I spent most of this week visiting audiences in Seoul, South Korea. My esteemed colleague and former central banker Mr. Byun arranged a series of terrific meetings. It was a great example of the trans-Pacific partnership we enjoy within Northern Trust.
Some of our conversations were conducted over wonderful Korean meals. The content and sequence of courses at the Korean table are designed to please the eyes, the palate and the system. Centuries of culinary tradition have informed the preparation of dishes and their position on the menu. Everything is in beautiful balance.
It will be critical to keep this theme of balance in mind as discussions aimed at a more- formal Trans-Pacific Partnership (TPP) proceed. Imports and exports are critical to the countries involved, but aspirations to expand them must be balanced with domestic considerations. And recent developments in China, which is not presently party to the TPP, may complicate efforts to expand free trade.
The tide over the past 30 years has definitely been in the direction of trade liberalization. Changes in economic philosophy and the completion of key accords like the North American Free Trade Agreement (NAFTA) have contributed to a huge expansion in the value of international goods shipments.
The expansion of merchandise flows has brought more choices and lower prices to consumers around the world. However, it has also created some industrial shifts and unemployment that make the topic of trade a sensitive one wherever and whenever it is discussed. Countries are unwilling to expose themselves to the potential loss of production if they are not entirely confident that others will play the game fairly.
There remains a great deal of protectionism around the world. Tariffs, quotas, regulations and subsidies to domestic producers are only a few of the many tools used for this purpose. The right-hand chart above shows a measure of trade restriction and illustrates that while some nations are more open, others are less so.
Global discussions aimed at bringing down more of these barriers have not made much progress. The World Trade Organizations (WTO) Doha Round began in 2001 but has not advanced as its sponsors hoped. Participants continue to seek special treatment for certain industries (agriculture is a favorite) and to protect state-owned enterprises from compliance.
In an effort to make the problem somewhat more manageable, the TPP was founded by a small set of countries that the United States joined in 2008. With Japans entry last year, the roster of nations in TPP discussions now numbers a dozen. The group was making some headway until about a year ago, when the pace slowed. The recent failure of U.S. President Barack Obama to secure approval from Congress for fast-track trade approval is the latest in a string of political disappointments for TPP advocates around the world.
China is notable by its absence from the discussions, both because of its huge role in global trade and because of its poor standing on trade restrictiveness. That posture is unlikely to improve, given the recent slowing in Chinese economic activity. One can expect China will be especially careful to protect its exporters and shelter domestic producers.
Any drop in Chinese growth or rise in Chinese protection would hinder the fortunes of countries and companies that sell into that market. The Western perspective on China is often limited to the wave of exports that comes from that part of the world. But what often goes unnoticed is the volume of exports that travel in the opposite direction.
U.S. exports to China now compose 7% of all exports, up from just 2% in 2000. This rise has helped to compensate for a shrinking share heading to Japan. And many emerging markets have extensive supply relationships with China.
As we discussed last week, some emerging markets have been under pressure since last spring. Softer sales to a key client will not help their efforts to restore growth and investor confidence.
The popularity of free trade is very cyclical. When times are good, the benefits of international exchange are stressed, and any dislocation of firms or workers seems manageable. When times are bad, countries often turn inward as they seek to address domestic concerns and the politics surrounding them. At present, the timing is not favorable to accords like the TPP.
Seoul is surrounded by a beautiful series of mountains. Unfortunately, the view of these peaks was obscured somewhat by a bit of smog that blew over from factories in China. The trade outlook for the region and the world is similarly clouded by what is going on in Asias big markets. We wont be able to see the peaks again until the air clears.
Can Chinas Defaults Be Contained?
Some say that learning to fail is essential to success. China may be about to find out if that is true, in a financial sense. Earlier this month, a Chinese manufacturer of solar panels became the first to default on publicly traded debt. While not terribly large (CNY1 billion, or $160 million U.S. dollars), this occurrence brings in to focus questions about the fault lines in Chinas financial sector. Is this the beginning of a worrisome contagion or simply a gentle warning to investors about risks to reconsider?
The Chinese authorities have the wherewithal to step in and manage problems that might create a serious meltdown. But the focus is on change, and the emphasis is on market reform and fostering the development of a healthy financial sector with reduced implicit guarantees of investments. An occasional failure helps place risk in perspective and can make finance healthier in the long term.
Unfortunately, this first corporate bond default may be seen as just the beginning. There are other Chinese firms experiencing the stress of tighter credit and reduced growth.
Wealth management products (WMPs) are part of the financial sector that stand to be affected. Earlier in the year, a China Credit Trust WMP experienced a near-default situation, not the first such occurrence. Reportedly, a large number of WMPs mature in 2014 and will seek refinancing. The extent of protection that will be forthcoming in this sector remains unknown.
At present, the Peoples Bank of China is proceeding cautiously. Selected curbs on credit were implemented, but the renminbi was allowed to depreciate as compensation. Optimists expect Chinese authorities to navigate successfully through the adjustment process of implementing market reforms. The less-optimistic would argue that investors will become wary as implicit guarantees look less certain and de-risk their portfolios.
If the current trickle of defaults becomes a flood, the challenge to Chinese policy-makers could be significant. They would have to make the delicate decision other nations faced in 2008: teach a lesson about moral hazard or provide support to avoid a crisis.
Premier Li Keqiang announced a 7.5% growth target during the recent National Peoples Congress, but he sounded nervous about its realization. The trillion-dollar question is if China can infuse market discipline and balance economic growth at the same time.
Eurozone Growth Outlook Details Cast Doubt on Sanguine Forecasts
Real gross domestic product (GDP) in the eurozone advanced very slowly during the final quarters of 2013. In spite of this, the European Central Bank (ECB) is predicting 1.2% growth this year followed by a 1.5% increase in 2015. Yet a look at growth trends in the components of GDP before and after the financial crisis suggests that these forecasts may prove optimistic.
Growth of consumer spending averaged 0.5% in the last three quarters of 2013, which is roughly a third of the pace (+1.7%) seen during 20032007. An elevated unemployment rate of 12%, with joblessness ranging from around 25% in Spain to about 5% in Germany, is not supportive of robust consumer spending in the quarters ahead.
Investment spending grew on a quarterly basis in the last three quarters of 2013, but the year-to-year change remains noticeably weak. By contrast, investment outlays advanced upward of 3.5% during 20032007. Ample spare capacity in the region bodes poorly for a rapid turnaround in investment projects.
Credit intermediation takes place largely through the banking sector in the eurozone. At present, bankers are immersed in the ECBs asset quality review. In this environment, underwriting new loans is not at the top of their to-do list. Bank lending to non-financial corporations declined in each of the 19 months ended January; the good news is that the pace of contraction has slowed.
Government spending is largely mothballed to meet deficit and debt targets. In other words, fiscal consolidation implies that government spending is unlikely to boost economic activity.
Roughly 40% of eurozone trade is outside the European Union (EU). Of non-EU trading partners, the United States, China and Russia are three of the largest four export destinations. The latest developments in Russia and signs of soft economic growth in China imply that growth in exports to these areas could be subdued. And the strength of the euro, mentioned by ECB President Mario Draghi in a speech this week, could trim export growth.
For all these reasons, there is a strong possibility that activity in the eurozone will be softer than expected. Marginally higher inflation during January compared with the gain in December, plus improvements in the purchasing managers survey and retail sales, influenced the ECBs March decision to leave the current monetary policy stance unchanged.
But risks still seem to be largely on the downside, and the ECB might be moved to take out an insurance policy against such an outcome. It will be hard to stand still if growth does not move ahead.