Recoupling

  Andrew asks me to say something about “decoupling.”  (I am going to resist the temptation to embed an image of an infamous Economist cover.)  The idea was that the U.S. was now a smaller part of the world economy than before, and thus U.S. trouble was unlikely to spread.  Why, he asks, did it turn out to be wrong?

My temptation is to take issue with the premise.  Was the world ever really coupled?  The research on business cycles is mixed, but the upshot appears to be that business cycles were never all that synchronized.    Even when limited to the big economies, there isn't much sign of coupling.  The implication is that although economic troubles do seem to spreading worldwide, they could have spread a lot further and a lot faster. 

You can also take issue with the premise from the other side.  Could it be that emerging markets are holding up well given the scale of the troubles?  After all, Brazil (and elsewhere in Latin America) are certainly coping a lot better than they would have a decade ago; even Mexico is experiencing a slowdown rather than a collapse.  (And you don't get more coupled than Mexico, do you?)  It used to be that when the U.S. sneezed, Latin America caught cold; now Latin America seems to just start sneezing as well.  That's some sort of decoupling.  The same could be said for China and India:  hit but not clobbered.

Finally, there is a third way to take issue with the premise:  “decoupling” was always a hypothesis, and never an accepted part of the conventional wisdom.  That's why the March 2008 Economist article on the subject has the phrase “even if it is the source of a great deal of controversy” in its second sentence.

But I quibble. The decoupling optimists were wrong. Basically, they missed three things.

1. World business cycles have always been more correlated than the underlying trade linkages would suggest. 
2. Lots of financial institutions overseas had exposure to the U.S. market.  There was this bizarre (but explicable) flow of capital from the poor world to the great United States over the past decade.  The good part was a build up of reserve cushions.  The bad part ... well.
3. Lots of financial institutions started borrowing in currencies with low interest rates and lending in currencies with high interest rates.  Whoops.

A fourth may be added soon:  the drying up of trade credit leading to far bigger falls in trade than anyone would have expected. 

Thoughts?

Comments

[Will Baird]

How accurate is Edward Hugh's posting on the world's economies? If you need to email this and blow away this comment, by all means. I'm curious.

[Noel Maurer]

I think that Ed Hugh is very smart and very accurate. That's not to say that I always agree with his interpretations; it is to say that he's a go-to source of info and I have been known to change my opinions after reading his argument.

I have only two general criticisms of his stuff. The minor one is that I'm still not convinced that demography is as important as he claims. That debate, however, has dropped off into second-order as the financial crisis has grown.

My major criticism is that his writing style is, for me, a little difficult to follow. I have to work harder to understand his arguments than I like. This may be because I am lazy, but there is so much good stuff in his posts that I wish he could take the time to write shorter and more cleanly. Nevertheless, since I don't think he makes money off his blog posts, I can't fault him for not putting in more than the incredible amount of effort that he already puts in.

In short, I go to Edward for information and analysis all the time, but I usually need to read him several times to be sure that I understand what he's arguing.

[Noel Maurer]

BTW, I agree with Edward's prognosis that China is likely to be hit far more stronger than current economic models predict.