Growth, currencies and interest rates

Four trade challenges to monetary policy  |  Short summary:


The Fed needs to be careful about the next monetary steps it takes because:

  1. The growth effects of Quantitative Easing (QE) in Europe are yet to be felt, if indeed they will be
  2. Neither China nor Korea’s trade surplus with the US is the Fed’s biggest concern in emerging Asia
  3. The weak yen is not boosting Japan’s exports to the US and is not responsible for its surplus
  4. Monetary policy is not the answer to trade and growth imbalances, but has unintended consequences



In its bi-annual report to Congress, the US Department of the Treasury, International Affairs, assessed the macroeconomic policies of its major trading partners to see if inappropriate activities are being used to manipulate the balance of trade with the US. It urged the governments of Germany, China, South Korea and Japan to do everything in their power to eliminate global economic imbalances by focusing on reducing their trade surpluses with the US and halting practices of competitive devaluation against the US dollar. Against a backdrop of strong US growth and weaker growth elsewhere, the report argued that addressing these imbalances through structural reform, monetary and fiscal policy was the only way of ensuring that the G20 balanced global growth targets were met.


Four trade reasons why monetary policy alone can’t create real growth:


1  |  The growth effects of QE in Europe are yet to be felt, if indeed they will be

The immediate effect of QE has been to push European equity markets to new highs and push down the value of the euro against the USD. It is unlikely to create real, export-led growth since the correlation of the euro with Europe’s trade is positive (i.e. an increase in the value increases trade). Where it does have an effect on boosting trade, it is likely to be felt most strongly in Germany. This will potentially exacerbate the problem of its trade surplus, particularly with the US (Figure 1).



Figure 1  |  Monthly Value of German Exports to the US (USDm), June 2001 – December 2015 vs. EUR-USD, Last Price Monthly, June 2001 – March 2015
Source  |  DeltaMetrics 2015, Bloomberg


The chart shows a positive correlation (0.67): in other words, as the value of the euro increases, so too do exports. This reflects the relative exchange rate inelasticity of trade between Germany and the US. Growth in exports from Germany to the US has been modest over the past two years and the sharp reduction in the value of the euro does not appear to be likely to make much difference to its trade balance with the US.

The weaker euro is unlikely to impact Europe’s or, more specifically, Germany’s trade surplus with the US. Indeed, it is also unlikely to lead to greater demand without an accompanying non-monetary policy in Europe, such as infrastructural spending and structural reform to boost both demand and competitiveness.


2  |  Neither China nor South Korea’s trade surplus with the US is the Fed’s biggest concern in emerging Asia

The yuan is kept within a 2% peg of the US dollar and, as such, has been increasing its value since the end of 2004 when the currency was first allowed to float. More recently, March 2015, the yuan has appreciated against the US dollar giving rise to speculation that the peg is about to be loosened or removed completely (Figure 2).




Figure 2  |  Monthly Value of Chinese Exports to the US (USDbn) vs. USD-CNY Spot Price, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg


The impact of the appreciation of the yuan is to suggest that Chinese exports to the US may flatten slightly during 2015. This provides some cause for optimism around the size of its trade surplus with the US. Of greater concern from a US perspective may be Russia’s decision to price oil and gas deals with China in yuan. This suggests that the yuan’s role as a trade finance currency is growing and that there will be further strengthening of the currency. This is likely to be a result of both a loosening of the peg and the role of the yuan as a trade finance currency. The threat of a stronger yuan and the prospect of a future currency war may be more unpalatable than the trade surplus now.

The won is slightly different in that it is only very weakly correlated with South Korea’s exports to the US at -0.46. In other words, any devaluation by the Korean monetary authorities is unlikely to have much, if any, impact on its trade surplus with the US. Given the speed that the Kospi has picked up since QE in Europe has prompted greater liquidity, the US would do well to look at the consequences of capital outflows and rising dollar-denominated debt as Asia’s slowdown works through. Priced in local currencies, such as the won, the markets look buoyant; priced in dollars, the rises are less substantial and represent both a loss in earning and pose a threat when dollar-denominated debt has to be repaid.


3  |  The weak yen is not boosting Japan’s exports to the US and is not responsible for its surplus

Japan’s QE programme has resulted in a substantial devaluation of the yen against the US dollar. However, this has not had the desired impact of increasing all exports to the world or the US in particular (Figure 3). Export-led growth has not materialised despite substantial QE-induced devaluation since the onset of Abenomics.




Figure 3  |  Monthly Value of Japanese Exports to the US vs. USD-JPY Spot, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg


In fact, if anything, exports to the US from Japan have been falling ever since the start of the most recent phase of QE in Japan. Alongside this, Japan’s imports from the US have been increasing and could grow by nearly 5% in 2015 as a result of Japan’s greater external energy dependency after Fukushima.


