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15 July 2024

Emerging markets can withstand US recession

By David Robertson


Decoupling is not a Mills & Boon euphemism. Nor is it something trains do. Rather, decoupling is a theory that is getting a lot of economists very excited and if it turns out to be true, then the only slowdown inhabitants of the United Arab Emirates will have to suffer in the near future will be on the motorway between Abu Dhabi and Dubai. If, on the other hand, the decoupling theory is hokum then you might want to cancel those plans to buy a new boat because life is about to get rocky.

In essence the argument for decoupling is that “the rest of the world” – ie the world outside North America and Europe – has grown up and can now look after itself.

In past years, a recession in the United States and Europe would have plunged China, Asia and other emerging markets into the same mire. As we head into another rough patch for Western economies, the pundits are attempting to calculate the potential collateral damage to the rest of the world. Will falling demand in the US for Chinese goods cause economic growth in the East to stall? Will a recession in the United States reduce oil consumption and finally knock the wind out of Opec and sustained high prices?

The decoupling camp believe not. They argue emerging markets are no longer solely reliant on selling things, whether it is oil, gas or dangerously constructed plastic toys, to the West. The domestic economies of these countries have grown sufficiently to create an internal demand motor that will cushion any shortfall from falling exports. A US recession may, therefore, knock one percentage point off Chinese growth this year, as some economists predict, but that will still only slow China’s development to a roaring nine or 10 per cent a year.

The decouplers’ view of the oil price in 2008 is underpinned by this same argument. US consumption may decline, political tension in the northern Middle East may ease, however, replacement demand from the growing economies will be sufficient to maintain a base level of $80 or $90 a barrel.

China, for example, is building seven million new cars a year and a new city the size of Dubai appears every couple of months; its energy demands are insatiable. The recent snowstorms in China have only reinforced just how critically short of power the nation is.

With more than a billion people shivering through the Chinese winter, while simultaneously dreaming of trading in their bicycles for cars, the decouplers have a strong case for claiming China will take up any slack created by a hiccup in America’s petrochemical consumption.

The concept of decoupling certainly sounds convincing, but so does any idea we have a vested interest in supporting. But like most economic theories decoupling is both right and wrong at the same time: the US really is less important to the rest of the world but at the same time it continues to underpin the system.

There is no avoiding the fact that US private consumption accounts for 20 per cent of world GDP and it is this debt-financed spending that has kept the American economy out of trouble and the rest of the world booming in recent years. As the air leaks out of the bubble it is inevitable other countries will deflate also.

Similarly, Opec cannot assume the petrochemical boom will continue in the face of a US slowdown just because the Chinese want more cars. The US consumes about a quarter of the world’s oil and, combined with its belligerent foreign policy, the country has effectively underwritten high crude prices for the past five years. As the US turns inward and its economy slows, the impact on oil prices could be dramatic.

Where will this lead the oil price in 2008? Down is a reasonable bet. But not all the way down to single-digit prices per barrel. Decoupling and demand transfer are real and should prevent a catastrophic collapse in oil prices but the US is too influential a consumer for a recession there to not take at least the peak off prices.

The large fuel consumers (airlines, power utilities, etc) I have spoken to expect oil to slip to the low $80s per barrel by the middle of this year and then slip into the $70s or even $60s early next year. That is why none of them are hedging their fuel bills at present – they are waiting for more manageable prices (and praying in some cases).

However, for the UAE, oil at $60 to $80 is hardly a disaster, but it may mean buying a slightly smaller boat this year.