Sunday, March 29, 2009
Export giants sink most as world trade slumps
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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Imagine, for a moment, you are in Germany. Some readers may already be there. You are in an economy that is still the world's biggest exporter, just beating off the challenge from China.

Manufacturing is regarded as the mainstay of the economy, as is the Mittelstand of medium-sized firms that are its backbone. While the rest of the world was enjoying a housing boom, Germany kept its feet on the ground.

German consumers kept their credit cards firmly in their wallets while most German banks avoided the over-exuberant follies of their international rivals. While the world enjoyed a champagne lifestyle, Germany stuck to Liebfraumilch.

The galling thing for Germany, however, is that this self-restraint did not spare its economy from a savage downturn. Official figures show Germany suffered the biggest decline of any European economy apart from Lithuania and Ireland in the final quarter of last year, shrinking by 2.1%.

This has given rise to some alarming predictions. Commerzbank, one of the country's leading banks, predicts a drop in gross domestic product (GDP) of as much as 7% this year and a rise in unemployment to 5m. Other forecasters are not so gloomy but see a GDP drop of 5% or more. Commerzbank also predicts a 7% drop in Japan's GDP.

The reason, of course, is that Germany is exposed to what is turning into an alarming plunge in world trade. So too is Japan, which reported last week that exports in February were no less than 49% down on a year earlier, with sales to America 58% lower. The export-led economies are discovering that what began as a banking crisis has quickly turned into the biggest reversal in world trade in living memory.

The World Trade Organisation (WTO) predicts that global trade, having grown strongly in recent years, will contract by 9% this year. This is easily the worst barring wartime disruptions since the big economies, led by America's abandoning of free trade, were erecting trade barriers in the Great Depression.

Indeed, the way things have been going, even a 9% world-trade decline may turn out to be over-optimistic. The crusties who will protest at this week's G20 meeting in London will, if they are articulating anything, be railing against globalisation. Given what is happening there should be a counter demonstration against the "de-globalisation" that is occurring.

Until September, more than a year into the credit crisis, most countries still faced the prospect of mild "technical" recessions. But the most deadly phase of the banking crisis, brought about by the collapse of Lehman Brothers, changed all that.

Normally there is a lag between financial-market developments and real-economy effects. This time the reaction was almost immediate. The global economy "fell off a cliff" in the fourth quarter, with GDP declines of 1.5% in the eurozone, 1.6% in Britain, 6.3% annualised in America, 2.1% in Germany, 3.2% in Japan. Even China's GDP was flat and the Asian tigers went from good growth to recession at the drop of a hat. American employment has fallen by nearly 2m in the space of three months.

Trade has been the transmission mechanism from the financial crisis to the world's factories. Pascal Lamy, the WTO's director-general, in a letter to the organisation's 153 member governments, estimates that world trade dropped by 5% in November last year, by a further 7% in December and by another 7% in January. There is no sign yet of the slide stabilising.

Why have the banking system's woes hit trade so hard and so quickly? There are four reasons. The global recession is more severe than most thought possible. In January the International Monetary Fund was apparently at its gloomiest, predicting just 0.5% global economic growth this year. Now it expects a contraction of between 0.5% and 1%.

This global recession, moreover, is unusually synchronised, certainly for advanced economies, which are all turning down together.

Second, according to the WTO, global supply chains mean that a downturn quickly spreads. Just as financial globalisation meant problems in one centre quickly led to others, so the trade interdependence of economies has rapidly transmitted the recession around the globe.

Third, and directly related to the financial crisis, trade finance has dried up. Firms have found it difficult to get export credits, without which they cannot do business.

Fourth, the global recession is breeding protectionism. Lamy identifies several types. "A pattern is beginning to emerge of increases in import licensing, import tariffs and surcharges and trade remedies to support industries that have faced difficulties," he writes. Most G20 members are doing it. Taxpayer support of troubled banks is leading to financial protectionism.

The G20 will meet in London's Docklands, an area where the cranes are now museum pieces but which owes its existence to free trade. It goes without saying that leaders of countries representing 85% of the world economy should make a firm stand against protectionism, and mean it.

Such is the collapse in global trade, however, that even rejecting protectionism is not enough. Completing the Doha trade round will help but so too will an active commitment to "re-globalising" the world economy by actively promoting trade.

A golden age of global trade between 2000 and 2008 trade in goods and commercial services rose by 12% a year in dollar terms has come to an abrupt end. Free trade has made the biggest contribution to more than 60 years of global prosperity. Preventing it going permanently into reverse is the G20's biggest task.

PS: Good week for Mervyn King. His comments on the inadvisability of a further big fiscal giveaway in the April 22 budget were followed by what seemed to be an immediate climbdown by Gordon Brown. The Treasury has been telling people for some time to focus on the generality of what the authorities are doing, including ultra-low interest rates, bank rescues and quantitative easing.

The prime minister could have taken his advice from another Bank man, Danny Blanchflower, who on the day before King's comments urged a 90 billion fiscal stimulus to help the unemployed. But he chose to listen to the governor, who could have gone a bit further. As I wrote two weeks ago, the budget has to include a credible plan for bringing the public finances back into the realms of manageability over the medium term.

Bad week for Mervyn King. We all had red faces when February's Retail Prices Index was only unchanged on a year earlier, giving us the lowest inflation zero for 49 years, but no deflation. Never had a negative number seemed so certain.

To add insult to injury for the governor, a small rise in the Consumer Prices Index, from 3% to 3.2%, meant he had to write a public letter of explanation to the chancellor. This inflation measure has been sticky, though I agree with him it will fall in the coming months, implying retail price inflation will go significantly negative. But having had to wait a month longer than expected, the excitement will not be there.

Where the governor went wrong, in evidence to the Commons Treasury committee, was sowing doubt about the Bank's commitment to quantitative easing, which caused confusion in the markets and contributed to the first under-subscription of an auction of UK government bonds gilts since 2002, and the first of conventional gilts (as opposed to index-linked stock) since 1995.

The government does not yet have a problem selling gilts. An auction the next day was got away easily, admittedly for index-linked stock, completing a year in which the Debt Management Office sold an astonishing 146 billion of gilts. But we could have done without the confusion. For central bankers, clear communication is everything.

From The Sunday Times, March 29 2009