Walker's World: Coupling and decoupling

WASHINGTON, Jan. 16 (UPI) -- Five months ago, when the subprime crisis began to bite, the Asian Development Bank was among the expert institutions that suggested that the U.S. financial troubles would not affect China. The fashionable word of the day was "decoupling."

This was the assumption that China and India and the booming Asian economies were becoming a freestanding economy no longer dependent on the United States as the world's locomotive of growth. The United States might sneeze but Asia would no longer catch pneumonia.

There is some truth in this, but it has been overstated. Consider the numbers. Housing construction has been contributing about 7 percent of U.S. gross domestic product, but new housing starts are down 40 percent. That means something approaching 3 percent of GDP is being taken out of the economy (allowing for the reduced sales of kitchen appliances, carpets, curtains and the like).

That 3 percent cut in GDP implies reduced U.S. consumption of roughly $300 billion. For China, whose total domestic consumption is not much more than $1.2 billion, and India (about half China's total), to make up that U.S. consumption shortfall, their consumers would have to increase their spending by about 20 percent almost overnight.

Since this is not going to happen, there will be a reduced market for Chinese and Asian exports into the United States, the country that has long been their biggest market.

Moreover, the fall in the dollar means that the Asians are not getting nearly as much money as they once did. China's currency broke through the 7.25 level against the dollar this week, which means that the yuan has risen in value by more than 14 percent since China ended its fixed exchange rate in 2005. The futures market is already pricing another 9 percent revaluation, forecasting 6.5 yuan to the dollar in 12 months.

So Haruhiko Kuroda, head of the ADB, this week revealed that the bank was dropping its growth prediction for Asia (excluding Japan) from 8.2 percent to less than 8 percent. Goldman Sachs is also predicting a modest slowdown in Asia.

This should not be a problem, except that China's stock market looks alarmingly over-valued, and so does India's. One way of assessing stock values is to examine the price-earnings ratio, and the higher it is, the longer it will take for the investor to recoup his money in earnings.

The P/E ratio of China's Shanghai composite index (which rose 160 percent last year) is at 45, the world's highest by far, and India's Sensex index is second at 28. The P/E ratio in the United States is 18.5, and 13.5 in Germany and 11.5 in Britain.

That suggests to cautious investors that Chinese stocks are an accident waiting to happen, perhaps triggered by bad news like the fall in U.S. imports, or the rise in Chinese inflation, or the slowing of Europe, or any of the other ominous signs that are mounting. Because of its fears of inflation, and of a local real estate bubble, the People's Bank of China (the central bank), last year increased interest rates half a dozen times and increased the commercial banks' reserve requirement ratios no fewer than 10 times.

There is another important way in which Asia and the other emergent markets have not been decoupled from the U.S. economy. Indeed, they are buying their way into it, much as Saudi Prince Alaweed bin Talal bought 15 percent of Citibank 15 years ago, when the Savings and Loan crisis plunged the United States into its last recession. He has now bought some more of Citigroup, along with the $7.5 billion stake Abu Dhabi bought six weeks ago.

The China Development Bank was to have contributed $2 billion of the $14 billion that Citigroup has now raised, but appears to have backed out, possibly for fear of getting burned again. China's new sovereign wealth fund, the China Investment Corp., lost (probably temporarily) about a third of the $3 billion it put into the Blackstone group last year.

But Beijing may also fear a political backlash, as cash-rich Asians and Arabs and Europeans are starting to eye cheap dollar assets in the United States. This is understandable. China felt humiliated when the U.S. Congress blocked its planned purchase of the Unocal oil group, and Arabs are still smarting from the way Dubai was blocked from buying the U.S. ports that come with its purchase of P&O.

Just because the big U.S. banks are writing off their subprime losses by the billions of dollars does not mean that U.S. politicians will happily see them bailed out by foreigners. As the bad debt problems spread from the U.S. housing market into credit cards and car loans, American banks are going to need more and more fresh capital, but its origins will be carefully watched.

Big banks like Citicorp may be too big to be allowed to fail, but the politicians are likely to emphasize (in an election year) that they are also too strategic to be allowed to fall into foreign ownership. In this instance, beggars may try very hard to be choosers, even if that means a taxpayer bailout.

In short, decoupling may not be a two-way street. Just because China and the other Asian and emerging economies are unlikely to be left unscathed by the slowdown of the U.S. economy, that does not mean Americans want their biggest banks to reinforce that growing global interdependence by allowing Chinese and Arab money to couple too intimately with U.S. strategic assets.