International Markets

The world economy is in trouble again. Following the sharp rebound from the 2009 global recession, economic headwinds have increased markedly since the second quarter of 2011. Although Japan’s supply chains are recovering at a speedy pace, the slower-than-expected recovery in the US and, more worryingly, the deepening of the sovereign debt crisis in Europe, are major causes for concern. Facing a double whammy, the world is braced for a renewed downturn in the year ahead, and past experience may provide clues as to the likely impact of the current crisis on our exports.

A brief history of financial and economic crises

The world has witnessed multiple financial and economic crises in its history. The causes of these crises are wide-ranging, including government policy errors, supply shocks, especially oil shocks, as well as malfunctions of the financial sector. Such crises could occur anywhere, yet those that happen in developed economies have greater impact. In particular, US crises have knock-on effects on a worldwide scale, given the country’s entrenched position in the world economy.

In the wake of the Great Depression of 1929, there have been a total of 13 recessions in the US. Prior to the most recent one starting from late 2007, the deepest recessions were those of 1973-75 and 1981-82, both stemming from oil crises and lasting for 16 months. Yet financial crises tend to be a much more serious and virulent cause of recession. Notable examples include the Great Depression, as well as the latest recession, which continues to impart substantial after-effects on the global economy.

US recessions since Great Depression

Source: National Bureau of Economic Research

How similar is the latest episode to the Great Depression?

The latest US recession has been the most severe since the Great Depression. Having a duration of 18 months, this recession began in December 2007 and ended in June 2009. The underlying cause of the recession was the subprime mortgage crisis, which led to the collapse of the US housing bubble, and falling housing-related assets in turn triggered the financial tsunami. As a result, a great number of countries fell into recession, with world GDP shrinking 0.7% in 2009, the deepest downturn in 80 years. Although the global economy has recovered since then, the aftermath of the financial tsunami has remained unabated.

However, the Great Depression has remained as the longest and deepest downturn in the history of the US and many other nations, lasting for 43 months from August 1929 until March 1933. The Great Depression originated from a US recession accompanied by the stock market crash in October 1929. The US downturn exerted contagious effects on a global scale, exacerbated by US trade protectionism that ultimately led to a full-fledged trade war. The decline in world and US GDPs during the Great Depression far exceeded the contraction of the latest recession.

US economic performance:Great Depression vs lastest recession

Source: Bureau of Economic Analysis

In both crises, fast credit expansion and new financial instruments brought about high leverage and increased susceptibilities to shocks, and malaises in the US financial sector spilled over to the real economy as well as other countries at a rapid pace. Yet there have been major differences. For one, government policy support was almost absent in the Great Depression, whereas US protectionism contributed to a global trade war, in contrast to unprecedented policy support and no pervasive resort to trade restrictions in the latest episode.

Meanwhile, although the US has been the epicentre of both crises, its economic weight has fallen notably. For now, developing countries, such as China and India, have assumed a more important role in the global economy. While developing economies could not spare themselves from the downturn induced by developed economies, they have been well poised to weather the adverse impacts due to their sound fundamentals, thus providing a buffer against the latest recession and any renewed crises. So even if the economic difficulties have increased after the global rebound in 2010, the chance of a renewed downturn similar to the Great Depression is still remote.

Source: The World Bank

Is a repeat of Japan’s Lost Decades likely in the US and Europe?

While another Great Depression is unlikely, the lingering effects of financial tsunami on the global economy have been devastating, with the US still working hard to stimulate the economy and the EU struggling to fix the debt problems. Some may therefore visualise a repeat of Japan’s Lost Decades in the US and Europe. From the early 1990s till now, Japan has suffered from an extended period of economic stagnation and price deflation amid the burst of its equity and property bubbles in 1989. In the 1980s, Japan’s economic performance was the envy of the world.

