The New Normal and Global Flattening

Much has been written about the ‘new normal’ as the long, grinding and stubbornly acyclical expansions which have characterised the US, the UK and to an extent Europe in the aftermath of the implosion of Western financial institutions. For Asia, the acyclicality of the West’s post-crisis expansion, at a time when central banks have deployed extraordinary policies in attempts to spark a recognizable business cycle into life, has resulted only sharp volatility of capital flows. During the initial period of near-zero Western interest rates, the result was a flood of capital into Asian economies which bore no relation to underlying trade flows. But since the recovery of the dollar in mid-2014, this flood abruptly reversed, with the outflows again fundamentally divorced from any underlying trade dynamic.

The new and seemingly purposeless volatility of capital flows, unrelated to savings imbalances either in Western or Asian economies (since the private sectors were almost universally running cashflow and savings surpluses), has distracted attention from a development in trading patterns which, in time, is likely to have a lasting impact.

But since the beginning of this year, a new stage of quasi-stabilization has been emerging, both in terms of capital flows (as shown in the stabilization in Asian fx reserves), and in terms of the reversion roughly to trend growth of both G3 imports and NE Asian exports.

So it is time to start thinking about the likely implications of this new stabilization. I think one of its key characteristics will be a global flattening of pricing opportunities, which will gradually result in the unexpected rediscovery of Western inflationary pressures,  as well as unexpected upward pressures on Asian currencies. (Perhaps this is how the reversal of the great Western bond bull market is finally discovered.) In addition, we ought to expect something of a convergence in rates of growth and return on capital. In fact, the ‘new normal’ may turn out to usher in a great flattening.

A major part of the dynamic powering globalization has been a sharp discovery of regional comparative advantages, in which Asia discovered a its comparative advantage was for low-cost mass manufacture, whilst the West discovered it retained comparative advantage in higher value-added manufacture.  As this discovery was a dynamic and expansive process drawing in ever-larger pools of labour, so the terms of the deal underpinning this aspect of globalization were that although Asia’s (in particular) share of trade in world low-cost manufacture rose inexorably, the growth in volume of exports was offset by a fall in prices.  By contrast, although the West lost volume, it’s ability to price its remaining exports was retained.

This underlying equilibrium generated a familiar divergence in the terms of trade (ie, movements of export prices relative to import prices) between the West and NE Asia. The chart below shows how, typically, whilst terms of trade for the US and Germany have remained roughly stable since 2000, NE Asia’s slid by approximately 40% between 2000 and 2011.  NE Asia’s exporters (including here Japan, S Korea and Taiwan) could win market share, but at the cost of emphatically being unable to price their goods.

However, looking again at the chart, it becomes clear that the long-term sustained fall in NE Asia’s terms of trade relative to those of the US and Germany has stopped - and in fact if we re-base terms of trade to Jan 2010 =100, it turns out that after the final fall in 2011, NE Asia is no longer losing out in terms of trade. Rather, it is at worst holding its own, and arguably, is now raising its terms of trade relative to the West. In global terms, it seems either that NE Asia has finally won or lost the ability to price its goods according to market dynamics in ways which are no longer very different to those of West. Either way, the fundamental pricing dynamic which underpinned the globalization to which we are accustomed no longer applies.