4  |  Monetary policy is not the answer to trade and growth imbalances, but has unintended consequences

The US Fed is now in a bind: its challenge is not the monetary policy of its trading partners, it is the unforeseen consequences of its next monetary moves. The US dollar is strong and while some of this is because the US economy itself is doing well compared with other economies, its strength is more than partly due to the fact that markets are speculating on when the Fed will put up rates. Fuelled by both QE and uncertainty around the announcement of a rise in rates, it is likely that the USD and the euro will reach parity imminently, if not by the end of April then during May. Similarly, the yen is hitting new lows against the USD.

The euro and the yen’s values are already distorted by the effects of QE. Alongside this, any increase in interest rates will exacerbate the dollar’s strength against the currencies of all its major trade partners except China. While currencies weaken, equity markets including the Dax, Nikkei, the HSI and the Kospi continue bull runs that are the direct result of large amounts of liquidity made cheaper, not just by low interest rates, but also by weaker currencies. The result will undoubtedly be aggravated by a rise in US rates: a strong US dollar is not necessarily the best for the US in the long run if corporate earnings, confidence and exports falter.

Webcast 030 | Lessons from QE in four charts

March 2015 marks the start of Quantitative Easing (QE) in Europe. Given broader uncertainty around the effectiveness of QE, what lessons can the ECB learn from QE in the US, Japan, and the UK?



Webcast 030 Author  |  Rebecca Harding  |  CEO

Lessons from QE in four charts

Why nothing should be taken for granted  |  March 2015 marks the start of Quantitative Easing (QE) in Europe. The much anticipated programme will inject €1.1tn into the eurozone’s coffers up to September 2016 at a rate of €60bn per month from next month. The European Central Bank will be purchasing national government bonds from member states and, in so doing, it will have become the “lender of last resort” in Europe at last ceding to demands that it provides a backstop to Europe’s fragile sovereign nations in the wake of the financial crisis.

While this has created an uneasy truce between markets and Europe, there is still a long way to go. With QE, systemic risk from sovereign default is avoided and the immediate impact has been to boost equity markets and weaken the value of the euro. Theoretically, this should boost confidence and exports. However, the volatility in markets at present is a product of the broader uncertainty around the effectiveness of QE. Markets need to be convinced that it was the right strategy in the first place, not least because of the broader uncertainties around European geopolitics at present, and are in a mood to test European policy makers in any way they can.

One of the principles of QE is that it reduces the value of the currency and thereby supports real economic growth through exports. Here are the lessons from that trade perspective in four charts:


Chart 1  |  US QE – market correction overdue




Figure 1  |  Monthly Value of US exports (USDbn) versus S&P 500, last price monthly
Source  |  DeltaMetrics 2015, Bloomberg


The chart shows the close correlation between monthly movements in trade and the S&P 500 at 0.715. Each horizontal line shows the start of a QE programme: December 2008, November 2010 and latterly September 2012. US exports during that time have grown modestly, while the S&P 500 has increased in value substantially faster than its pre-crisis rates, particularly since QE3 in 2012. It appears that one effect of QE has been to worsen the disconnect between asset values and the real economy up to the start of this year.


Chart 2  |  Abenomics and the paradox of the yen




Figure 2  |  Monthly value of Japanese exports versus JPY per USD spot price, Last Price Monthly, June 2001-Dec 2015
Source  |  DeltaMetrics 2015, Bloomberg


Japan’s relationship with QE has been a long one and has produced a bizarre result: except for the period between October 2004 and May 2007, the relationship between the strength of the yen and exports has been the reverse of what would be expected. As the value of the yen strengthened between June 2001 and October 2004, exports increased. Similarly, as the value of the yen decreased shortly before the implementation of Abenomics in 2012 through to Shinzo Abe’s final asset purchases in October 2014, export trade actually fell. This is a lesson for the developed world economies: exports are currency inelastic and therefore depreciation is unlikely to have much impact on export-led growth.


Chart 3  |  UK QE and the export mystery


The purpose of UK QE was arguably to protect against systemic risk and loosen up the supply of credit in the banking system to enable bank-to-bank lending. It did not have as its primary focus either exports or real growth. However, as the rest of the world started to pull out of the downturn in the wake of the financial crisis, the question of why sterling had depreciated so much without any impact on exports took on renewed importance. The Conservatives, elected in 2010, set export-led growth as its target and set a goal to double UK exports between 2010 and 2020 to a value of £1 trillion.




Figure 3  |  Monthly value of UK exports (USDbn) vs EURGBP spot (value of 1 euro in sterling), June 2001-Dec 2015
Source  |  DeltaMetrics 2015, Bloomberg


UK QE started in September 2009 and was boosted further in October and November 2009. In October 2011 an additional £75bn in QE was announced followed by £50bn each in February and July 2012. Rather than causing the value of sterling to drop, the immediate market reaction was for it to strengthen. Interestingly, the terms of trade are negatively correlated with the value of sterling at -0.754. In other words, exports will grow in value in relation to imports as the value of the currency depreciates. This is exactly as it should be. Yet the facts demonstrate a very weak correlation (0.466) between the value of sterling and exports. QE has strengthened rather than weakened sterling, as in the US, especially against the euro but even so, sterling has not returned to its levels against the euro of 2001 and has therefore depreciated over the whole period, as have exports.


