TOKYO – Japan just added Yoshihide Suga’s scalp to the bill for a fast-worsening economy.
Dramatic as Prime Minister Suga’s September 3 resignation was, similar shockwaves are being felt around the globe. Japan’s export-led economy is as good a weathervane as any for the Covid-19 headwinds bearing down on the global recovery.
The Delta variant is steadily undoing hopes that “V-shaped” recoveries would rev up factories, offices and schools and restore business and household confidence. Where we are now is as good as it is going to get for the global economy in the last four months of 2021 and the start of 2022.
The abrupt slowdown in US employment growth in August – adding 235,000 jobs, well south of the expected 720,000 – is far more troubling than Japan’s data misses. So are the signs emanating from China, where manufacturing has been stalling.
China’s V-shaped recovery hopes aren’t going quietly. Exports unexpectedly jumped 25.6% in US dollar terms in August from a year earlier, to a record $294.3 billion. Imports rose more than 33%, leaving the mainland with a trade surplus of $58.3 billion.
However, the balance of other data and global trends suggest less robust conditions ahead.
In August, factory output slowed, putting China on the precipice of contraction. Asia’s biggest economy is sustaining blows from fresh Covid waves, higher raw material prices and increasing uncertainty about 2022.
China’s non-manufacturing purchasing managers index fell to 47.5, below the 50-level denoting expansion.
As analysts at Nomura put it: “The worse-than-expected August PMIs add conviction to our view that the growth slowdown in the second half could be quite notable. We expect Beijing to maintain its policy combination of ‘targeted tightening’ for a few sectors, especially the property sector and high-polluting industries, complemented by ‘universal easing’ for the rest of the economy.”
Julian Evans-Pritchard at Capital Economics adds that “the latest surveys suggest that China’s economy contracted as virus disruptions weighed heavily on services activity. Industry also continued to come off the boil as supply chain bottlenecks worsened and demand softened.”
For those worried about China’s health, Sydney-based Stephen Koukoulas at TD Economics notes “it’s not good” that iron ore prices have fallen toward US$130 per ton. “The slump in iron ore prices will limit the speed of the post-lockdown recovery” in Australia, he says.
As arguably the globe’s biggest leveraged bet on Chinese demand, the downshift there augurs poorly for the global economy heading toward 2022. That has observers reversing bets the People’s Bank of China might “taper” this year.
Odds are now, it will be increasing stimulus instead.
For starters, many figure the PBOC will soon announce additional cuts to the amount of cash banks must hold as reserves to boost growth. In July 2021, the PBOC released about 1 trillion yuan, or $155 billion, in long-term liquidity into the banking system.
The question is how much recent Covid-19 lockdowns depress both global and domestic demand.
Doubling down on decoupling
There also could be bigger tensions to come. Australia, for example, is still demanding that China answer for what happened with Covid-19 in Wuhan, enraging Beijing. Not only hasn’t Prime Minister Scott Morrison backed down to Chinese President Xi Jinping, he may dig in further.
Morrison’s predecessor Malcolm Turnbull says China’s campaign to “make us more compliant” has “completely backfired.” Beijing’s pressure, Turnbull notes, “has demonstrated to China that they can pull all these levers and it doesn’t actually work.”
Economist Luke Patey, author of How China Loses, adds that “it’s hard for people to believe that Australia can withstand China’s economic coercion. But it has. And if a country with 30% of its exports heading to China can manage and mitigate the risk, so can most.”
Will the US try?
Since moving into the White House in January, President Joe Biden has refused to unwind predecessor Donald Trump’s trade war policies – much to Beijing’s surprise.
In a recent Bloomberg interview, Pascal Lamy, the former head of the World Trade Organization, warned China’s tech crackdown adds another “decoupling engine” to the global economy, which could further undermine Chinese growth prospects.
“One interpretation can be that Xi Jinping is moving further into a strategy of increasing control over the economy, behaving as if there was a threat for the system and for the party, even though the indications we have don’t point in the direction of there being a threat,” Lamy says.
