From Stephen Roach at Morgan Stanley:
<<...To the extent that foreign purchases of dollar-denominated assets represent the functional equivalent of a subsidy to US interest rates, asset markets enjoy artificial valuation support. The result is a surge in housing values that many Americans now perceive to be a new and permanent source of saving. This, in turn, has had a profound impact in reshaping saving and spending strategies of US consumers. In essence, the income-based consumption models of yesteryear have been replaced by asset-driven frameworks. The repercussions of this transformation are profound: The income-based personal saving rate has plunged deeper into negative territory than at any point since 1933. At the same time, US consumers can only create newfound purchasing power by extracting equity from an ever-expanding housing stock. This is where debt enters the equation — in effect, the cost of equity extraction. The overall household sector debt ratio has been pushed up by 20 percentage points of GDP over the past five years — equal to the gain in the preceding 20 years; moreover, reflecting this overhang in the outstanding stock of indebtedness, US household sector debt-service burdens have risen to record highs — even in the context of an unusually low interest rate climate. The result is unprecedented consumer vulnerability on both the saving and debt fronts.
“So what!” retorts the symbiosis crowd. After all, these are precisely the excesses — both for China and the US — that we in the rebalancing crowd have been bemoaning for years. Fair point. Moreover, a year ago, when there were widespread concerns over global imbalances, the dollar rose instead of fell — and those concerns lost credibility. As long as the world is willing to finance America’s saving shortfall, goes the argument, there is no reason to worry about sustainability. This, in my view, is the essence of the “symbiosis trap.” The consensus has been lulled into a false sense of security — believing that imbalances will remain a non-issue for the global economy and world financial markets.
That view could well be tested in 2006. For starters, global imbalances are likely to go from bad to worse over the next 12-18 months, pushing tensions in both the US and China ever closer to the breaking point. In the case of the US, pressures are likely to intensify on two fronts — the first being the housing market. There are those, of course, who still doubt that the US property market has ascended to bubble stature. I am not in that camp. Through 3Q05, fully 40 major metropolitan areas were still experiencing year-over-year house price inflation of at least 20%; at the state level — a broader geographic unit — residential home prices for 25 states plus the District of Columbia were still rising in excess of 10%. Of course, not every home in America has gone to bubble-like extremes. But to the extent that a sizable portion of the national property market has, the broader asset class is probably in the danger zone — along with the asset- and debt-dependent American consumer.
A second area of pressures in the US is likely to come from the saving front. In a high-energy-price climate, US households are likely to defend their lifestyles by pushing the personal saving rate deeper into negative territory. Moreover, as Dick Berner and Ted Wieseman note below, the outlook for the Federal budget deficit is deteriorating once again. The net result is likely to be further erosion in America’s net national saving rate, which has been hovering at a record low of around 1.5% of GDP since early 2002. As the domestic saving rate moves inexorably toward the “zero” threshold, the US can be expected to import more and more surplus saving from abroad by running ever-widening current account and trade deficits to attract the foreign capital. In fact, our latest estimates suggest that the US current account deficit, which stood at a record 6.4% of GDP in the first half of 2005, could well increase toward 7.5% over the next year. In short, America will be upping the ante in terms of what it expects from China and the rest of the world in order to sustain the symbiosis trade.
Such an outcome could put increasingly acute pressure on an already unbalanced Chinese economy. The more dramatic the shortfall in domestic US saving, the greater the need to fill the void with foreign saving. That will put pressure on the biggest piece of America’s already gaping trade deficit — namely, the US-China bilateral trade imbalance. That, in turn, would tend to support Chinese export growth, as well as export-led fixed investment -- thereby further extending the same two sectors that have already gone to excess. At the same time, there is good reason to believe that most of America’s foreign creditors are rational — likely to exercise increasing caution in managing reserve portfolios by gradually pruning their overweight in dollar-denominated assets. That would then put added pressure on China to compensate for any shifts out of dollars — especially if it remains steadfast in resisting a sharp appreciation of the renminbi. In short, if China wants to preserve the symbiosis trade in the context of a further deterioration of the US current account deficit, it may well have to up the ante on its own imbalances.
The case for global rebalancing was dealt a tough blow in 2005. The dollar’s surprising appreciation led many to believe that financial markets are perfectly capable of coping with massive external imbalances. In my view, that coping mechanism has led to a false sense of complacency that could well be tested in 2006. In particular, a further deterioration of global imbalances — more likely than not over the next year — could well have adverse consequences for already-extended US and Chinese economies. The result could be a sharp decline in the dollar and related upward pressures on US real interest rates — developments that would take generally complacent investors by surprise. I have long been wary of new theories that spring up to explain away old problems. That was the problem with the so-called new paradigm thinking of the late 1990s. And it could well be the ultimate peril of the symbiosis trap...>>
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