Over the Cliff We Go

Forget about the 2.9 percent fall in China's exports in December compared with a year ago. The statistic that should really shock is the fall in China's imports – a mammoth 23 percent last month to $72 billion, pushing its trade surplus to $39 billion.

The data tell several different but interlocking stories. The first is that China's exports are about to fall as dramatically as those of its neighbors, Taiwan and Korea. Taiwan was down 40 percent in December and Korea down 17 percent. Embedded in the Chinese data is the additional statistic that excluding processing trade – the assembling and packaging business with mostly low value-added – imports fell 16 percent. In other words the processing trade was down by close to 30 percent.

China is mostly at the final stage of the manufacturer's supply chain so it is natural that the steepest fall in exports will come after those of Taiwan, Korea and others who supply components to their assembly operations. Until around year-end China's export performance was reflecting more the third-quarter weakness in foreign markets rather than a fall-off-a-cliff fourth quarter. This explains why the trade data, while poor, do not reflect as yet the weeping and gnashing of teeth heard from the toy, electronics and assorted other assembly plants in the Pearl River delta, plants which have been laying off workers by the hundreds of thousands and appealing to governments in Hong Kong as well as Beijing for help.

Some of this collapse in demand may prove short-term and that in reality consumer demand in the west for these items will not fall by more than 5 percent over 2009 as a whole. Some of the collapse in orders has been due to de-stocking, exaggerated by the financial crisis, which has limited trade credit. But it seems likely that at least some of the losses in orders for Chinese factories will be permanent as consumer demand patterns in the west alter, savings rise on a permanent basis, manufacturers locate assembly operations to cheaper locations such as Vietnam or ones closer to North American and European markets, and some Korean, Taiwan and Japanese ones bring work back home.

But while China can gradually substitute domestic demand for some exports, the same is not true of the other sufferers from the collapse of China's imports – the suppliers of raw materials that lack the foreign currency cushion that China possesses. It is as yet hard to determine how much of the fall in materials imports values is due to volume cutbacks and how much to price falls. Most likely there has been de-stocking following the rush to buy supposedly scarce ores and fuels in the first half of 2008. So volume may begin to recover, at least by the second quarter of 2009. However, imports have almost certainly not yet fully reflected the price falls of the past few months. So it is not only the oil exporters who will be suffering but most of Southeast Asia and Australasia.

Malaysia, Indonesia and Australia could all be facing declines of 20 percent in their terms of trade which will sustain Australia's already excessive current account deficit, turn Indonesia from a modest surplus to a deficit of perhaps 7 percent of GDP, and entirely eliminate Malaysia's surplus which had been running at double digits. Metals and energy exporters will be worst hit but crop producers, particularly palm oil and rubber, are suffering badly too. Rice has held up best. Though prices have fallen 35 percent from their May 2008 peak they are around average levels for the past 12 months and still significantly higher than two years ago.

The US trade deficit is falling – the latest month is $40 billion, down from a peak of over $60 billion – and China's surplus is likely to moderate rather than disappear due to the falls in commodity prices. Europe and developed Asia will see export losses but gains from lower import prices. So the burden of trade re-adjustment will fall most heavily on commodity exporters. Most of the oil exporters can afford it even if they have to run down reserves. The most vulnerable nations are the developing economies of Asia and Latin America which will need to attract foreign capital to fill the current account void if they are to continue to grow.

There is not much hope that the global private sector, now retrenching after years of easy money and rising profits, will be forthcoming. So what can the public sector do? The International Monetary Fund's Dominique Strauss-Kahn says his organization needs another US$150 billion to help developing countries through the crisis. That's actually peanuts compared with the numbers being bandied around in China and Europe, let alone the US. It is almost certainly far from enough if countries from Brazil to Indonesia via Turkey and India are not to have to see seriously curtailed growth and possibly re-impose restrictions on trade and access to foreign currencies. Yet the amount of which Strauss-Kahn talks is tiny compared with, for example, the reserves of Japan and Taiwan, let alone China's $1.95 trillion and even less than Korea's $200 billion in reserves, deemed by the market insufficient to guard against a run on the won.

Unless the IMF is to be able to attract large additional funds from surplus countries, or to get them to agree to new SDR issues to provide foreign currency liquidity to a developing world, there must be strong logic behind the rapid emergence of an east Asian IMF which will focus on channeling at least some of its surpluses into hard-hit regional countries, and particularly those whose infrastructure needs and growing populations promise more substantial long run returns than can be achieved by holding US Treasury paper.

For East Asia the question is whether it knows how to use its clout for common good, and if so whether it will elect to do so on a global or merely regional basis.