The death of BRICs and decoupling?

The announcement by China of a 4 trillion yuan stimulus package (approaching the size of the entire Australian economy) has provided the clearest signal that the BRICs theory could be coming to an end and with it the idea of decoupling.

The BRICs Dream

It was in the wake of events in Septemeber of 2001 that investors searched for ways to spread risk and rebalance their portfolios heavily weighted towards advanced markets. Jim O’Neill, an economist at Goldman Sachs, in a paper entitled Dreaming with BRICs coined the now ubiquitous term and created with it the theory of decoupling: the notion that European and emerging economies, such as Brazil, Russia, India and China (BRICs), have diversified and deepened enough to sustain growth during economic downturns in the US.

From 2003 to 2007 the idea was holding up pretty well. The rapid climb of the BRICs was breathtaking. The world economic tables compiled by Angus Maddison gave a stunning picture of the “arc” that China in particular was following in its industrialization. Germany and Japan were notching up respectable growth figures at last. The US economy was well on its way to full recovery with a series of tax cuts and low interest rates. Things were looking pretty solid.

Repricing

Then as the first wave of repricing of sub-prime mortgages began in late 2007, things began to unravel quickly. Global fund managers and banks in a synchronized manner started to re-examine, declare and write-down their exposures linked to these mortgages.

At the annual World Economic Forum in Davos, Switzerland, CNN’s Richard Quest began polling participants on their views regarding the possible contagion effect the US housing crisis would have on the rest of the world. Those who projected a slowdown edged out the doom sayers who saw a prolonged recession.

At the conclusion of the forum, the International Herald Tribune ran a piece called Decoupling: Theory vs. Reality. The message was that only a partial decoupling had occurred. As America sneezed, Europe would not catch a fever, just a mild cold, neither would Asia contract pneumonia, just the flu. This prognosis rested on the case that China could not substitute fully domestic consumption for lost exports and that investors had oversubscribed Chinese shares in the five years since the BRICs Dream came out.

The IMF as late as June of this year, released a study called Convergence or Decoupling supporting the notion that decoupling and integration could actually occur simultaneously. From 1985, globalization has brought about greater integration and increasing finance and trade flows among countries. This has led to the coupling of business cycles among countries with similar levels of per capita income, but evidence of decoupling for groups of countries at various stages of development was also found.

Then the September surprise on Wall Street hit beginning with Merrill Lynch, Lehman Brothers, and AIG. Synchronous market gyrations, recession stalking a number of EU members followed by the slowing of Chinese and Indian growth prospects have all but eclipsed the decoupling thesis. A briefing paper entitled Synchronised Dive into Recession prepared by the International Economics Programme of the UK-based think tank Chatham House in October has said:

(u)p to mid-2008, the emerging markets remained strong – ‘decoupling’ did work. Now the crisis has deepened, no region will remain immune to shock waves.

In other words, all bets are off!