Monday 11 December 2017

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HSBC Global Research: The Great Rotation

Forget the West, focus on China

With all the worries over the US fiscal position, the eurozone’s future and the stimulus-versus-austerity debate, it’s all too easy to lose sight of the momentous shifts taking place in the global economy. We are rapidly moving away from an “old world” dominated by Europe, the US and Japan to a “new world” led by China.

Admittedly, with its thousands of years of civilisation, the “new world” moniker might seem inappropriate for the Middle Kingdom but China’s impact on the rest of the world in recent years has been revolutionary. No longer is it possible to understand the behaviour of the global economy without acknowledging the gravitational pull of China. We are living through the Great Rotation.

Led by China, the “new world” has dominated the global economy over the last decade. Even as the contributions to global growth from the “old world” have shrivelled, so global growth has re-accelerated. Over the last decade, per capita incomes have barely risen in the “old world” whereas in China, per capita incomes have risen at a faster rate than in any other decade in the post-war period. Other major emerging nations have also offered impressive performances but none of them comes close to matching China’s electric pace.

Admittedly, China is, like other nations, exposed to the ups and downs of the global economic cycle. In 2012, for example, Chinese exports softened thanks primarily to eurozone-led “old world” weakness. Yet, unlike India and Brazil, where slower growth owed a lot to domestic disappointments, the Chinese economy was eventually able to shrug off its external difficulties thanks, in part, to a reacceleration in infrastructure spending. As 2012 came to an end, it seemed as though the Chinese economy was staging a mini-revival, a theme reflected in our latest forecasts: after a modest 7.8% gain in 2012, we expect Chinese GDP to deliver an increase of 8.6% in 2013. Although this may still seem like a low number by Chinese standards, China is now a much bigger economy than it used to be: on our forecasts, China will add more to global growth in 2014 than ever before.

The Great Rotation

How does a China-led world differ from a US- or Europe-led world? So far, the benefits of the Great Rotation have accrued mostly to those countries either geographically close to China or important in satisfying China’s insatiable demand for commodities.

One way to measure this is to look at the overall increase in exports to China as a share of a country’s GDP since the beginning of the 21st century. The results are striking. South Korea’s exports to China now amount to 12% of South Korea’s GDP whereas in 2000 they accounted for a more modest 3.5%. Likewise, Malaysia and Singapore have experienced big increases in their export exposure to China. Commodity producers – including Australia, Chile, Kazakhstan and Saudi Arabia – have also shared in the spoils. And, demonstrating China’s ever-increasing connections with Africa, Angola is now China’s 14th most important source of imports, ahead of India, France, Canada, Italy and the UK.

The “old world” has yet to catch the China express. The US exports a mere 0.7% of its GDP to China. Canada, France and Italy are more or less the same. The UK’s exposure to China is lamentable: exports to China account for only 0.4% of UK GDP, not much more than a rounding error. Japan and Germany do a lot better yet their higher exposures can’t hide underlying weaknesses. In Japan’s case, its uneasy political relationship with its mainland rival – exemplified in an unresolved island dispute – led to a collapse in exports from Japan to China in the second half of 2012. Meanwhile, Germany’s heightened trade relationship with China has been absolutely swamped by an even bigger increase in its dependency on the rest of Europe, one reason why, despite its competitive advantages, Germany found itself succumbing in the second half of 2012 to a crisis which had already engulfed other parts of the eurozone.

Making the connection

There can be no doubt that a stronger China connection pays dividends. Those countries which have increased their trade exposure to China – typically at the expense of their exposures to the “old world” – have mostly enjoyed rapid gains in economic activity over the last decade or so. In contrast, those countries which have shunned China’s advances have mostly found themselves suffering from persistently disappointing GDP growth. Worse, China’s success has, indirectly, imposed costs on the “old world”: higher commodity prices and, thanks to outsourcing, lower wages have hardly helped the “old world” to cope with the debt excesses of recent years. This, combined with traumas closer to home, has left “old world” economic recoveries seriously off the pace, undermining medium-term fiscal outlooks.

Official forecasters, however, have yet to recalibrate their models, continuing to believe that sustained recovery lies just around the corner. Capital spending provides the perfect example of the forecaster’s problem. Many “old world” companies – at least the big multinationals – are cash-rich yet “old world” investment volumes remain very low. Countless explanations have been offered for this apparent anomaly, ranging from political uncertainty through to the impact of the iPad on the need to replace costly – and bulky – mainframe computers. Yet looking at the problem through a global lens, it’s easier to understand what has been going on. Those companies with funds are investing, but they’re doing so primarily in the emerging world.

Forecasts and implications

Our China forecasts remain relatively upbeat compared with consensus, but other parts of the world are not looking quite as impressive. This quarter, we have made major cuts to our growth forecasts for Japan, India and Brazil. We remain cautious on the outlook for the eurozone, even though the break-up fears which dominated sentiment over the summer have thankfully faded. We assume that the fiscal cliff talks will reach some kind of constructive conclusion, thus preventing a US economic collapse at the beginning of 2013. Nevertheless, we believe the pace of US economic recovery will remain poor relative to previous episodes. Policy-wise, we think 2013 will be a year where unconventional policies will increasingly become part of the conventional mainstream and where central banks and governments will be on the look-out for alternatives to inflation-targeting: already, the Federal Reserve has shifted the emphasis towards unemployment while Mark Carney, the Governor-elect of the Bank of England, has expressed an interest in nominal GDP targeting.

In terms of asset allocation, we prefer equities over bonds at the beginning of 2013 as uncertainties over the fiscal cliff and the eurozone’s future ease. Opportunities to buy bonds should re-present themselves later on, however. With the pursuit of ever-more unconventional polices, it’s plausible to argue that long-dated index-linked bonds will continue to find favour. In the emerging world, we favour exposure to consumer themes in those markets where growth is likely to re-accelerate. And, given the UK’s ongoing economic problems, sterling may end up proving to be the weakest of the major currencies in 2013.

The full report including key forecasts for over 40 countries across the world, monetary and fiscal policy assumptions, emerging market setbacks, identifying what shareholders want, and global economic forecasts related to GDP, consumer prices, exchange rates, investment spending and exports among others, is available at


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