Until very recently, China’s surging economy made it the biggest trading partner for most Asian economies and China was seen as the critical driver of Asian growth. Blessed, it would seem, by a strong government that laid out clear and ambitious plans for the future, it was projected to overtake the US as the world’s largest economy in short order. The US, on the other hand, was perceived as a has-been for Asia, a stumbling giant which was unable to manage the Covid pandemic and which was riven with political and social crises of its own making.
What a difference a few months make. Today, it is China’s economy which is struggling with a multitude of challenges. Confidence in its future has ebbed as investors and businesses were disappointed by slow policy responses which fall short of what is needed to tackle deep structural weaknesses. The US, in contrast, has surprised even the most optimistic forecasters: its economy has been growing more or less in line with its potential — no mean feat given the effects of the harshest monetary tightening in 40 years.
More than that, the economy has also weathered the energy price shock and the geo-political tumult that followed the Ukraine war. Its central bank appears to be close to bringing inflation under control, while its financial agencies have been able to resolve serious financial stresses like the collapse of regional banks such as Silicon Valley Bank earlier this year.
There are important lessons for our region from the contrasting performances of the two big powers. Many commentators have been too quick to conclude that China would eclipse the US as the principal determinant of Asian economic fortunes. The US has many failings and it would not surprise us if we saw a few more political or policy or financial mishaps in the coming year or two.
But even if those events materialise, we believe that the American economy will remain the primary factor in shaping Asia’s economic prospects.
Once we take account of all the channels through which one economy influences another, it is still the US which matters most:
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As we explain below, the US as a market for our exports, as a source of direct investment as well as financial capital, and as a fount of technology and innovative business models, will remain key. In financial matters, it will still be the US dollar and the US monetary policy which will mainly determine where our currencies head and how our asset markets perform.
Surprising resilience of the US economy will help Asian exports turn around in 2024
Against expectations of a recession, the US economy expanded at around a 2% annualised pace in the first six months of the year. Astoundingly, several agencies are putting the current estimate of third-quarter growth at close to 6%, based on July data. Looking at the main forces at work on the economy, our view is that the July pace will almost certainly slow as some of the headwinds confronting the economy take their toll; but that the economy is likely to continue growing at a modest but healthy pace:
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• The US consumer has been helped by the hoard of savings that grew as ordinary folks held back from spending during the Covid period. Total household savings exceeded the normal trend level by US$2.1 trillion ($2.8 trillion) last year, helping to finance strong consumer spending. Now, however, there is only an estimated US$190 billion of these excess savings remaining, and at the current pace of spending, this is likely to be used up by the end of this quarter. So, an important source of growth will no longer be available by the end of this year.
• However, a strong labour market will probably remain supportive of growth. Ordinary citizens were able to remain confident enough to spend because of a tight labour market. With the unemployment rate at a historic low of 3.5%, people feel secure about their jobs. Most forecasters are expecting the jobs market to cool but few expect a big surge in unemployment. It helps that labour markets are cooling through reduced hirings rather than outright layoffs which would be more damaging to consumer confidence.
• Although inflation has eaten into real incomes, wage growth is now catching up with prices. In fact, real disposable incomes have been rising at the fastest pace in almost three years in recent months. That will help sustain a decent degree of consumer spending growth, even taking account of likely problems such as the ending of the moratorium on student loan repayments.
• The economy has also been supported by the Biden Administration’s economic initiatives, in particular the Inflation Reduction Act and the Chips Act. Some estimates suggest that about US$500 billion in new capital spending on items such as new factories and upgraded equipment has been spurred by these policies.
Digging deeper into the economy, what underlies this better-than-expected performance has been the commendable flexibility and adaptability of the US economy. For example, one reason why the labour market has held up is that American companies have been adept at adjusting to the many shocks that the economy has faced: They could absorb sharply higher borrowing costs because they had used the low-interest period well to build up their financial buffers. This flexibility could also explain why capital goods spending has not fallen as much as one would have expected in a rising interest rate era. With their finances in good shape, the majority of American companies are able to look beyond any current cyclical weaknesses to the opportunities being presented by President Joe Biden’s policies and new technologies.
With the economy averting recession and set to grow at a decent pace, US import demand has not weakened as much as one would have expected. In fact, the World Trade Organization is now predicting that global demand will bottom out soon, allowing a recovery that will support Asian export growth in 2024.
