Put down the comfort blanket. Step away from the idea of decoupling. It may not be the thing to save the day after all.
As Martin Wolf pointed out this week in the FT, we are in the midst of “the great unwinding” – the re-import by the US of the stimulus it imparted to the rest of the world between 1996 and 2004, when its domestic purchases grew faster than GDP and the current account deficit exploded.
The US wants its stimulus back. And with an ever weaker dollar, it’s going to get it, dammit.
This unwinding is a turning point, says Wolf. The rest of the world and the emerging markets in particular must now become the demand engines of the world economy. “Will they do so? This is the big macroeconomic question to be answered over the next few years,” he writes.
So keep clinging to the decoupling life raft and praying that we all stay afloat, right?
Wrong. The backlash has begun.
Melvyn Krauss, senior fellow at the Hoover Institution, Stanford University, this week was scathing of the European faith in decoupling to save their economic skins. Writing in the Japan Times he said:
Decoupling is an idea that is based on bad economics — and on some Europeans’ reluctance to accept the fact that Europe’s short but sweet economic expansion is also coming to an end.
So what if the US has become less important for European exports, while Asia’s significance has grown, he asks?
The links between Europe and America are, frankly, much more complex than the advocates of decoupling appreciate.
And the idea that a US recession has no effect on Asia is, says Krauss, nonsense.
So Europeans should not be tempted to think that they are somehow “decoupled” from America’s foibles and woes. Until recently, many Europeans thought they were insulated from the current US housing and mortgage crisis. But in what has been a truly malignant “export” from America to Europe, the US created “garbage debt” in the form of sub-prime mortgages, and Europeans — hungry for extra yield, and as reckless as Americans — bought it. Many European banks’ balance sheets are now as contaminated as those of American banks, and no one is sure who is holding — or hiding — the junk, and how to value it.
The theory of decoupling then is not a panacea – it’s a curse, designed to deny the “very real threats” to the robustness of Europe’s economy. It’s very existence, says Krauss, should be a cause for concern.
And if we needed further convincing, FT Alphaville’s favourite bear Nouriel Roubini has also this week torched our decoupling succor.
In a sense, the argument is now defunct, says Roubini. Even the most ardent proponents of decoupling would struggle to make the case that in the event of a US hard landing that Europe and the rest of the world could just keep on trucking.
But in any case, he adds, what we have is recoupling, not decoupling. In fact, the eurozone has experienced a double whammy – loss of competitiveness relative to the US dollar and other dollar-zone currencies.
Recoupling or contagion is also evident in financial markets. Certainly European financial markets did not decouple from the summer and fall financial turmoil in US financial markets; rather there was massive contagion: the ECB was forced to inject liquidity faster and more than the Fed. And the lingering liquidity and credit crunch has been as severe – if not more severe – in Europe than in the US.
Equity markets have also recoupled with downward pressure in the US rapidly reflected in European equities, argues Roubini. And global shocks – higher risk aversion, the housing cycle, oil and energy prices, other commodity price shocks – will affect Europe as much as the US. Recoupling occurs through confidence channels – as European corporations pull sharply back on capex. A US recession says Roubini will lead to a “serious and significant” slowdown of growth in the rest of the world.
In a repeat of 2001 to 2003, the delusion that the Eurozone can decouple from the US will delay the appropriate action, simply ensuring that, again, the slump is deeper and more protracted than the US version, he adds.
For now it is clear that it is still the case that when the US sneezes the rest of the world gets the cold. And since the US will not just sneeze but is risking a serious case of protracted and severe pneumonia the rest of the world should start to worry about a serious viral contagion from this US sickness….There was never real decoupling; the perceived “decoupling” was only a side effect of the modest slowdown of US growth; now that the slowdown is turning into a hard landing contagion and recoupling is reestablishing itself with a vengeance.