A rounder world threatens Asia's economies

Fri Jul 4, 2008 7:14am EDT

A man looks at stock market monitors in Taipei June 27, 2008. REUTERS/Nicky Loh

A man looks at stock market monitors in Taipei June 27, 2008.

Credit: Reuters/Nicky Loh

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

LONDON (Reuters) - The "flat" globalized world is getting a bit rounder, as high energy prices increase the costs of transportation and undermine Asia's economic miracle.

The idea that the world was flat -- a phrase coined by Thomas Friedman meaning that goods and services could be easily produced in one place and sold across the globe -- was one of the crucial underpinnings of China and other Asian export-based economies.

But much of this was predicated on cheap transportation and energy, and with oil at $140 a barrel the sums increasingly don't add up.

"This will stress-test the entire Asian model, which has been built in a time of low energy costs and low shipping cost," said Stephen Jen, a strategist at Morgan Stanley in London.

"The world has completely changed and we, including myself, are only starting to realize some of the implications. In China a lot of the factories were built in the past 10 years with certain levels of energy costs in mind. I suspect we have significantly breached the levels of energy costs that would make these factories viable."

The upshot for Asia, which has thus far shrugged off the worst of the effects of the global credit malaise, is a continued fall in profit margins and with it continued falls in stocks and some currencies.

The MSCI Emerging Asia index .MIMS00000PUS has fallen sharply recently, tracking the main markets in China, and is down about 23 percent so far this year, as compared with a loss of about 14 percent in the S&P 500 .SPX.

And the pressure won't just be on China, it will be felt across the region.

Asia has developed a highly efficient and highly interdependent manufacturing model. Manufacture of a good may begin in very low wage areas like Vietnam, often with materials sourced thousands of miles away, and then be taken to high-tech factories in China for more skilled and high-value finishing, before finally being shipped across the globe to consumers in Europe or the United States.

That model uses lots of energy for transport, a cost that has massively increased. In fact, the proportion of China's exports that were first imported from elsewhere before being finished and sold on has dropped to 44 percent from over 50 percent last year, moving down as oil moved up.

CIBC World Markets economists Jeff Rubin and Benjamin Tal estimate that the cost of shipping a 40 foot container from Shanghai to the east coast of the United States is close to $10,000 with oil at $150, about double the 2005 price. By comparison the same container costs just $4,000 to ship from Mexico at $150 per barrel.

An irony is that the move to container ships, which cut the costs of shipping and turbo charged globalization, means fuel price increases are more keenly felt and more inflationary. While old-fashioned ships burned fuel just like containerized ones, a higher proportion of their costs were other things, like stevedores.

That means that every dollar increase in the price of oil has a proportionally bigger impact on overall shipping costs than it would have even ten years ago.

HOW LONG WILL CHINA SUBSIDISE ENERGY?

And of course the rising price of goods from China is not just a problem for China and its firms, but for the United States and its monetary policy makers, who for years have had their jobs made easier as cheap imports from Asia held down overall inflation.

A key question is how long China, which subsidizes energy, will continue to spend its money this way. China hiked diesel and gasoline prices by about 18 percent two weeks ago, the first such move in eight months and biggest ever one off rise.

There will clearly be winners as globalization's effects are blunted. Manufacturers in Mexico, Canada, Eastern Europe and even in the United States and Western Europe will find they are more competitive. This has already happened in the steel industry, where U.S. makers are newly competitive due to being closer to the source of raw materials, unlike Chinese steel firms that must import iron ore from Brazil or Australia.

"Globalization was centered around China," said Jen at Morgan Stanley. "China is going to be one of the major victims. The parts of Asia servicing China, benefiting from China, will also be hurt."

Jen sees Asian companies as caught in a squeeze, with pressure from their currencies, which are appreciating against the dollar, and further pressure on profit margins from surging wage and energy costs.

There is also the small matter of demand from the United States and Europe, which is a good bet to weaken or stagnate.

"Equities will get killed in Asia," Jen said.

"This is just the beginning of the process."

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund)

(Editing by Ruth Pitchford)

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