Quotes of the Day
When a country or a company depends to an important degree on the U.S. for its livelihood, you might think that recent financial events there would amount to very bad news indeed. America's economy flagged in the second half of last year and the dollar has dropped sharply against the euro and other currencies, making exports to the U.S. less competitive. Yet Nicola Leibinger-Kammüller, for one, is still smiling.
She's the chief executive of Trumpf, a German family-owned machine-tool firm. It has enjoyed a surge in worldwide orders over the past three years, with sales jumping 35% since 2004. Demand from the U.S., the firm's second-largest market after Germany, has accounted for a significant part of this growth. But even though the pace of American orders is now slowing, Trumpf's sales elsewhere—from Saudi Arabia to Singapore, and especially back home in Germany—continue to rack up double-digit growth rates. "We can feel the U.S. slowdown, but it's not unsettling. There's no crash," Leibinger-Kammüller says. The continuing buoyancy of global trade "is amazing. We have to keep telling ourselves: Careful, this can't last."
As 2007 gets underway, that uneasy mixture of confidence and incredulity seems to be a global phenomenon. Economists, bankers and policymakers have long argued about the extent to which the world economy remains dependent on America, and the issue will loom large at this year's World Economic Forum in the Swiss mountain resort of Davos in late January. The U.S. constitutes about 28% of global gross domestic product as measured in dollars, and it accounted for one-fifth of worldwide growth between 2000 and 2006. So the big question is: If America's growth doesn't pick up significantly, can other countries make up the shortfall? That question has taken on fresh urgency as the once hot U.S. housing market has cooled, putting a chill on the rest of the domestic economy. U.S. GDP growth dropped to 2% in the third quarter, less than half the blistering 5.6% rate of the first three months of 2006. The prospect of a continuing slowdown has sent shivers of concern from Bangkok to Bordeaux.
But so far, at least, the answer seems to be that the world can indeed ride out a period of U.S. weakness. "The overwhelming evidence of the past few months is that the rest of the world is doing just fine, and that some places are doing better than just fine," says Jim O'Neill, London-based head of global economic research for Goldman Sachs. Even if the U.S. economy remains soft for much of the year, O'Neill adds, "we're pretty confident that the rest of the world will withstand it." At the German Engineering Federation in Frankfurt, chief economist Ralph Wiechers concurs. "It used to be that the U.S. economy supported the world economy," he says. "Now it's the other way around."
Not everyone agrees with this upbeat assessment, of course, and the debate about the extent to which the world has decoupled from the U.S. rages on. Critically, many forecasts for the U.S. predict weaker growth in 2007 but not the ultimate test of full-blown recession. Indeed, judging by some of the latest data that shows rising U.S. wages and exports, the worst may already be over. The International Monetary Fund recently increased its prediction for global GDP growth in 2007 to 4.9% from 4.7%. If that turns out to be correct, this year will be the fourth in a row with an economic expansion rate above or close to 5%, the best performance since the early 1970s. China continues to race ahead at the astonishing pace of 10% growth or more, pulling much of Asia with it. Japan's economy, the world's second largest, is again expanding and the deflation that has racked the country for years is coming to an end. And in Europe, where the economy has been sluggish for most of this decade, there's fresh evidence that Germany—after four years of almost no growth—is finally rebounding.
Such resilience highlights the degree to which the structure of the world's economy has been profoundly reshaped by globalization. The increasingly free flow of goods and capital has brought about greater integration of national economies, while at the same time broadly dispersing economic power. The old industrialized-world triad of the U.S., Japan and Western Europe no longer dominates to the degree it once did. China is close to snatching the No. 3 slot on the list of the world's biggest economies away from Germany, while India and South Korea are set to join the top 10 within a decade. India's GDP has expanded by a total of $350 billion over the past six years, an amount equivalent to the entire economy of the Netherlands in 2000. Once moribund countries such as Argentina and Russia are booming, too. Indeed, developing economies are doing much of the heavy lifting today. According to the World Bank, they collectively grew about 7% last year—more than twice as fast as high-income countries—and developing nations now account for 49% of world economic output, up from 39% in 1990. "For the first time in many decades, the global economy enjoys multiple sources of economic growth, of which the U.S. is not the most important," says Gail Fosler, chief economist at the Conference Board, a business-research outfit in New York.