Chart 4  |  QE in Europe – a combination of both?


Previous trade views have expressed scepticism at the impact on trade of any reduction in the value of the euro. Like Japan, the eurozone’s trade is highly currency inelastic and, as a result, the depreciation of the euro is unlikely substantially to increase exports and therefore provide a much-needed boost to growth.




Figure 4  |  Monthly value of eurozone exports (USDbn) vs Dax Index, Last Price Monthly, June 2001-Dec 2015
Source  |  DeltaMetrics 2015, Bloomberg


However, it is likely that the value of European stock markets could increase substantially. The Dax has reached all-time highs since QE was announced and this creates as substantial a disconnect between economic fundamentals and equities in Europe as there has been in the US and the UK. But this QE-induced asset boost, unlike in the US, comes without an accompanying boost to the real economy in the form of infrastructure spending. Instead, it may well come with restrictions on real growth if sovereign responsibility is tied to austerity rather than structural reform and long-term growth.

Policy makers in Europe now have to ask which lessons they want to learn, and from which chart.

The Fallacy of Quantitative Easing

There is no doubt the EU project has benefited the German economy above all else: a bit like the cat got all the cream and then some. But it cannot be put off any longer; as Voltaire once said, with great power comes great responsibility. In an unusual act of defiance against German apprehension to the ECB’s sovereign bond-buying programme, the ECB will press ahead with QE1. There will be a week to thrash out the exact details after the ECJ verdict on 14th January on the legality of such a move, but a formal announcement is expected on 22nd January.

The decision to “press the button” is more likely now than ever before given the falling prices in the Eurozone. Some would argue that we are being too quick to diagnose a deflationary spiral: that these are just temporary falls in prices. The truth is that falling prices were evident in the Eurozone long before the recent external (oil) supply shock took effect. Europe’s problems run much deeper.

In the short term, any announcement in QE is unlikely to be large enough or make a significant impact on economic fundamentals: much like plugging holes in a leaking dam. QE will only act as a plaster over the real structural differences that besiege the Eurozone. Indeed, some of the world’s major economies have implemented QE with dubious results: the USA has been through three rounds of QE with more favourable outcomes, however, whether that’s purely down to QE or other more dynamic variables has yet to be proven. The UK has gone through two rounds: with the first being more effective than the second. Japan on the other hand has had to endure NINE rounds of injections (yes, QE9!) with little effect. Even after 20+ years, the legacy of deflation is engrained and growth remains elusive.

In the more medium term, what is clear is that QE will contribute to bloating banks’ balance sheets, with little in the way of affecting the real economy. This is unlikely to prompt banks to lend more. On the contrary, the winners of QE will be the bond holders, mostly the well-off, whom are unlikely to spread to the gains evenly around the economy, but would rather pile into assets thus further perpetuating asset price inflation. It’s an inefficient allocation of resources: the “wrong” people are being targeted.

What else if not QE one might ask? Recent reports suggest that Japan is toying with the idea of implementing a more innovative monetary policy tool known as “helicopter money”: dropping money directly into the pockets of every citizen. Whilst this would target the “right” people, it may all be too radical for the bureaucrats of Europe. Many economists view this measure with great suspicion partly because it hasn’t been tested robustly enough. However, the belief that prices will fall further may already be entrenched into the minds of EU citizen, so any windfall in the way of helicopter money (if too small) may be squirrelled away rather than spent on stimulating the local economy. Introducing a voucher- based system for certain goods and services is marginally better, but this too comes with a host of complications in terms of which good and services qualify, and ensuring money is not leaked out of the system.
It will need more than QE to resuscitate the Eurozone. A Eurozone break up is out of the question no matter how necessary it may be in economic terms: politics will trump economics. What is more likely is that there will be QE-light – but this still falls short of what is really needed: further structural reforms and deeper fiscal consolidation. One thing is for sure: being timid never got anyone anywhere…


The Fallacy of Quantitative Easing  |  Author  |  Shefali Enaker  |  Economist

In Abe-yance

Why trade still holds the key to Japan’s growth  |  The decision by the Bank of Japan to boost the Japanese economy by around $712bn at the end of October was Quantitative Easing (QE) on such as scale that it took markets by surprise. It signals the determination of Japan’s policy makers to “do whatever it takes” to boost Japan’s sluggish economy, to increase the value of the Yen against the US Dollar and to prevent latent deflationary pressures from taking hold yet again. Boosting the Yen will import some inflation while it is hoped the QE will halt the contraction of Japan’s economy of 7.1% seen in Q2 this year.

Shinzo Abe is now faced with a decision: does he raise the sales tax introduced in April 2014 from 8% to 10%? That there should even be a question around this is remarkable.