US monetary policy still matters
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Aside from the demand for Asia’s exports, another channel through which the US economy affects the region is the US Federal Reserve Bank’s monetary policy decisions. The most likely scenario for the pathway of American interest rates is for one or two more hikes in the official policy rate, followed by an extended period of stable rates. Fed Chairman Jerome Powell’s latest comments, delivered at the annual Jackson Hole meeting of top central bankers, signalled a determination to maintain the anti-inflation priority in policymaking. But he noted that the current level of interest rates is already fairly restrictive, suggesting that if inflation continues to cool — as we expect — the monetary tightening cycle will soon end in the US.
That will provide a relief to emerging markets in Asia which have been hit every time there is a bout of concerns over further Fed rate increases. Once the Fed pauses, global investors are likely to become less risk-averse and more willing to invest in emerging markets in Asia.
There will be some longer-term fallout from the monetary tightening, though.
• First, long periods of ultra-low interest rates and easy money tend to create imbalances and excessive risk-taking. We saw this with the financial behaviour that led to the collapse of Silicon Valley Bank and also with the near-implosion of UK pension funds last year. As monetary conditions are likely to remain tight for a long period, we would not be surprised if more such financial shocks occur. Each time there is such a shock, there tends to be sharp pullbacks in fund flows to risky assets, including emerging Asian ones.
• Second, and more fundamentally, we expect a permanent rise in long-term US rates compared to the last 20 years. As we have argued before, that is bound to change the asset pricing regime — the higher long-term rates are, the lower asset prices tend to be. As investors realise that long rates will now operate in a much higher range than in the past and that the reflex tendency of the Fed and some other central banks to step in to stabilise markets whenever there is a financial panic, valuations of assets will see further downside.
US dollar will also remain key to Asia
Also, the fate of the US dollar is quite closely related to US monetary policy. As monetary tightening in the US reaches a peak in the next few months, the US dollar will also reach its zenith. We expect the US dollar to weaken thereafter. That should provide some relief to Asian currencies which had been pressured by a strong greenback. Asian central banks will also find greater flexibility in managing monetary policy to focus on domestic issues if a rising dollar is not pressuring their currencies.
What about efforts by America’s rivals to displace the US dollar? Certainly, the US did not help itself by its prolific use of financial sanctions that exploit the vital role the dollar and US-dominated financial arrangements play in global finance. That has given many countries — including allies of the US such as Europe — a stronger incentive to replace the US dollar. More nations are seeking ways to get around the dollar. The recent summit of Brics countries spoke about the need to diversify away from the dollar.
Over the course of many years, this might succeed. But remember that a global currency has three major functions — medium of exchange, store of value and unit of account. It is hardly likely for any tangible changes to be felt in Asia any time soon. Replacing the dollar in trade settlements, as China, Russia and a few others are doing, may diminish the role of the dollar as a medium of exchange over time — but even here, we believe, the progress will be slow.
Divisions among the countries seeking to move away from the dollar will not help either — note how India has been somewhat reluctant to go along with the other Brics countries on the dollar issue. Moreover, in terms of the dollar as a store of value, American financial markets are so broad and deep that they offer irreplaceable opportunities for global savers that no other region can match. Similarly, we do not see the dollar being replaced quickly as a unit of account to denominate contracts.
The US is also still the major generator of innovations and new business models
Over the past century or more, the US has put in place a unique ecosystem for innovation. Not only is the US the single largest source of scientific progress in the world, it is also quite creative in converting new ideas and inventions into commercial opportunities. Although China is catching up in some areas, it is only the US that has so many uniquely innovative academic and research institutions, and the combination of financing mechanisms and dynamic entrepreneurs, to convert those into commercial reality.
Conclusion
There was a tendency in recent years to underestimate the US as China surged and the US stumbled into political and financial difficulties. However, across many channels of impact, it is still the US that remains the single most important driver of the global economy and Asian economies. With all its flaws, it is still an extraordinarily dynamic, innovative economy capable of flexibly adjusting to big changes — and that will help the US sustain its dominant influence in the global and Asian economies for a while more.
Manu Bhaskaran is CEO at Centennial Asia Advisors