Still, even the biggest optimists concede that nobody would escape unscathed if the U.S. economy were to hit a wall. Its immediate neighbors, Mexico and Canada, would probably be hurt the most as they are particularly dependent on trade with the U.S., but the reverberations would be felt worldwide. The key bone of contention is the extent of the suffering. Those who dispute the decoupling theory point to the seemingly insatiable appetite of American consumers for imported goods, which has been a critical driver of the world's economic expansion. There are still relatively few signs that German, Japanese or Chinese consumers are ready to step up to replace them. For example, while China's imports are way up, those gains are due less to a free-spending middle class than to increasing demand for raw materials and components to feed the country's manufacturing sector, which turns the material into a mountain of finished products to ship to the U.S. "If you just look at the numbers, it looks like Asia's exports to China are larger than they are to the U.S.," says Rob Subbaraman, senior Asia economist for Lehman Brothers in Hong Kong. "But people aren't taking into account where the end demand is coming from." Stephen Roach, Morgan Stanley's chief economist and one of the most skeptical observers of the world economy, has long warned about the dangers of flagging U.S. demand. "The rest of the world doesn't have enough vigor in its private consumption" to offset U.S. declines, he says. Now he's concerned, too, about signs he sees of a possible Chinese slowdown, including a steep drop in the growth of investment spending and reduced gains in industrial output. A less dynamic China is one reason Roach thinks global growth this year will be "significantly below what most are expecting."
Others argue that the global economy is now better able to withstand potential shocks such as slower Chinese growth because it's more flexible and healthier, and because interest rates around the globe are relatively low. Kenneth Rogoff, a Harvard professor and former chief economist at the IMF, believes Asia is not immune to a sharp U.S. slowdown, although he says Europe may be better insulated because of its big internal market, which now covers 490 million people. But he also points out that, until the early 1990s, Japan was a vital source of global growth that virtually disappeared during the country's prolonged economic slump. "It turned out to be no big deal because the world adapted," Rogoff says. "If U.S. growth falls to 1% and stays there for three years, it would be painful at first, but over time others would adapt to that, too."
Certainly, there's less nervousness in financial markets today about the risks of instability in one country spreading elsewhere, as the example of Thailand suggests. The country became the epicenter of the 1997 Asian financial crisis when its currency plunged and set off a chain reaction that hurt emerging markets from Russia to Vietnam. Nearly a decade later, Thailand last month risked triggering a similar meltdown when the country's central bank imposed capital controls in an attempt to curb a big appreciation of the national currency, the baht. Coming just three months after a military junta seized power, the move spooked foreign investors and sent Thai stocks plunging nearly 15% in a day before the government partially reversed itself. Yet there was no regional domino effect. Some Asian markets dipped in reaction to the Thai scare, but they quickly rebounded. What has changed? Among other factors, Asian governments today have far more balanced accounts, higher foreign-exchange reserves and less debt, while the region's corporations are now better financed. "There was no worry of contagion," says Sukhbir Khanijoh, senior securities analyst for Kasikorn Securities in Bangkok. "In 1997, the whole region was suffering from problematic economic fundamentals. This time, the crisis was only in Thailand. It was a crisis we created ourselves and that we had to solve ourselves."
Many dangers to the world economy are still lurking, of course. Oil prices have dropped back recently from $70 to the low $50s, but they are still far higher than just a few years ago, and other commodity prices have soared, fueling inflation. Business leaders across the world are also watching nervously for signs of a protectionist blast from the new Democratic-majority Congress in Washington. Isolated cases of protectionism abound on both sides of the Atlantic: in December, the U.S. Department of Transportation turned down an application by Virgin America, a start-up airline partly owned by British billionaire Richard Branson, to begin domestic U.S. flights because of the carrier's foreign ownership. In Europe, meanwhile, the French government proudly touts its doctrine of "economic patriotism" and has tried, with mixed success, to engineer domestic mergers in the drugs and energy sectors to ward off foreign takeovers.
Yet for the moment, these risks seem manageable. Central banks, especially in Europe, have been raising rates to head off inflation. And there are several initiatives underway between Europe and the U.S. that aim to counteract protectionist pressures at home and abroad. German Chancellor Angela Merkel visited Washington this month to push a plan that would harmonize investment and trade rules across the Atlantic. And the European Union and the U.S. recently got back together in a new and perhaps final attempt to salvage the World Trade Organization's Doha Round of negotiations. "We are in the endgame," says Peter Mandelson, the E.U.'s Trade Commissioner.
Economic forecasting is a dismal science, and this year could well turn out to be very different from the "happy slowdown" that Goldman's O'Neill predicts. Here are some of the factors that will influence the outcome:
AMERICA'S HOUSING BLUES
After years of torrid price increases that made homeowners feel more confident about spending, the U.S. housing market has tumbled. Construction of single-family homes dropped 18% in the third quarter of 2006, and real estate prices have cooled, particularly in overheated markets like California. Steve Steele, 53, made a good living buying houses on credit in San Diego, fixing them up and then reselling them for a lush profit. But now he's shifting his focus to New Mexico. "I think reality has set in," he says. "California is going to be flat for some time."
