Decoupling Theory

I personally feel Decoupling Theory is no more than a high sounding name given to the trick adopted in 2006 by investment managers in US to encourage the potential investors to part with their monies for investment in emerging markets. I do not think any serious academic work has been done on this theory.

Decoupling theory contrasts with the concept of markets' integration on which a lot of work has been done and empirical analyses carried out to discover that markets are indeed more integrated today than earlier.

Many reports were published around 2006 suggesting that the rest of the world could continue to grow despite significant slowdown in the US economy. This view is commonly called “decoupling”. Its proponents pointed out:
· Emerging markets constitute 30 percent of the world economy and contribute 60 percent of global growth
· Consumption in emerging markets has risen to the extent where it can replace consumption declines in the US.
· Trade linkages with the US was becoming increasingly less important for many countries
· Demographic factors favor emerging market countries - while working age population in emerging market countries will rise by one billion people by 2050, this group will shrink by 120 million in developed countries.

In short, the position was that emerging market and developing countries may have decoupled enough from the US to continue on the path of economic growth even with a major slowdown in the US economy. Thus the theory as the name suggests, says that the emerging markets economies are no longer dependant of US economy for growth. The idea is that the growth in these economies is essentially domestic consumption driven. The driving force was said to be the rise of a substantial middle class appreciative of good things. The theory was supported by strong out-performance of stock markets in India and China (and other such economies) compared to the US stocks. The theory looked plausible till Jan 2008 when most Asian markets crashed after the crash of Dow John’s.

Finally in September 2008 came the financial tsunami caused by the sub prime mortgages. It turned out that many financial institutions outside US faced bankruptcies and needed public support for survival. Growth rates plummeted across the globe and pat came the observation that “decoupling theory” has proved to be a myth. Some cautious observers have merely called it “pre-mature”.

It seems that that the proponents of the theory did not consider the multiple economic relationships and globalization trends. It came in very handy for wealth managers to encourage US investors to invest abroad. The rise and fall of the theory can be best appreciated by looking at the growth data of US and emerging economies. The chart compares the growth data of US and of India.

The proponents were most vociferous during the period when US growth was declining but India’s was rising. Even after it turned out that the emerging markets were not quite insulated from the turmoil of US markets, some proponents, perhaps unwilling to go back so soon on their words, maintained that the segments of the U.S. economy that were showing wear and tear then were those to which the rest of the world would never be heavily exposed.

One head of equity research in an American advisory firm shared his beliefs that “it is possible for globalization and decoupling to coexist”. His arguments: in fact, globalization gave rise to decoupling! With libaeralisation of economic policies, market forces rushed to fulfil the pent up demand. They could not have done so unless capital came from abroad. Thus the local growth, not linked to growth rate of the US, (decoupled) was possible because of foreign capital (globalisation).

Some prominent individuals / organizations propounding this theory were:
1. Merrill Lynch’s (see their 2007 Global Economics Report titled “Global Decoupling: A Marathon, Not a Sprint” here
2. Peter Schiff, see his write-up in The Money Map Report here
3. Jim Rogers (cofounder - with George Soros- of Quantum Fund)
4. Jonathan Garner (head of Global Markets Equity Strategy, at Morgan Stanley)
5. Jim O’Neill (head of Global Economic Research for Goldman Sachs)
6. Joseph Quinlan (Chief Market Strategist, Bank of America Capital Management)
7. Ralph Wiechers (Chief Economist, German Engineering Federation).

(No prescience is required to note that all, except the last, are connected with wealth management and have obvious pecuniary interest in propounding a theory that would encourage investors to part with their monies to these proponents.)