Thrifty resilience

It is a common belief that as the US economy moves, so moves the world. Students are taught that US interest rates drive world rates and pundits confidently assure viewers that worldwide financial markets follow those of their American counterparts.

This was a happy assumption while US growth remained strong. But with the future of the US domestic economy looking ever shakier, analysts are nervously revisiting the question of how much a US slowdown would affect worldwide markets.

With 20% of global GDP resting upon US consumption, according to World Bank and US Department of Labor statistics, the outlook may appear grim.

China, with its huge export sector and critical trade relationship with the US, seems unlikely to escape the effects of a slowdown on the other side of the Pacific Ocean. On the other hand, it may be uniquely suited to weather a retrenchment in US consumer demand.

It is widely accepted that the US domestic economy has been kept aloft in recent years by rising real estate prices.

Consumer spending, which accounts for 70% of GDP, has remained strong in the face of stagnant real wages because consumers borrowed against the rising value of their homes. This equity-financed spending has been responsible for as much as 40% of recent GDP growth, according to Bloomberg analysts.

"The housing market has really been the only thing keeping the economy afloat over the last five years," commented Thomas Stevens, president of the National Association of Realtors.

"As the housing market slows, it can't help but have some impact on the overall economy."

Asset erosion

The problem for US consumers may become apparent if asset values begin to fall. And, sooner or later, fall they will.

According to data released by the US Census Bureau, house sales in the first six months of 2006 dropped 14% from 2005.

Given the circumstances, a retrenchment of growth rates seems inevitable.

"The construction sector is already in recession. The important question is no longer how bad the slowdown will be, but how much of a consumer knock-on effect we will see," said Jonathon Anderson, chief Asia economist at UBS.

Still, economists are less certain how tight to fasten the hatches.

According to Federal Reserve Board data, housing-derived wealth represents 40% of total household wealth. Assuming real-estate is overvalued by up to a tenth, Oxford Economic Forecasting predicts this could lead to a 4% decline in total household wealth and pull down GDP growth by more than 1% this quarter alone.

"It's the million dollar question," said Thomas Nechyba, chair of economics at Duke University. "If it becomes a major downturn, the impact could be very large, especially given the degree to which the average consumer is leveraged."
This modest decline in domestic growth would yield an equivalent shortfall globally, which could worsen as investor confidence wanes.

Cutting back

A consumer driven downturn would hit exporters especially hard as US consumers finally begin pinching pennies and cutting down on expenditures that have kept worldwide manufacturers in the black for the last decade.

Traditionally, this has meant cutting down on foreign imports, which tend to represent the more expensive cross-section of products available, in favor of cheaper made-at-home alternatives.

As evidence, share prices of some major European exporters have already declined on the face of this potential slowdown.

Data released by Beijing indicates that China's current account surplus of US$160.8 billion (in October) represents more than 7% of GDP. Since the US accounts for 21% of China's total exports, the overall health of the PRC's economy would, at first glance, appear to be tightly tied to the vagaries of American consumers and their spending.

However, Chinese exports are mostly low-price, durable consumer goods not likely to be substituted in the event of delayed consumption.

As Han Meng, of the Chinese Academy of Social Sciences, told state media: "The impact [of the US housing slump] on Chinese export growth would be insignificant at least in the short and medium term."

This view is echoed by Nicholas Lardy, senior fellow at the Institute for International Economics: "The net effect on China should be relatively small. The only effect we expect to see is in manufacturing employment, which should be very modest."

China has risen to the number three spot in global export rankings primarily by virtue of its cheap goods. A Morgan Stanley study found Chinese goods have saved US consumers a total of US$600 billion over the last 10 years.

It is by virtue of these cheap goods that China is likely to buck the trend that once would have seen the more frugal consumers in the US substitute foreign products with cheap homemade ones in the face of a period of belt-tightening.

With a premium now paid for homegrown goods, should the US economy slow, its consumers are likely to turn convention on its head and substitute even more US-made products with cheaper alternatives from abroad.

In the new world order, China may have little to fear, and perhaps something to gain, from a slump across the pond.