Northeast Asia Exports: China’s New Year Caveats, Japan’s J-Curve in the Wings

Let’s start with a serious caveat: the way Chinese New Year wanders around the calendar makes it dangerous to read too much into China’s economic data during the first two to three months of every year. Trade data, retail data, inflation, money - all are affected - and even after decades of trying, I’m still uncertain how to which numbers will be affected, and in what way.

This year, it ought to be relatively simple: Chinese New Year fell on January 31st,  whilst in 2013 it fell on February 10th.  So generally, we ought to expect January to have had fewer working days this year relative to 2013 and consequently figures for industrial output and exports to be relatively depressed in January before rebounding in February.

But quite possibly it won’t work out like that. The  nearest similar timing would be in 2009 (when Chinese New Year fell on Jan 26th, vs Feb 07 in the previous year): in January 2009, China’s exports were down 0.4SDs from trend in January before collapsing 1.9SDs in February.   But one can counter that with what happened in 2003 (Feb 1st 2003 vs FEb 12th 2002), when January’s exports were 2.3SDs stronger than expected, before giving back 0.8SDs in February.

So perhaps China’s Ministry of Commerce spokesman was telling nothing but the truth, when he was quoted yesterday as warning the 1Q exports will be 'volatile'  and 'we can't rule out the possibility that February’s trade figures will show an abnormal change from last year.'  And ‘we should be clear that [January’s] export surge doesn't necessarily indicate favourable times for Chinese exporters’, even if the outlook for the year as a whole is ‘cautiously optimistic’.

And whilst we’re reading the runes, the willingness to let the Rmb depreciate over the last week is also compatible with nervousness about February’s export numbers.

Nevetheless, January’s export data was strong not just for China, but for Japan and Northeast Asia as a whole in a way which defies the popular belief that Asian economies are slowing, and which essentially has not been recognized. In dollar terms, NE Asia’s exports rose 4.7% yoy in January against 2013’s toughest base of comparison (exports jumped 15.5% yoy in Jan 2013).

In momentum terms, January’s movement was 1.6SDs above historic seasonal trends.  As the chart below shows, this was merely an acceleration of a trend of rising momentum that had been quietly building throughout 4Q13. In fact, on a 6m basis, the underlying momentum in January reached its highest point for three years.  Whilst consensus seems resigned to another year of single-digit  export growth from NE Asia in 2014 (following 2.5% in 2013, 3.1% in 2012), even if the unnoticed outperformance of the last six months dies right now, Northeast Asian exports are likely to grow in the high 'teens in 2014.  I suspect this is not yet on anyone's radar.

Although China inevitably bulks large over this data, since China accounts for nearly 59% of NE Asia’s exports, it is not the only contributor.  In Japan, too (still about 19% of NE Asia exports), January was strong, with exports up 9.5% yoy in yen terms, which beat historic seasonal trends by 0.4SDs. The statistical impact of yen devaluation is beginning to slide out of the data: the yen was down 14.7% yoy against the dollar in Jan vs 19.2% yoy in December. Consequently, the fact that in dollar terms exports fell 6.6% yoy disguised an outperformance vs seasonal trends of 0.6SDs, allowing the 6m momentum trendline to break into substantially positive territory for the first time since May 2012.


The chart below measures 6m changes in export momentum for China, Japan, S Korea and Taiwan, both in local currency terms, and also in volume terms. By January, each economy was showing positive and accelerating momentum, led by China and Japan. 

Finally, there is one other piece of surprising news - Japan’s trade numbers may finally be beginning to benefit from the J-curve impact of the depreciation in the yen. The J-curve’s arrival has been delayed so long we’ve stopped expecting it. And on the face of it, the record Y2.79tr trade deficit in January is just another demonstration of its absence. However, there are two reasons to see beyond that. First, January’s trade balance was principally the victim of a 37.7% yoy collapse in ship exports - the classic ‘lumpy item’ distortion.