As Figure 1 shows, Japan’s imports were not impacted immediately by the sales tax and in fact rose between April 2014 and September 2014. However, we are forecasting a marked drop in imports from October, which, even with a brief spike in March 2015, will still represent a negative trend to the end of Q1. There is little sense in damaging what is at best a fragile recovery and this policy should be put on hold for the time being.




Figure 1  |  Monthly value of Japanese imports (USDbn) versus JPY-USD spot, June 2001-September 2014
Source  |  DeltaMetrics 2014, Bloomberg (currency data)


Japan’s imports since April alongside a marked depreciation in the value of the Yen point to one of the persistent paradoxes of Abenomics: why has trade failed to pull Japan out of its economic torpor?

Delta Economics is of the view that, since the Fukushima disaster in 2011, Japan’s policy makers have had relatively little influence over trade through manipulation of the Yen’s value. This is quite clear from Figure 2, which shows Japanese Terms of Trade in relation to the value of the Yen against the US Dollar.



Figure 2  |  Japan’s terms of trade (value of exports in terms of value of imports) in relation to Yen per USD Last Price Monthly, June 2001-September 2014
Source  |  Delta Economics analysis


The depreciation in the Yen against the Dollar pre-dates Abenomics by six months and, despite a mild pick-up in the terms of trade between July 2012 and April 2013, the impact of the currency depreciation since has been, perversely, for the terms of trade to deteriorate further. In other words, export values have not increased relative to import values, which might have been the result of an expected boost to exports from a currency devaluation.

This has less to do with fact that the relationship between the currency and trade has broken down (the so-called J-curve effect) and more to do with the fact that Japan’s dependency on energy imports has increased in the wake of the Fukushima disaster. Japan’s terms of trade deteriorated by nearly 9% between the disaster in March 2011 and the real start of currency depreciation in July 2012; over the same period, energy imports rose by nearly 14% (Figure 3).



Figure 3  |  Monthly value of Japanese imports (total and energy), June 2001- June 2015
Source  |  DeltaMetrics 2014


The figure shows two things: first, Japanese imports generally have fallen in value since the immediate post-crisis recovery and, in real terms will only be at the value they were immediately pre-crisis by June 2015. Insofar as Japan’s imports reflect its demand, this is a sharp reminder of the fact that the economy is still sluggish. Second, although energy imports in 2014 represent nearly 37% of Japan’s imports compared to just under 30% at the end of 2010, the fact that growth is also forecast to be sluggish into Q2 2015 suggests that industrial as well as consumer demand is likely to remain flat for some time.



Figure 4  |  Japanese trade – full of paradoxes
Source  |  DeltaMetrics 2014


Japan’s demand is likely to improve slightly in 2015 as witnessed by the mild pick up in imports that we are predicting for 2015. Exports, which have been sluggish globally as well as in Japan, will pick up. Electronics exports, for example, may well recover from the contraction in growth of 3% this year to flat or slightly negative growth in 2015. Similarly we are predicting a slight slow-down in the contraction of automotive exports in 2015.

The fact that flagship sectors, like cars and electronics are likely to see negative trade growth even into next year may suggest that Japan’s economy itself is no longer competitive. However, this is too simplistic. In an era of global supply chains, it is a mistake to suggest that the decline in exports represent the declining competitiveness of a whole country: global corporations locate globally to take advantage of competitive strengths elsewhere and Japan’s companies do this as much as their German, American or South Korean counterparts.

In a sense, then, it is imports that are of more interest because they illustrate some of the underlying patterns of demand within an economy. Japan’s policy makers have had their foot on the economic accelerator and brake at the same time, arguably since the Fukushima crisis rather than the beginning of Abenomics. Deliberate currency depreciation and fiscal stimulus alongside a sales tax has done little to boost exports or stimulate domestic demand. And because of the greater energy component of imports, falling oil prices now mean that Japan will be as prone to the disinflationary pressures seen in Europe and Asia. There is little that further currency depreciation can do to prevent this and while falling energy prices may help, if every country has falling energy prices, then it does little to boost comparative advantage.

Similarly, increasing the sales tax by a further 2% now may not have much of an effect on an already fragile start into 2015 that Delta Economics sees. It could well have a further negative effect in Q2 2015 and this is something to be avoided at all costs.

Webcast 014 | Asia – is slower growth the new normal?

Delta Economics’ CEO, Rebecca Harding, and new Global Vice President, Tony Nash, discuss current opportunities in Asia and the risks facing Asian markets. In particular, there is focus on the high levels of indebtedness, dangers of deflation and the need for greater competitiveness. The discussion focuses on smaller emerging Asian economies like Myanmar and argues that even though growth is rapid, it is potentially still not enough to create ‘tiger’ like growth.


Webcast 014 Author  |  Rebecca Harding  |  CEO

Trade Returns?

