Decoupling By: Gabriel PotterMBA, AIFA® 2014.12.10

Prior to the financial crisis, there was talk in financial circles about decoupling between large economies.  So, for instance, even if the United States economy looked a little rough in 2006 because of the housing market slowdown, the explosive growth in countries like China and India was still going to occur.  There was some justification for this point of view:  developed market economies were already operating at high levels (and high presumptions) of efficiency while emerging markets had lots of room for improvement in terms of corruption, sophistication, infrastructure, and so on.  The over borrowing and leveraged economies in developed markets might take a nosedive, but cash-rich emerging markets wouldn’t be affected by the financial crisis.

In the final analysis, this was too optimistic for emerging market economies, at least as it is reflected in their equity market valuations.  The reality is that a lot of key emerging markets were cash rich because they sold cheap labor, goods, and raw materials to richer developed market economies.  When the buyers in the EU and the US hit a recession, the emerging markets had a slowdown as well.  In other words, emerging market economies were dependent on producing goods and services for an international audience.  As a result, there have been significant efforts in key economies, like China, towards bolstering domestic consumption as a more stable foundation for economic growth.

Ironically, the relative strength of the US economy is now sparking talk of decoupling, but now favoring the exact opposite point of view.  Now, we’ve seen arguments that the US economy – despite its size and global reach - can function perfectly well as a closed system.  If a smaller emerging market economy speeds up or slows down, it doesn’t have a material effect on US growth rates because we have high domestic consumption of domestically produced goods and services.  If China grows 7% or 2%, it doesn’t have a significant impact on the aggregate purchasing and pricing decisions within the US economy.

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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