Second, the fall of Japan’s share of NE Asia’s exports is now finally slowing. As the chart below shows, the peak of Japan losing market share came in August 2013, when over the previous 12 months it had slipped by 3.2pps to 19.5%. By January, that market share loss had slowed to 2.5pp, with a market share of 18.7%. It's not dramatic – indeed, it still hasn't broken the surface. But it is there: the J-curve is in the wings.

Foreign Investors and the US Taper

The news that in December foreign investors sold a net US$45.88bn of US securities capped a year in which, unprecedentedly, the world repatriated capital from the US.  Although it may not seem immediately obvious, there are circumstances in which this might matter a lot to the US in 2014 and beyond.

The capital outflow came to US$133bn during 2013, and it contrasts with the US$613bn net capital inflow into the US in 2012 – so it's a turnaround in financial behaviour of approximately US$746bn in a single year. What's more, the fact that the US saw a net capital repatriation by its foreign investors is something that has happened only once before in post-Cold War financial history, as the chart shows. Even at the depth of the financial crisis of 2008/09 capital still flowed into the US. Not now.

This seems like a genuinely historic change in behaviour. Changes in financial behaviour tend to be extremely rare – a once in a generation reconsideration of tactics and strategies. If it proves so, it will influence the underlying flows of capital and trade for years and possibly decades to come.

All of which makes it remarkable that it has had no noticeable impact on the US: money supply, bond yields, dollar value, net foreign liability position of the US banking system – none seem to have been challenged by this abrupt reversal of international capital flows. If it is a historic change, it is one which has arrived seemingly without consequence.

The reason, of course, is the link between the Fed's buying (and guidance) and net foreign investment. On the one hand, the Fed has simply been prepared to buy all the bonds foreign investors wanted to sell.  Whilst foreign investors sold US$133bn of securities in 2013, the Fed bought no fewer than US$1.08tr. The chart below shows the way in which Fed buying has tended to offset net foreign buying over the last few years. 

But of course the relationship between the Fed and foreign investors has another strand: like other investors, foreign investors spent much of 2013 anticipating the onset of the Fed’s tapering. Net selling started in February, but then peaked in the 3m to June with US$115bn of net selling, as markets absorbed April’s FOMC news that tapering was probably on its way.  So the Fed’s forward guidance might be said to have both encouraged foreign capital out of US treasury markets at the same time as buying the securities they wanted to sell. 

Even so, such net foreign selling should be expected to erode the positive monetary stimulus of the Fed’s treasuries buying.  And indeed it has: the Fed initiated QE3 in September 2012, and the Fed’s balance sheet shows its holdings of securities rising $51.1bn only in 2012, but $1.0844tr in 2013.  But once you adjust this for the reversal of foreign capital flows, the net buying changes only from US$664bn in 2012 to US$951.2bn in 2013.  As the chart shows, the net effect has been . . . . moderate. 

What matters for now is whether the foreign net outflow of 2013 was purely a trading response to the realization that the taper was on its way, or whether it represents a fundamental shift in global financial behaviour.

If the former, then we can conclude that the exit of foreign capital essentially initiated a de facto tapering some nine months earlier than officially executed. More, it raises the possibility that the visible negative impact of the Fed’s actual tapering this year may itself now be positively offset by a return of foreign capital inflows, or at least a cessation of the outflow.   

Since December, the Fed has announced a cut in its monthly bond buying from the original US$85bn per month to US$65bn. This tightening of US$20bn a month would be halved simply by a cessation of net capital outflows (which averaged US$11bn a month in 2013).

If, by contrast, the willingness to repatriate capital from US securities markets represents a once-in-a-generation re-ordering of financial risks and rewards, then the Fed’s taper could be a gamble which turns out to be unexpectedly painful.

In short, the monthly net long-term capital flows announcements from the US now demand watching closely.