Why Obama was wrong to leave Japan without a deal | There is little doubt that President Obama’s visit to Asia was all about trade. The TransPacific Partnership (TPP) negotiations aim to enhance trade, economic integration and growth across the Asia-Pacific region particularly through the establishment of a free trade area (FTA) between the participants. That President Obama left Japan without an agreement is significant for the future of the TPP and his warnings to South Korea about its treatment of US exporters did nothing to reassure markets that the agreement was any closer.

However, at first glance, the relationship between inter-regional trade and key Asian markets and currencies would suggest that there is little for markets to be concerned about. US exports to and US imports from key countries within the region are strongly and negatively correlated with the Hang Seng Index (all above -0.72) and with the S&P 500 (again, all above -0.55). Similarly, Indonesia’s trade with the US is mildly but negatively correlated with the Rupiah’s value against the US dollar and India’s trade is mildly but again negatively correlated with the value against the US dollar of the Rupee. The only exception is Thailand: its exports to the US are highly and positively correlated with the Bhat’s value against the US dollar at 0.85.

If the links are so weak with currencies and strong but negative with key markets, why attempt to build a Free Trade Area? The conclusion from these largely negative correlations must surely be that Asia-Pacific is better served by intra-regional trade. The US, in this context has more to gain from the relationship than does Asia.

Japan-US trade is a proxy for countries elsewhere in the region and illustrates how the relationship between equity and currency markets and US-Asia trade has broken down since the financial crisis. For example, the relationship between Japanese and US trade was positively correlated with the Nikkei until July 2009. Although exports from Japan to the US continued to grow until September 2011, the correlation turned negative after that point and is particularly marked since the beginning of 2013, ironically, the start of President Abe’s tenure, as illustrated in Figure 1. While overall the correlation is negative at -0.55, much of this is accounted for by the post-crisis period.


Figure 1 | Value of Japanese exports to the United States, June 2001-Dec 2014 (USDm) vs Nikkei Last Price Monthly, June 2001-March 2014

Figure 1 Source | DeltaMetrics 2014

Similarly, as with other economies in the region, there is also a weak, but negative correlation between Japan’s exports to the US and the value of the Yen against the USD (Figure 2).


Figure 2 | Value of Japan’s exports to the US, June 2001-Dec 2014, USDm vs Yen per US Dollar, Last Price Monthly, June 2001-March 2014

Figure 2 Source | DeltaMetrics 2014

Again, the most marked post-crisis turning point in the relationship between exports to the US and the value of the Yen is at the start of Abenomics where the Yen has been depreciating against the dollar. This cannot be seen as anything to do with trade HGH since it is a deliberate policy choice, and the correlation, -0.29, reflects that. However, what is very clear from Figure 2 is that the currency depreciation is not having a marked effect on increasing exports to the US.

And again like other countries in the Asia-Pacific region, Japan is heavily dependent on intra-regional trade: some seven out of ten of its top export destinations are within the region. The correlation between Japan’s terms of trade (the value of exports in relation to the value of imports) and the value of its currency against the dollar is positive at 0.79 suggesting that the depreciation of the Yen is likely to be important in shoring up the value of its exports more generally.


Figure 3 | Japan’s terms of trade (value of exports/value of imports), June 2001-Dec 2014 vs JPY per US Dollar, Last Price Monthly, June 2001-March 2014

Figure 3 Source | DeltaMetrics 2014

These negative correlations between trade and equity and currency markets are replicated across the region. Indian trade with China is negatively correlated with the value of the Rupee against the US Dollar, for example. But this should not be a surprise. Much of Asia is still emerging and all of Asia-Pacific is heavily dependent on trade with itself. The structure of trade is, even between advanced economies within the region and less advanced economies, dominated by commodities and intermediate manufacturing; the equity and currency values, in contrast, have been heavily driven by speculation in the post crisis period and while South-South trade remains set to grow by just 5.3% over the next year it will be some time before this type of hubris resumes (Figure 4).


Figure 4 | USDbn value of North-North and South-South trade, June 2001-Dec 2015

Figure 4 Source | DeltaMetrics 2014

Neither the US nor Asia can afford to leave the negotiations in limbo, not just because of the importance of export-led growth in a sustainable global recovery. There are two reasons for this. First, an FTA in the Asia-Pacific region that extends beyond the South-East Asian nations (already represented through ASEAN) would create advantages from the reduction of costs of trade between nations and potentially help to shore up the south-south trade that was so much a feature of post-crisis recovery but that has waned since.

But second, the US would become a minority trading bloc accounting for just under 12% of world trade compared to the nearly 35% of world trade that the Asia-Pacific region accounts for and the just over 34% that the European Union accounts for including intra-regional trade. In the end, by leaving Asia without a trade deal, the US has weakened rather than strengthened its position: China is currently excluded from TPP but is critical to its trade structure. There is, potentially, more scope for an agreement between all nations in the region including China than there is between the region and the US if the US does not take a pragmatic approach to negotiations. President Obama and his team should be thinking about trade returns in every sense.

Even a stopped clock….?

