An "Emerging" Menace to the U.S. Economy? Hardly

May 9, 2014 4:25 PM
By Milton Ezrati

A recent article emphasizing America’s vulnerability to setbacks in emerging markets is unnecessarily alarmist.

A recent Barron’s article (May 3, 2014) may have stirred some concern in an already wary investment community. The piece, drawing on work form a noted New York think tank, saw an increased danger in the rise of emerging economies to some 40% of the world’s gross domestic product (GDP). It argued that this increased prominence made the U.S. economy, and financial markets, much more vulnerable than previously to foreign economic fluctuations. The author speculated that a setback in emerging economies would force the U.S. Federal Reserve to keep short-term interest rates lower for longer than many now expect.

Yes, the U.S. economy may suffer a setback induced by events elsewhere. The Fed may have to keep an easy policy stance as a result. But the rise of emerging economies hardly makes such events more likely. The United States, after all, has long been vulnerable to overseas setbacks. As large as it is, the U.S. economy accounts for barely 30% of global GDP, according to MSCI, smaller than the European Union (EU)—even after all Europe’s troubles of recent years—and also now the emerging economies as a group. If any of these, or a significant combination of other overseas economies, were to suffer a major setback, the U.S. economy could not help but experience ill effects, and the Fed would have to trim its policies accordingly. This has been an economic fact for decades. It was only in the late 1940s and 1950s that the U.S. economy was so dominant that it seemed immune to foreign influences. That, however, was long ago. Pointing out America’s economic vulnerability to external shocks now hardly constitutes an argument that such setbacks are likely.

Nor are emerging economies especially dangerous in this regard. As they have developed, they have become less volatile, and less correlated to one another than they once were. And of all foreign economies, emerging markets, despite their new larger scale, are less likely to do harm in the United States than, say, a collapse in Europe. That fact is evident in patterns of trade. With most emerging economies, the United States buys much more from them than those economies buy from the United States. This fact makes them more vulnerable to developments in the United States than the other way around. That is not necessarily the case with America’s other trading partners, where trade patterns are more balanced. Indeed, if emerging economies were to suffer some problem, they might well look ever more earnestly to sales in the United States as a remedy. This increased trade could potentially mitigate any ill effects from such adverse developments. 

The object here is neither to dismiss the U.S. economy’s vulnerability to external shocks nor to say that the rise of emerging economies does not have consequences. Both are facts of economic life. The point is that the new prominence of emerging economies neither makes much difference nor likely raises the probabilities of trouble. To the extent that that their new prominence diversifies U.S. markets abroad, it may actually mitigate the very vulnerability that Barron’s frets about.

Milton Ezrati is Partner, Senior Economist and Market Strategist for Lord Abbett.

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