The ship won’t sink

The noises coming from Samson Holdings in December betrayed a degree of nervousness.

“Yes, the company is concerned and the board is busy looking for ways to avoid the difficulty,” a spokesman said. And would it be possible to speak to Samuel Kuo, Samson’s chairman and founder, about his strategy? “No. Mr Kuo will not take any interviews until the company has found a solution.”

Samson, which is based in the southern Chinese city of Dongguan, has become one of Asia’s most successful residential furniture manufacturers over the last 20 years. It has carved out a strong niche for itself in the US and relies on this market for 95% of its revenue.

Now, on top of rising production costs and taxes at home, Samson is feeling the pain as its top customer cuts back.

“The overall US furniture industry has been getting weak since the second half of 2006 because of the weak housing market, [the] subprime mortgage problem [and] increase[s] in oil price[s] and operating costs,” the Hong Kong-listed company said in its 2007 interim report. “The overall US furniture industry is tough and [we are] not expecting any significant improvement.”

In the first half of 2007, net profits fell 45% year-on-year to US$29.7 million.

Uncertain times

Samson’s dependency on US demand is far greater than that of the average Chinese firm. But this hasn’t held back fears among exporters of a potential downturn in the US economy in 2008.

Speaking at the World Knowledge Forum in Seoul in late October, Stephen Roach, Asia chairman at investment bank Morgan Stanley, painted a gloomy picture of US and Asian prospects. Roach warned that, with property market showing signs of weakness, Americans could no longer prolong their seven-year consumption binge by borrowing against the value of their homes.

“If the US consumer goes, there is no one on the demand side who can fill the void,” he said. “If the US consumer goes down, Asia will feel it.”

Not everyone shares Roach’s pessimism. Dr Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics (IIE) in Washington, notes that US third-quarter growth was revised upwards, employment growth is strong and residential housing accounts for just 5% of GDP growth.

However, the credit tightening that has come in the wake of the subprime crisis – which saw banks write off billions in mortgage-backed bonds after low-end mortgage holders defaulted on their payments in response to higher interest rates – is more of a concern.

“The total amount of credit outstanding in bank loans and commercial paper has fallen 10% since the subprime problems started – an almost unprecedented decline for such a short period of time,” said Lardy. “I would say that a US slowdown is quite likely but whether or not there is a recession is less certain.”

So what does this mean for China? Widely touted as the factory to the world, the country saw its exports grow 27.2% year-on-year in 2006 to US$968.9 billion. The US absorbs about 20% of these exports although orders are already dwindling and, as a result, Europe has overtaken America as the single largest destination of Chinese-made goods. This increasingly diversified demand base – the Asian share of Chinese exports is also rising – could insulate Beijing provided economic troubles hit the US alone.

“If you tell me that the problems in the US will be so severe that we get a slowdown in European growth as well then I would expect China’s export growth to falter,” said Tim Condon,  head of Asia financial markets research for Dutch financial conglomerate ING. “More of the same in 2008 is not a worry.”

Even if the slowdown is worse than expected, history shows that the Chinese economy is reasonably resilient to export shocks. For example, the global dot com downturn of 2001 saw Chinese export growth fall to 6.8% from 27.8% the previous year, yet GDP growth only took a mild hit, falling one percentage point to 8.3%. By comparison, the likes of Malaysia, Taiwan, Hong Kong and Singapore went into recession as their economies declined between 8% and 12%.

The reason for this, according to Jonathan Anderson, chief Asia economist at investment bank UBS, is Hong Kong and Singapore are highly dependent on export-led growth while China is not. The export share of the country’s production-side GDP is only about 10% to the 30%-plus seen in Hong Kong and Singapore. China’s export sector isn’t insignificant, it just isn’t big as a proportion of the economy as a whole. As a result, the country is better positioned than its Asian neighbors to withstand a slowdown in the US.

“When a heavyweight boxer throws a punch, if another heavyweight boxer is on the receiving end then he can take it,” said Anderson. “A featherweight boxer would get knocked out.”

Adding value

At the same time, though, a large chunk of China’s economic growth of the last two years has come on the back of rocketing exports. The country’s trade surplus is likely to pass US$250 billion in 2007, up from US$32.1 billion in 2004. UBS says exports accounted for around 2.5% of the 11.5% growth in GDP seen during the first three quarters of 2007.

Yet this rise has as much to do with China’s export-oriented neighbors as with China itself. The country serves as a final assembly point for a large number of goods produced in Asia. These goods are becoming increasingly high-end. JPMorgan found that mechanical and electrical products accounted for 59.3% of Chinese export growth between January 2006 and October 2007. Textile-related products came in a 14.1%.

Goods such as electronics have a high foreign value-added element: When a Chinese-made computer is sold in the US, the lion’s share of the revenue goes to the Taiwan company that made the components. If the value added in China is 15%, for every US$1 fall in exports to the US, China loses US$0.15 while the Taiwan company loses US$0.85.

“A fall in exports would hurt the component maker more than the assembler,” said Anderson.

This interpretation of the Asian manufacturing model also sheds new light on the idea that the region is decoupling from the US – and so better positioned to withstand a slowdown in America.

“People look at the Asia export numbers, see the US share falling and the Chinese share growing and say that Asia is less dependent on the US and more dependent on China,” said Qu Hongbin, chief China economist at HSBC.

“But this is simply a reflection of the shift in manufacturing. Of China’s imports from other Asian countries, 60% are intermediate goods which are used as the inputs for assembly and processing.”