Why economists are right to be cautious about the recovery | In a recent after-dinner speech at an Economists’ event I attended, a senior UK economist and a former external member of the Monetary Policy Committee explained why economists are cautious about stating unequivocally that the recovery in the UK and Europe has started. The argument ran something like this: first, economists generally as a profession did not predict the downturn; second, although there are plenty of individuals who will state that they knew it was coming, it was not predicted in our models and therefore we should be wary of declaring recovery – just in case everything collapses again; third, there are plenty of signs that any recovery in 2014 is weak and is unlikely lead to global “escape velocity”, as Christine Lagarde, the Head of the IMF reminded us last week.

As the World Trade Organisation (WTO) looks back into its crystal ball on the 14th April, tells us what happened to merchandise trade in 2013 and revises what it thinks will happen in 2014, it would do well to remember the humility with which all economists should treat any forecast. In a sense, its job is easy. It is revising its forecasts for 2013 and therefore 2014. It is likely to come in at a trade growth figure for 2013 around 1.9% in contrast to its forecast of 2.5% for last year. This will mean that it will also have to revise downwards its forecast for 2014 as it will be starting from a lower base but, because it is using the more optimistic assumptions modelled by the IMF of faster growth in developed countries, it will still be very optimistic on trade growth for the year.

Delta Economics’ own estimate of trade growth in 2013 suggests that trade growth has been lower than the 1.9% that the WT0 was informally predicting back in December at just 1.4% averaging out imports and export growth. Our modelling is based on the monthly IMF Direction of Trade Statistics, the United Nations Comtrade Statistics and 93 national statistics offices. The first two are the same datasets that the WTO itself uses, the third harmonises the data with national data to bring it up to date.


Figure 1 | Delta Economics Q1 2014 World Trade Forecast overview

Figure 1 Source | DeltaMetrics 2014

Given that the data is similar to that used by the WTO, it is hard to see why it would come in with a value as high as 1.9%, but estimating techniques vary and the figure of 1.5% growth in imports in 2013 without a correction for global disinflation may explain the difference.

However, what matters more is the fact that the Delta Economics forecast for world trade growth in 2014 has been falling over the past six months and will, no doubt, be several percentage points below that of the WTO’s which currently stands at 4.5% for 2014. While, like the WTO/IMF’s forecasts, we saw more buoyant conditions at the end of 2013 but even so, the moving average forecast over the past 6 months suggests that world trade growth in 2014 will be only just above 1% compared to 1.5% that we were forecasting in December.

There are several reasons why Delta Economics is cautious about predicting a rapid expansion in trade growth this year. The first is that, as Figure 1 suggests, while we are more positive about the US, Germany and the UK, we are more negative or neutral about exports from other top trading nations: China, France and Japan. Our forecasts are also more negative for other, key, economies such as Canada, Mexico, India, Saudi Arabia and the UAE. This leads us to have a generally more negative outlook for export growth in every region except Europe and for Europe we are forecasting a slightly slower contraction rather than growth.

The second reason why we are less positive about trade is because of the patterns of trade between developed and emerging economies. The main feature of the post-crisis recovery was a more rapid recovery of emerging economies in trade terms compared to developed nations, shown in Figure 2.


Figure 2 | North-North and South-South trade, June 2001-Dec 2016 (USDbn values)

Figure 2 Source | DeltaMetrics 2014

North-North trade has yet to return to its pre-crisis levels and will remain flat for the next three years according to our forecasts, but more importantly, South-South trade, which drove trade recovery after the downturn globally, will grow by just over 5% in 2014 compared to over 18% in nominal values between 2011 and 2012. And since this is predominantly accounted for by commodities, infrastructure and intermediate manufactured goods, it suggests that these economies will not be demanding the products that fuel growth for the foreseeable future. Declining export forecasts for China, India and Mexico, as well as slower forecast growth in Asia, Latin America and MENA illustrates just how the spillover effects of South-South slowdown work through to these countries.

Some of the fall in prices is because of how trade is measured. We, like the IMF and the WTO, use US Dollar nominal values to create our trends but what this does, is illustrate very clearly that if there has been downward pressure on prices this, in and for itself would explain why we are showing slower actual growth. The current price forecasts that Delta Economics models, effectively show how trade volumes will be affected if prices remain the same. On the basis of this, we are forecasting only modest growth in South-South and flat growth in North-North trade volumes.

Why this is important is because of the effect that it has on equity markets in particular. For example, the BSE Sensex is highly correlated with South-South trade (0.92) and this is illustratively presented in Figure 3.


Figure 3 | South-South trade and the Indian BSE Sensex last price monthly, June 2001-Feb 2014

Figure 3 Source | DeltaMetrics 2014

When equity prices generally fell between 2007 and the end of 2008, the subsequent lock-down in credit affected markets for trade finance with the result that South-South trade fell as well after a time-lag. The upward trend of the market and emerging world trade continues until the end of 2010 when again, a drop in the market created uncertainties, particularly about India’s trade and economic performance and again led to a drop in trade after a four month time lag.