“He has his own view that China needs further doses of decoupling from global market capitalism. If you add that to the US stance, we now have two decoupling engines.”
Should growth stumble heading into 2022, there are questions about how much latitude governments will have to support growth.
Monetary easing space is limited. Even before the last 20-plus months of Covid-related easing, borrowing costs in the US, Europe and Japan were already at record lows.
The European Central Bank has limited scope to ease as the region’s own PMI dropped to a six-month low in August. Yet the economic realities hitting the continent are both slamming demand and adding to inflation worries.
In Europe and the UK, says economist Chris Williamson at IHS Markit, “part of the slowdown can be linked to weaker growth of new orders for construction work.”
But supply constraints are making the data hard to analyze for clues about future activity. For example, he says, it’s also the case that suppliers are “either unable to produce enough parts or are facing a lack of shipping capacity to meet logistics demand.”
Governments, meantime, already tossed trillions of dollars of support at cratering economies. Japan alone threw $2.2 trillion of spending at its recession, or about 40% of gross domestic product (GDP).
“Many intangibles feed into whether markets are willing to buy new debt, especially when a bad shock is likely to sharply increase supply,” says economist Robin Brooks at the Institute of International Finance.
Brooks points specifically at a Japan now shopping around for Suga’s replacement.
In Asia’s No 2 economy, he says, “debt-to-GDP has risen from 2012 to 2021, with continued very low interest cost on that debt. This contrasts with many countries that have far lower debt levels, but face high interest rates and difficult access to markets. In the end, debt or interest-based ratios do little to inform this fiscal risk premium that drives market access.”
Demand drying up
For the developing world, 2021 is producing headwinds from both ends.
From one end, there’s slowing demand from the US, China, Europe and Japan. Look no further than Thailand and Vietnam being forced to shutter factories and close down their all-important tourism industries.
From the other, rising inflation has central banks hitting the brakes on liquidity. As Robert Sierra, director of economics at Fitch Ratings, sees it, emerging-market central banks everywhere are responding assertively to upward price pressures.
“Despite this more reassuring picture, central bankers are not taking any chances,” Sierra says. “While they view the current inflation episode as transitory, policymakers are concerned that higher inflation rates could feed through to higher inflation expectations, with the latter at risk of becoming entrenched. Brazil and Russia have raised rates forcefully in recent months.”
Sierra notes that the speed with which the broad direction of emerging-market monetary policy has changed is striking given that many of the factors generating inflation look transitory.
He points to soaring food and energy prices, supply bottlenecks, country-specific one-off factors and base effects that make demand in many economies look healthy.
For Asia, Fitch notes, the shock from the food and energy prices can’t be overstated.
In the region’s developing markets, between 35% and 50% of the total weight is assigned to food and fuel. So a rise in the prices of rice, soybeans and petroleum can have a considerable impact on headline inflation.”
It’s all rather disorienting, Sierra says.
“Underlying drivers of inflation continue to be consistent with steadier rates of inflation in the medium term,” he argues. “Domestic inflation pressures have been uneven with some labor markets tightening as unemployment rates decline, but this is not evident across all countries.
“Wage pressure appears to be low and the pass-through to consumer prices seems limited. Base effects will bring down aggregate emerging-market year-on-year CPI inflation later this year if monthly rates remain stable.”
The resulting “output gaps remain deeply negative” in some emerging markets. One possible outcome is that the Delta variant and the emerging “mu” strain will halt inflation in its tracks.
Alternatively: In the view of former US Treasury Secretary Lawrence Summers, new coronavirus variants could do the opposite and fan inflation.
Summers worries that as Covid infections create a new demand headwind, they will also contribute to supply-chain woes. “I don’t see the Delta as making me feel better about inflation,” he says. “If anything, it’s maybe making me feel a little worse.”
In the months ahead, Summers is sure to have considerable company as the road to 2022 gets bumpier than just about everyone hoped.
The troubles that cost Japan’s Suga his job could be just the tip of the proverbial iceberg.