The canary in the coal mine

In a tradition that carried on well into the 20th Century, coal miners used to carry caged canaries while at work. If there was any methane or carbon monoxide in the mine, the canary would die before the levels of the gas reached those hazardous to humans. The canary in the coal mine has since become a metaphor for an advanced warning of danger.

Economic signals also act as canaries in the coal mine, warning of impending doom. Small open economies that are heavily dependent on exports and are exposed to trends in global supply chains are often the ‘canaries in the coal mine’, warning of impending expansion or contraction.

With that in mind, it’s important to watch out for changes in underlying activity in the South Korean economy. For while China remains the global manufacturing hub it is dependent on South Korea for the supply of critical materials such as semiconductors.

The ‘signal’ that South Korea provides has taken on even greater importance since the outbreak of the coronavirus since late 2019. For while the SE Asian country was one of the first countries to suffer a large hit – both to the health of its citizens and economically – it has also been one of the first to emerge over the other side (for now at least).

To carry the metaphor to a philosophical extreme; when that same canary splutters back to life and begins to stand tall on its perch once more, it may signal that the danger has passed.

South Korean data tend to provide an early signal of what’s going on with global trade and earnings growth, which is one reason why we like to pay attention to this number. It is also likely to be a more reliable read on consumer and business confidence than activity in China, the epicentre of the outbreak. According to the latest IHS Markit PMI survey, businesses in South Korea suffered a disastrous March with very few signs of a resurgence in activity:

Export sales also declined at the strongest rate in just over 11 years, with firms operating in the automotive sector among those reporting a lack of foreign demand. China, Japan and the US were among the countries driving the drop in exports. Looking ahead, South Korean goods producers were negative towards the prospects for output over the coming 12 months. A number of firms were concerned that a recession caused by COVID-19 could have a long-lasting negative impact on the economy. Overall, businesses were the most pessimistic since expectations were first recorded in April 2012.

The ‘bullwhip’ effect arising from disrupted global supply chains means that even if export orders show a marked rebound there is no guarantee that a) the South Korean manufacturers will be able to deliver the products required (especially if the government has to crackdown in the event of a spike in infections as it is doing now in early April or an infection outbreak results in a factory shutting down to be disinfected), and b) that the demand will still be there when the products are shipped, for example markets in Western Europe and the US may suffer falls in demand once the products are still in transit.

Focus on actions rather than words. Under normal times asking business managers what they think will happen over the next month can be a reliable way of gauging sentiment. In times of immense volatility where economic and health effects can have non-linear impacts, opinions don’t hold as much weight.

In the absence of a better indicator, follow activity in South Korea as an early signal of a return to healthier global economy. Expect plenty more coughing and spluttering from this canary ahead.

Related article: Deciphering Chinese economic activity post-COVID-19

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