And this matters at a global level as well. Figure 4 replicates the same diagram for the S&P 500 and world trade.


Figure 4 | S&P last price monthly and value of World trade, USD bn, June 2001-Feb 2014

Figure 4 Source | DeltaMetrics 2014

Since 2001, equity prices and trade have been highly correlated. In 2008 we saw a major drop in equity prices and the simultaneous lock-down of credit. What this did was restrict access to trade finance with the consequential 23% drop in trade that we saw in 2009. They moved together with a high positive correlation up to April 2011 reflecting general confidence in markets, but, since then, the relationship has been an equally strong negative correlation.

What this tells us is that markets have not been reacting to economic fundamentals for the last nearly 3 years but instead are reacting to sentiment and political/geo-political events. This makes them volatile, which, as our modelling demonstrates, increases uncertainty and therefore trade itself. It also suggests that there is a correction due during the course of 2014 if we are to return to the high levels of correlation up to 2011.

There is plenty to worry about in world trade at the moment. It is not like GDP in that it is directly affected by geo-political risk, which often works through trade sanctions and embargoes, and it is directly affected by economic uncertainty because this makes the trade finance environment more difficult and can restrict access to finance for exporters. This in and for itself will negatively impact GDP and economic development through trade.

Given the importance of trade to markets, trade finance and to economies generally, improving the accuracy and timeliness of trade forecasts is vital. Delta Economics is erring on the side of caution in proclaiming a recovery, not because it is insuring itself against the likelihood of a downturn but because the geo-political and deflationary downside risks globally suggest that the trade picture is more negative than is currently being predicted elsewhere. Trade, like financial markets, is internationally inter-dependent – one falls and the other falls too. It is no longer adequate to be like a stopped clock – right twice a day.

Asia Pacific

Most obvious declines in estimated and forecast trade are in China, Japan and Australia in Asia. Australia is highly dependent on China as an export partner, particularly for its iron ore and coal and, as China’s infrastructure construction boom slows and China’s economic growth also slows, Australia’s forecast export growth is also expected to fall. Japan’s export trade has failed to pick up despite the devaluation of the Yen against the US Dollar and this trend is likely to continue into 2014 with exports pretty much static compared to a mild growth in 2013.

The Dog That Never Barked?

Why deflation may yet bite | Deflation has come back on to the agenda. It never really left – it is the dog that never barked in the wake of the downturn: the sheer scale of the fiscal stimulus around the world has meant that, with the notable exception of Japan, we have experienced dis-inflation, or falling price levels, rather than deflation, which is negative price levels. With recovery in Europe and North America apparently beginning to take hold, why would commentators and analysts start to fear its bite now?

The answer is that it is not just Europe that needs to worry about deflation. Chinese trend growth is falling and March’s declines in copper and iron ore prices underscore the over-capacity in the Chinese economy that are symptomatic of lower domestic demand and that raise the spectre of deflationary contagion for Asia and the rest of the world.

The similarities with Europe are striking. Lack of demand in Germany  keeps inflation low in the Eurozone. While this benefits the weaker economies in the Eurozone in terms of competitiveness, making their prices cheaper and giving their consumers some spending power, if German demand remains low, then its inflation remains low. Because it is a surplus nation, its over-production pushes down prices in peripheral countries too, putting further downward pressure on investments and increasing the cost of their debt.

The threat of deflation from China’s lack of demand is best seen through the lens of South-South trade, illustrated in Figure 1a and 1b. China’s demand is a major determinant of South-South Trade, and the two charts show clearly the inverse relationship between South-South trade and the strength or weakness of the currency.


Figure 1a (left)  |  Real-USD and Zloty-USD Last Price Monthly versus monthly USDm monthly value of South-South trade, June 2001-Feb 2014

Figure 1b (right)  |  INR-USD versus monthly USDm monthly value of South-South trade, June 2001-Feb 2014

Source  |  DeltaMetrics 2014, Bloomberg

The post-crisis recovery in trade continued until the beginning of Q2 2011 and the emerging currencies 
continued to strengthen. Since then, however, South-South trade has been volatile but with flat trend growth. The Real and the Rupee have deteriorated against the US Dollar. The Zloty has strengthened slightly, but this is because Poland is integrated into European supply chains, especially through Germany.

This points to two dangers: first, the fact that China’s trade is volatile and not increasing at the rate that it was between 2010 and the middle of 2011, meaning that South-South trade is relatively unpredictable and not as buoyant as it was either pre- or post-crisis. This will put downward pressure on prices in China and in other emerging economies. As prices fall, servicing debt becomes more difficult.

Second, the fact that emerging market currencies (here proxied by the Rupee and the Real in particular) are associated with South-South trade growth presents a further challenge for US denominated debt. Emerging market trade is slowing and the pressure on prices is downward. This puts downward pressure on the value of the currencies too, making dollar denominated debt more expensive – further exacerbating the debt challenges caused by any potential deflation.

Figure 2 looks at the problem on a global scale and shows how deflation may already be working its way into trade values and into lower metal prices.



