World trade shock and synchronised manufacturing slowdown…?

If you have been “watching” you will have noticed a fairly sharp deceleration in global economic activity since the middle of 2014.   World trade volume growth in particular has been heading into recession type territory:


And industrial production has likewise decelerated:


In the US new order growth has sharply decelerated since the summer of 14.  Much of the sharp upturn was due to transportation orders, but the subsequent weakness has lasted longer than one would expect if we were merely adjusting for such an outlier:


US manufacturing output has also been weakening of late: in the chart below I show monthly change in manufacturing output based on seasonally adjusted data as well as a 6 monthly rolling average.  The smoothed data shows a clear deceleration in monthly data:


The top 3 manufacturers are China, the US and Japan in that order.  Recent Chinese PMI data suggests a continuing deceleration in manufacturing.  This is a concern: China is the world’s largest manufacturer, having surpassed the US in 2010.  A Chinese growth shock likely has a larger amplitude than it used to.   What may have started out as a typical adjustment to a period of higher growth (in the summer of 2014) may have become extended by a marked slowdown/deceleration in Chinese growth.   Economies like Canada, where some concern has been recently expressed over weak trade dynamics, may well be the proverbial canary in the coalmine. 

Of particular note are the vulnerabilities associated with household debt and rising housing prices. And we must acknowledge that today’s action could exacerbate these vulnerabilities. However, as we noted in our Financial System Review, financial vulnerabilities would usually translate into full-blown risks — with attendant consequences for the economy — only if there was a trigger, such as a widespread and sharp decline in economic activity and employment. The terms-of-trade shock we are experiencing, which has already translated into an increase in excess capacity and downward pressure on inflation, has the potential to act as such a trigger, if left unaddressed.

Industrial production in Japan has also been on a slide in 2015 although manufacturers production plans suggest output will bounce back in the next month or two.  Recent data from Europe also shows a deceleration in growth.

Interest rates are low, global debt is higher than ever and we appear to be experiencing a growth shock transmitted via China, in particular, through world trade.  There is not much room for leveraging further growth.  

Just as I finished this quickly penned blog I came across this IMF working paper on the subject:

Network Effects of International Shocks and Spillovers Prepared by Alexei Kireyev and Andrei Leonidov

This paper proposes a new method for assessing international spillovers from nominal demand shocks. The method is derived from complex network theory and quantifies the impact of a shock in the country affected by the crisis (called here the “epicenter country”) on all other countries. In the first round, the drop in demand at the epicenter affects all its trading partners across the world (the direct spillover effect). In the second round, all affected trading partners propagate the shock to their respective partners (the spill-in effect). Finally, all countries affected by the shock in the first two rounds, radiate the shock back to the epicenter country (the spill-back effect). The method assumes that in the short run the countries affected by the shock cannot take measures to prevent spillovers”

The report has a specific section on China which is of note:

Significant growth slowdown in China represents yet another potential shock with major international spillovers…..China trades with virtually all countries in the world….is central in the international trade network.

The visualization based on the Fruchterman-Reingold (1991) force-directed layout algorithm shows that the largest trade flows of the world pass through China…..This algorithm squarely places China in the middle of the world trade network suggesting that any shock with the epicenter in China would have major impact on the rest of the world economy.

The network structure of China’s trade is unbalanced. The value of its trade in most directions is unbalanced, with large trade surpluses with many important countries…..

Asymmetries in China’s export and import partner network structures have important consequences for shock spillovers. As an import demand shock originated in China would lead to an immediate drop in export revenue of its partners in the proportion of China’s share in their exports.

The shock most likely would amplify at each iteration, because all of China’s main partners (United States, Hong Kong SAR, Korea, Italy, India) are large spillover amplifiers. Most other partners are spillover absorbers (Japan, Germany, United Kingdom, Netherlands) but even taken together have smaller share in China’s imports.

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