatility from a capital account shock. Economies that relied on exports for growth weren’t invulnerable to external shocks. They just weren’t as vulnerable to capital account shocks ...

The US took a risk by relying so heavily -- for a time-- on China’s government for financing. China likely bought about $400b of US debt in 2008, a non-trivial sum. But China took a risk by relying so heavily on American and European households for demand. Since these households relied on credit t maintain a high level of spending, China was exposed to a US banking and financial crisis.

Asian nations responded to the crises of the 1990s by taking a slew of steps to reduce their vulnerability to capital account crises, but in the process increased their vulnerability to "current account crises." Their economies became more dependent on exports, and more of their exports came from countries whose external and internal finances looked a bit shaky ...

One big question going forward is how will Asian nations try to reduce their vulnerability to crisis that come from the current account ....

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