25-11-2008: Deeper downturn in the offing, says Moody Economy.Com

25-11-2008: Deeper downturn in the offing, says Moody Economy.Com
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SYDNEY: Although policymakers around Asia insist the region is well-placed to withstand global financial instability, risks of a deeper downturn are rising, said Moody Economy.Com associate economist Alaistair Chan.

He said a number of third quarter (3Q) gross domestic product (GDP) releases highlighted the already-deteriorating situation and Asian countries might face a future of lower potential growth.

“Conditions across Asia continue to worsen. Japan and Singapore are ‘officially’ in recession, and growth in most other countries is slowing. Exports are slowing sharply, and investment is also weak.

“There is a growing realisation that problems in the US are more protracted than first thought and that conditions will not return to the way they were a few years ago any time soon, if ever,” he said in a report yesterday.

Chan said there was a case to be made that a global downturn would hurt Asia more than it would the United States.

“The reason is that Asian countries run current account surpluses, while the US runs a current account deficit. This seems counterintuitive. But it matters because it means Asian countries are mostly net producers, while the US is a net consumer.

“A reduction in global demand means a reduction in global supply, so although the US downturn will trigger this reduced global demand, Asia could bear the brunt of the problem through reduced global supply,” he said.

Chan said much research had been done on the Great Depression and one overlooked reason for why the United States was so affected during the Great Depression was that in the 1930s, the US was the world’s largest exporter and ran the world’s largest current account surplus, while Europe had the place of the US today, running a trade deficit and consuming American goods.

“So when demand collapsed, there was overcapacity, mostly in the United States. Rather than boost domestic demand to absorb the excess production, the government imposed import tariffs, notably the Smoot-Hawley Act. This led other countries to retaliate, further blocking off markets for American goods.

“This resulted in a painful adjustment period, when production had to fall to the level of consumption, which was ultimately corrected with the onset of government spending for World War II,” he said.

Chan said the US now was undergoing another period of adjustment in which consumption and investment relative to GDP fall while saving increased.

Among other things, he said this implied a reduction in the US current account deficit and hence a reduction in Asian current account and trade surpluses. “Given that China is its second biggest import supplier and the country with which it has the largest bilateral trade deficit, it is likely to bear a large part of the adjustment.”

Many commentators claim to know the solution for Asia — stimulate domestic demand. But if the process were straightforward, governments would likely have done so already. The flip side is that they have no other choice. With little demand in Western markets, either domestic demand must compensate, or supply must shrink.

Chan said If the adjustment in consumption and saving in the US was part of a long-term correction, there would be major implications for Asia.

“For one thing, entire export industries will have to be retooled to serve domestic sectors.
“Retooling, say, factories in Shenzhen from assembling iPods and mobile phones toward products that Chinese consumers would buy would require a long process of reconfiguring supply chains across Asia, affecting, among other things, semiconductor production in Taiwan, memory production in Korea and hard drive production in Singapore.”

Chan said the process was likely to take decades. and in terms of government policy, to boost domestic consumption, saving would have to be discouraged.