Figure 2  |  World Trade (USDm) versus Copper, Steel, Platinum and Gold Spot Last Price Monthly (June 2001-Feb 2014)

Source  |  DeltaMetrics 2014, Bloomberg

The first point from this chart is the clear flat-lining of trade values since March 2011 and a decline from May 2013 through to February 2014 in nominal value terms. Second, through the whole period, key metal prices are highly correlated with world trade, at above 0.79 for all metals. However, since August 2008 only Copper and Gold have been highly correlated (0.71 and 0.79 respectively) with world trade.

Both Copper and gold prices have fallen over the last 14 months but for quite different reasons. Copper is a proxy for economic development and manufacturing. In this context, its price will be strongly associated with economies that have strong manufacturing components to their trade, as illustrated in Figure 3.


Figure 3  |  Copper Spot prices against the world’s largest exporters (value of exports USDm against Copper Last Price Monthly, June 2001-Feb 2014)

Source  |  DeltaMetrics 2014


The copper price is highly correlated (at above 0.85) for all these countries’ exports. However, since August 2008, China’s exports have exhibited the weakest correlation at 0.57. This may suggest that investors are already looking at stronger growth in Europe and the US in the near term while also expecting flatter manufacturing exports from China as a reflection of over-supply in Asia.

Gold prices, in contrast, are often used as a hedge against inflation and deflation. Theoretically, where deflation is a risk, gold, as a store of value during low or negative interest rates, would rise in price, although, as Figure 4 shows, the price of gold rose up to early 2008 despite sustained Japanese deflation. But Figure 4 also shows a marked decrease in the price between January 2008 and October 2008 and then from September 2012. These were periods of marked disinflation, as opposed to deflation.


Figure 4  |  Gold Spot Last Price Monthly against Export Trade values for Germany, China, the US and Japan (June 2001-Feb 2014)

Source  |  DeltaMetrics 2014, Bloomberg

For the whole period, China, Germany, the US and Japan’s export trade has been highly correlated with Gold prices at 0.85 and 0.90 for China and Germany and 0.94 for Japan. Since the crisis, the correlation with Gold for Germany, the US and Japan has remained strong at 0.75, 0.79 and 0.86 but has weakened for China to 0.48. This is purely descriptive data but it suggests that investors have potentially been more concerned about the direct effects of deflation in developed economies until recently and have not regarded falling export prices in China as anything other than a competitive correction leading to disinflation rather
than deflation itself.

How worried to we need to be about either German or Chinese surpluses? There clearly is a deflationary trend globally manifesting itself through nominal trade values. But will this spill over into either the Eurozone or more widely across Asia?




Figure 5  |  China and Germany’s Trade Ratio (exports/imports), June 2001-Dec 2014

Source  |  DeltaMetrics 2014


If the problem in either Germany or China is the balance of exports over imports, then Figure 5 is enlightening. Germany’s trade ratio has remained remarkably static since June 2001 suggesting that it is not Germany’s surplus that is causing new problems. Similarly, China’s trade ratio has tipped in favour of imports over exports since the downturn since it has declined overall since 2001. In other words, the challenges of over-production are not new for two economies that are export-driven or for their neighbours.

However, if there is an issue, it is that investors and commentators alike may yet talk themselves into a deflationary spiral based on what is, increasingly, compelling evidence that disinflation could turn into deflation.



Figure 6  |  China and Germany’s trade balance, USDm against Gold Spot, Last Price Monthly, June 2001 – Feb 2014

Source  |  DeltaMetrics 2014, Bloomberg


Figure 6 shows a high correlation between the Gold Price and Germany and China’s trade balances. It is the most recent months, where disinflation has been present, that both the trade balances and the gold price have declines most sharply. The only other time when the simultaneous decline was as strong was between July 2008 and January 2011. But while German trade is highly correlated since this point, suggesting investors have priced in European disinflation, the decline in gold prices appears to lead the Chinese trade surplus since September 2012. In other words, investors began to worry about Asian prices then but may not see this as a real issue of deflation since recent price rises are strongly associated with geo-politics rather than economics.

In the end, trade flows in nominal value terms provide evidence that disinflation is an issue in both China and Germany with obvious effects for Asia, South-South trade and Europe. Of particular concern is the size of the debt burden of peripheral countries in Europe and Dollar-denominated debt in Asian markets. Defaults alongside downward pricing pressures could make deflation really bite and this is what markets are currently nervous about. And, as Figure 7 shows, the correlation between World Trade and the S&P 500 was positive up until August 2013 but has been negative since suggesting some form of correction is perhaps overdue.



Figure 7  |  World Trade Values (USDm) against S&P 500 Last Price Monthly, June 2001-Feb 2014

Source  |  DeltaMetrics 2014, Bloomberg

However, whether or not the dog will start to bark will depend on recovery in Europe and the US. If this proves sustainable, then it is yet possible that deflation’s bark may be worse than its bite.