The Japanese economy since 1980

Source: International Monetary Fund, World Economic Outlook Database, September 2011

In some ways, the parallels between Japan’s Lost Decades and the financial tsunami triggered by the US have been conspicuous. Both property bubbles were fuelled by easy credit and new financial products. There has been a striking dissimilarity, however. While the US (as well as other countries) was prompt in making policy responses to contain the crisis, Japan was tardy in taking remedial action. It waited for over a year before cutting interest rates. By the time the government injected huge funds to revive growth in the late 1990s, the Japanese economy was already in a prolonged slump scarred with ingrained deflation.

If anything, the crux of the current downturn is arguably an erosion of confidence. Yet developments are only mediocre. In the US, continued monetary easing should help avoid deflation and restore confidence there. In the EU, the coordinated efforts enlisted by eurozone members to resolve the debt crisis, which entail an expansion of the European Financial Stability Facility (EFSF), are expected to bring some relief, although the region, especially the heavily indebted member states, will remain in difficult conditions.

Complicated times ahead in 2012

That said, the global economy is only expected to see halting growth in 2012 against a backdrop of great uncertainty. In particular, developed economies will stay in the slower lane. Although Japan’s supply chains have been recovering at a rapid pace, the slower-than-expected recovery in the US and, more worryingly, the spectre of EU sovereign debt crisis, are major causes for concern. Even with the prevailing efforts to stem the crisis, there is still a lack of actions to stimulate growth. Fiscal austerity, however, will be ubiquitous in Europe. As such, consumption and hence import demand in most traditional markets will be subdued.

Given their solid economic fundamentals, emerging economies should have a reasonably good chance to weather the current crisis with moderate slowdown. Of interest to Hong Kong exporters, there exists abundant business opportunities in a number of markets. Holding particular potential are the Asian countries with a huge domestic market like India, Indonesia and especially the Chinese mainland. Also of attraction are the commodity-exporting nations, such as Russia, Brazil and some Middle East countries, which are slated to benefit from sustained commodity prices.

Gold and WTI crude oil at spot

Source: The Pacific Exchange Rate Service, University of British Columbia; US Energy Information Administration

Prices of crude oil as well as other commodities like metals and precious materials, though slackening from the highs stemming from the outbreak of political unrest in the Middle East and North Africa (MENA), have remained firm. Sustained oil and other commodity prices could presage better market prospects for commodity-exporting nations.

On the other hand, Hong Kong firms will be confronted with great challenges arising from higher wages in China, as the 12th Five-Year Plan strives to tackle the structural problems that constrain domestic consumption. Separately, a strong RMB against the US dollar, in view of mounting pressure in the run-up to the US presidential election, will translate into even heavier production costs, while some firms may also face persistent borrowing costs amid the uncertain external environment. But most Hong Kong companies are not able to fully transfer these increased costs to their customers for fear of losing business.

Changes in labour costs on the mainland

Note: Percentages denote the proportions of surveyed companies
Source: HKTDC Export Index Survey

Leaner and meaner businesses for Hong Kong exporters

To some extent, the upward price pressure on Hong Kong exports is expected to persist in 2012. While consumer frugality in overseas markets will translate into downward price pressure on Hong Kong exports, the juxtaposition of skyrocketing labour costs on the Chinese mainland, an unremitting revaluation of the RMB, in tandem with still-high prices of crude oil and certain other commodities, will exert even sturdier upward pressure on input costs. As a result, the unit values of Hong Kong exports should continue to rise, although such increases will unlikely be able to offset the escalated input costs in their totality, thus eroding the profit margins of exporters.

Growth forecast for Hong Kong exports

Source: Hong Kong Trade Development Council

Despite higher unit values, Hong Kong exports are barely expected to show marginal growth next year. A renewed downturn in the global economy, alongside the attendant sluggishness in overseas demand, will certainly depress the expansion of Hong Kong exports. Our forecast is for Hong Kong’s total exports to increase by 1% in value but fall by 3% in volume. While re-exports, which account for the bulk of Hong Kong’s exports, are also expected to grow by 1% in value yet drop by 3% in volume, domestic exports are likely to contract by 15% in nominal terms and 19% in real terms.