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How Long Can This Last?

East Asia has been enjoying a stellar spurt of growth recently, but as the U.S. and Mainland economies slow down, the good times are not expected to last much longer, writes DAVID O'REAR

Since January, two-way trade in East Asia has been growing at a blistering 25 percent year-on-year, half again as fast as in the first eight months of 2003. The first chart shows the strong correlation between world trade and global economic growth, and last year's powerful results. This year, global growth may top 5 percent, and the driving forces are low interest rates and booming trade.

What is unusual about this strong performance is the lack of a corresponding rise in real U.S. interest rates. Typically, Federal Reserve Board interest rates will increase faster than inflation when global growth is strong (see second chart). Yet, in the past two years real rates have been held very low. Low interest rates stimulate a variety of areas, from property to equities and trade. Rising rates will increase mortgage repayments and dampen consumer spending on other purchases.

Other signs are also pointing to a slowdown in 2005. In the U.S., job creation is far below trend for this point in the economic cycle. Business lending by commercial banks has contracted year-on-year for a record 38 straight months. The massive fiscal and current-account deficits portend poor prospects for the value of the U.S. dollar.

The second engine of growth

When the U.S. has a good year, the world has a much easier time. However, a new factor has come into play in recent years: China's appetite for imports. Last year, China surpassed Japan as the largest importer in Asia and this year is likely to be the top exporter as well. That's a primary reason why every economy in East Asia, save the Philippines, is recording double-digit growth in trade: China is driving other countries' economies.

China's role in global growth is surging, despite its modest 4 percent share of the world economy. Utilized foreign investment is up 21 percent in the first three quarters of the year, and likely to reach US$60 billion. Investment and exports fuel imports, which have risen nearly 35 percent over the past two years. According to the World Trade Organization, China contributed 2.1 percent of the growth in global imports in 1994-98, as compared to the States' 19.1 percent share of the rise. China's share rose to 13.4 percent in 1999-2003, while that of the U.S. remained constant, at 19.2 percent.

While the renminbi and Hong Kong dollar pegs to the U.S. dollar should keep interest rates linked to American levels, there has been divergence lately. The rise in U.S. rates has brought PRC rates back to trend, but Hong Kong has yet to follow. As the spread between U.S. and Hong Kong rates widens, capital will flow out of the Hong Kong dollar, pushing up interbank rates at a time when global demand -- and particularly that of our major trading partners -- is slowing.

The two driving forces in Hong Kong's trade this year are electrical machinery and parts and telecommunications and audio/visual equipment. Each grew at better than 30 percent year-on-year in the first eight months, and together are worth about 53 percent of the rise in total re-exports. By destination, two-way trade with the rest of China accounts for 45 percent of the growth in trade this year.

As capital investment and consumer demand in the U.S. wane, and investment in China slows, the flow of goods through Hong Kong will taper off. China's two-way trade with the world is likely to slow to the low double digits next year, possibly even down to the single digits. That will directly affect Hong Kong's trade flows, and knock on to jobs and local consumption. 2005 is not going to be a good year. 

David O'Rear is the Chamber's Chief Economist. He can be reached at david@chamber.org.hk