What economists are struggling to predict is how extensive the impact of this housing slowdown will be. Many other real estate markets around the globe rose in tandem with the U.S. in recent years, but so far none have come back down to earth with the same force. Perhaps most surprisingly, American consumers are continuing to spend, regardless: automobile purchases are sluggish, but monthly retail sales rose by a higher-than-forecast 0.9% from November to December. "I'm not prepared to bet against the American consumer. That's a highly dangerous proposition," says Jesper Koll, chief Japan economist for Merrill Lynch.
Jean-Philippe Cotis, chief economist at the Paris-based Organisation for Economic Co-operation and Development, says the critical question is whether America's housing woes are a signal that the entire U.S. economy is overextended. "For the moment it looks like there is only marginal overheating," he says. That's very different from the situation in 2000, when massive overinvestment in technology around the world created the Internet bubble. When that popped, it sent global financial markets and economies into a tailspin. Today, though, Cotis sees the issue as "an idiosyncratic problem in the U.S. spilling over only moderately to the rest of the world." But he adds: "We need to watch what happens very carefully."
CURRENCIES AND EXPORTS
Spending by Asia's rising middle classes has made the region far less dependent on America's appetite for Asian exports. Today, only 16.5% of Asia's exports are sold in the U.S., down from 25.5% in 1993. Yet there are significant regional differences. Jonathan Anderson, chief economist for Asia at Swiss bank UBS, says Singapore, Malaysia and Japan remain more vulnerable if tapped-out Americans start to shop less, given that their own domestic spending is relatively weak; by contrast, China's consumption is rising steadily, propelled partly by housing demand. He points out that China wasn't hit as badly as other Asian countries by the U.S. downturn in 2001, and that it's in a stronger position now to weather a slowdown.
But a factor that could weigh on China's continued export growth is its strengthening currency. After years of urging by Washington, Chinese authorities have allowed the yuan to rise about 5% against the dollar over the past 18 months. That makes Chinese goods more expensive in America, and the pinch is already being felt by some of China's manufacturers of textiles and other low-end merchandise. The annual trade fair in Guangzhou, a city at the vanguard of China's march toward capitalism over the past two decades, was overcrowded as usual last October with prospective foreign buyers of toys, clothing, shoes and handbags. But there was a difference, say businessmen who attended. "A lot of purchasers came to negotiate, but they didn't want to pay the higher prices," says Zhen Dahui, an executive for an umbrella-and-handbag manufacturer in China's Fujian province, complaining that his firm did fewer deals than usual.
EUROPE'S OVERDUE REVIVAL
Thailand's latest crisis was partly the result of a 16% increase in the value of the baht against the dollar during the first 11 months of 2006. But the euro and the pound sterling have also strengthened, with the E.U. currency rising by about 10% in the past year alone. A stronger currency makes European exports more expensive for foreign buyers. But that didn't prevent Germany from notching up a $200 billion trade surplus in the first 11 months of last year, the largest since the fall of the Berlin Wall. The good news is that buoyant exports have boosted business confidence in Europe's biggest economy and led to an unexpectedly strong increase in domestic demand. German companies appear to be hiring again: in December, the number of jobless fell by 100,000, the best monthly improvement in years, although the overall unemployment number remains a very high 9.6% of the workforce.
There are still big questions about how sustainable Germany's upturn is, and whether it will be able to pull the rest of Europe with it. Growth in the 13 nations that have adopted the euro is expected to be 2.6% in 2006, an unusually strong showing for the continent. The European recovery is uneven, though, with Italy and France faring less well. And Germany has only begun to tackle some of the politically unpopular reforms of its health, pension and labor systems that economists say are needed to boost long-term growth. Still, "Europe is going to have a great year," reckons Harvard's Rogoff.
Nicola Leibinger-Kammüller, the chief executive of machine-tool firm Trumpf, certainly hopes so. The euro's current exchange rate of about $1.30 is painful "but not existential," she says, as the firm has used currency transactions to hedge against the risk of a weaker dollar. Trumpf's strong sales growth is in large part the fruit of geographical diversification by the company: it established a subsidiary in the U.S. way back in 1969 and opened an office in Japan eight years later. It's currently investing in facilities in the Czech Republic, Mexico and South Korea. "Our main competition used to be in the U.S., but it has disappeared there and now it's Japan," Leibinger-Kammüller says. Still, Trumpf uses its U.S. manufacturing operations as a springboard not just to the American market but also to Asia, where it exports part of its U.S. production. "Russia is going well, so are OPEC countries," she says. "But we also believe in the American economy." While the world tries to figure out just how critical the U.S. is to future growth, the strategy of keeping many eggs in a lot of different baskets may turn out to be very shrewd.
- Peter Gumbel