Finally, we need to look at the other side of the transaction:  US$133bn is a sizeable amount of capital repatriation. It would be enough to form a powerful offset to the view that news of Fed tapering has stripped easy capital from emerging markets and helped precipitate a range of currency crises. But alas, the main selling has come not from Asia, but from Europe.  In December, for example, when total net selling came to US$45.9bn, European investors sold US$48.8bn, whilst Asian investors bought a net US$7.1bn, with China’s net US$5.36bn selling offset by net buying from Japan of US$6.73bn.

Turkey - The J-Curve Can't Come Soon Enough

Turkey’s current account deficit to US$8.32bn, the worst since March 2011, tells us that Turkey’s cashflows continued to deteriorate sharply in 4Q, with no sign yet of the sort of turnaround which would justify any relaxation of the pressures on the Lira.  December’s current account deficit featured not only a $2.67bn widening of the trade deficit, but also a $767mn rise in gross international income payments and a $1bn narrowing of the services surplus.

Eventually, of course, we should see the devaluation of the Lira produce a J-curve upswing in trade flows, but for December, exports rose only 4.5% yoy, on a monthly movement which was 1SD below seasonal historic trends, whilst imports rose 16.7% yoy, which was 0.1SDs above historic trends.

In fact, private sector liquidity trends are probably slightly worse than the current account deficit trends suggest, since the total savings/investment balance is actually being improved by 4Q fiscal restraint in Turkey.  In every month in 4Q, the government’s total domestic debt actually fell slightly, in all by L4.939bn, which in theory should have moderated the decline in the current account deficit.  So the Turkey’s private sector savings position was in deficit to the tune of L36.9bn in 4Q, equivalent to an estimated 9.4% of 4Q GDP, and taking the 2013 private sector savings deficit to 6.9% of GDP.  This deficit expanded throughout 2013, and compares to 4.9% in 2012.

The private sector savings deficit is, of course, a key measure of the cashflow position between Turkey’s private sector and its financial system: in this case, we can see that somehow the financial system must either generate enough cashflow to keep the private sector’s activities unchanged – by selling government bonds or by taking on foreign liabilities – or alternatively the private sector’s activities need to change in order to curb its net demand for cash. 

The balance sheet of Turkey's banks shows clearly enough how the private savings deficit has been financed. In the year to Dec, banks' loan books grew 32.9% yoy, or by and amount equivalent to approximately 14.4% of GDP,  but also equivalent to about 170% of estimated nominal GDP growth in 2013. The stock of bank debt at end-2013 was approximately 58.2% of GDP, up from 47.9% at end-2012. December's figures, incidentally, show no sign of any slowdown in lending momentum.   Meanwhile, deposits grew only 21.7% yoy in 2013, so the loan/deposit ratio was pushed up to 103.1% by end-2013.

Turkey's banks financed this in the way one would expect: net foreign liabilities of Turkey's banks grew by US$22bn in 2013, almost doubling to US$5.58bn.   At the same time, the amount of securities held for sale fell 1.4% yoy, and their total securities book grew only 3.4% yoy. 

With Turkey’s central bank raising its overnight lending rate to 12% from 7.75% at the end of January, it is now clear that the private sector’s economic and financial behaviour is expected to make the adjustment. The fact that it has a net cashflow deficit of approximately 6.9% of GDP tells us this will be painful. So that J-curve improvement in trade and current account balances cannot come soon enough. 

But there is a kicker which the rest of Europe is likely to feel. With Turkey's banks willing to fund private sector savings & cashflow deficits, it is no surprise that investment spending continued to surge throughout 2013, with national accounts showing capital formation spending rising 9.6% yoy during the first nine months of  2013. By my estimate (formed by depreciating all gross fixed capital formation over 10yrs), Turkey's capital stock is currently growing around 11.7%. Topline growth has not kept up with this pace, so asset turns, and probably return on capital,  have declined uninterruptedly since mid-2011. 

But what happens now is precisely that this capital spending will stop, and Turkey's industries will raise asset turns and cashflow precisely by satisfying export demand, at no matter what price. The rest of Europe must expect that as Turkey seeks to deploy that capital stock more intensely, its industries will be eating someone else's lunch – almost certainly those of its near neighbours in the Eurozone.