A Precarious Balance

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CURRENCIES AND EXPORTS
Spending by Asia's rising middle classes has made the region far less dependent on America's appetite for Asian exports. Today, only 16.5% of Asia's exports are sold in the U.S., down from 25.5% in 1993. Yet there are significant regional differences. Jonathan Anderson, chief economist for Asia at Swiss bank UBS, says Singapore, Malaysia and Japan remain more vulnerable if tapped-out Americans start to shop less, given that their own domestic spending is relatively weak; by contrast, China's consumption is rising steadily, propelled partly by housing demand. He points out that China wasn't hit as badly as other Asian countries by the U.S. downturn in 2001, and that it's in a stronger position now to weather a slowdown.

But a factor that could weigh on China's continued export growth is its strengthening currency. After years of urging by Washington, Chinese authorities have allowed the yuan to rise about 5% against the dollar over the past 18 months. That makes Chinese goods more expensive in America, and the pinch is already being felt by some of China's manufacturers of textiles and other low-end merchandise. The annual trade fair in Guangzhou, a city at the vanguard of China's march toward capitalism over the past two decades, was overcrowded as usual last October with prospective foreign buyers of toys, clothing, shoes and handbags. But there was a difference, say businessmen who attended. "A lot of purchasers came to negotiate, but they didn't want to pay the higher prices," says Zhen Dahui, an executive for an umbrella-and-handbag manufacturer in China's Fujian province, complaining that his firm did fewer deals than usual.

EUROPE'S OVERDUE REVIVAL
Thailand's latest crisis was partly the result of a 16% increase in the value of the baht against the dollar during the first 11 months of 2006. But the euro and the pound sterling have also strengthened, with the E.U. currency rising by about 10% in the past year alone. A stronger currency makes European exports more expensive for foreign buyers. But that didn't prevent Germany from notching up a $200 billion trade surplus in the first 11 months of last year, the largest since the fall of the Berlin Wall. The good news is that buoyant exports have boosted business confidence in Europe's biggest economy and led to an unexpectedly strong increase in domestic demand. German companies appear to be hiring again: in December, the number of jobless fell by 100,000, the best monthly improvement in years, although the overall unemployment number remains a very high 9.6% of the workforce.

There are still big questions about how sustainable Germany's upturn is, and whether it will be able to pull the rest of Europe with it. Growth in the 13 nations that have adopted the euro is expected to be 2.6% in 2006, an unusually strong showing for the continent. The European recovery is uneven, though, with Italy and France faring less well. And Germany has only begun to tackle some of the politically unpopular reforms of its health, pension and labor systems that economists say are needed to boost long-term growth. Still, "Europe is going to have a great year," reckons Harvard's Rogoff.

Nicola Leibinger-Kammüller, the chief executive of machine-tool firm Trumpf, certainly hopes so. The euro's current exchange rate of about $1.30 is painful "but not existential," she says, as the firm has used currency transactions to hedge against the risk of a weaker dollar. Trumpf's strong sales growth is in large part the fruit of geographical diversification by the company: it established a subsidiary in the U.S. way back in 1969 and opened an office in Japan eight years later. It's currently investing in facilities in the Czech Republic, Mexico and South Korea. "Our main competition used to be in the U.S., but it has disappeared there and now it's Japan," Leibinger-Kammüller says. Still, Trumpf uses its U.S. manufacturing operations as a springboard not just to the American market but also to Asia, where it exports part of its U.S. production. "Russia is going well, so are OPEC countries," she says. "But we also believe in the American economy." While the world tries to figure out just how critical the U.S. is to future growth, the strategy of keeping many eggs in a lot of different baskets may turn out to be very shrewd.