Global: Another New Paradigm
Stephen Roach (New York)
As the US economy now shifts gears, hopes of a full-blown global upturn are in the air. Our economists in the US and Japan have raised their sights as the incoming data flow has moved to the upside. So far, they are largely alone in reworking their numbers, but there are hopes that revival may spread elsewhere around the world. This raises a key question as to the character of any potential upturn in the global business cycle: Can the world break the mold of the US-centric growth dynamic that has been in place over the past seven years? The answer could well be decisive in determining the sustainability of any recovery in the global economy.
It all starts with “traction” -- whether reflationary liquidity injections engineered by the fiscal and monetary authorities can spark the time-honored forces of self-sustaining economic recovery. While this concept is best understood on a country-specific basis, little attention is given as to how it works on a global basis. Two options frame a broad range of possible outcomes -- the first relying on cross-border trade linkages and whether asynchronous growth from one country or region has spillover effects on the rest of the world. The other extreme is that of the synchronous global recovery -- a growth dynamic that is more dependent on the autonomous vigor of domestic demand in the major economies of the world. The ideal outcome, of course, is for both sources of growth to come into play, as trade induced-rebounds in economic activity spark employment and income generation -- the sustenance of domestic demand growth. That’s normally what it takes to power the cumulative, self-reinforcing dynamic of a full-blown global recovery.
Therein lies a key challenge for today’s extraordinarily lopsided world economy. As I noted recently, the latest figures indicate that the United States accounted for fully 96% of the cumulative increase in world GDP growth (at market exchange rates) over the 1995 to 2002 interval (see my 2 September essay in Investment Perspectives, “Do Imbalances Matter?”). Global traction, in this context, is very different than would be the case if the world economy were more balanced. In my view, mounting imbalances in the US and in the broader US-centric world economy put the onus of recovery much more on the global domestic demand model. America is no longer in the position to keep powering the world ahead. That’s an unmistakable message from a gaping US current account deficit -- a record 5.1% of GDP in 1Q03. Current-account surpluses elsewhere in the world -- especially in Asia but also in Europe -- are the mirror image of a non-US world that is lacking in autonomous domestic demand. At work is a set of extraordinary tensions in the global economy. As the IMF has stressed, the disparities between nations with current-account deficits and those with surpluses have never been larger in the post-World War II era (see the Preface to the IMF’s World Economic Outlook: September 2002). A synchronous global recovery, in my view, cannot occur in such an unbalanced world. A global rebalancing is necessary.
That is not a view widely shared in the United States or elsewhere in the world. Yet convictions are deep that the US-centric global growth model that has been in place over the past seven years has the potential to pull it off again. Most believe that America’s current account deficit is not a serious problem -- that it’s driven more by an insatiable demand for dollar-denominated assets by return-starved investors elsewhere in the world. As long as the United States has the world’s most flexible, entrepreneurial, and innovative system, goes the argument, an ever-widening capital account surplus -- the flip-side of the current-account deficit -- is viewed as quite sustainable. Nor have the recent flows of foreign investors dispelled this notion. In the second quarter of 2003, foreign ownership of the outstanding stock of US Treasuries hit a record 46%, more than double the share of about 20% prevailing at the onset of the last synchronous global recovery in the early 1990s. At the same time, central banks remain massively overweight in dollar-denominated assets; the dollar portion of official foreign exchange reserves held at close to 75% though 2002 (latest data available) -- more than double America’s share in the world economy. With global asset allocators voting with their feet, why can’t a US-centric world simply stay this course?
To me, it boils down to flows versus analytics. With all due respect to the consensus, I worry that this flow-based logic smacks of a bubble-induced mindset very reminiscent of the New Paradigm thinking of the late 1990s. It’s an effort to concoct a new theory to explain what up until now has been an extraordinary anomaly -- an unprecedented strain of US-centric global growth and its concomitant imbalances. Yet just as it was critical to scrutinize the assumptions that underpinned the new-wave analytics of the Great Bubble, it is equally important to lay bare the assumptions that are being made today in this dismissal of global imbalances.
As I see it, the model of a sustained US-centric global growth dynamic rests critically on a very stylized depiction of the world economy. It implicitly presumes that ever-mounting current account deficits in the world’s growth engine do not trigger a depreciation in the value of the US dollar. This is basically the functional equivalent of a one-currency model in an increasingly borderless world. As such, it also presumes that the rest of the world has an insatiable appetite for dollar-denominated assets. There are also obvious geopolitical implications of this stylized depiction of the world as well: America’s gaping and ever-rising current account deficit is basically being judged as a small price to pay for US geopolitical hegemony. In other words, as long as America takes care of the world’s security, its imbalances can be freely financed.
I just don’t buy it. Despite upward revisions to our global forecast, the world economy is still a very sluggish place. And such a sluggish global climate, beset by ongoing labor market distress, remains very much a zero-sum game as politicians now take the upper hand in driving the battle over market share. That’s why the Japanese have been intervening massively to stem the appreciation of the yen. That’s why European leaders are now sending signals that they believe it is unfair for the euro to bear a disproportionate share of any downward adjustment in the dollar. That’s also why the US Congress has now singled out China as a scapegoat for America’s jobless recovery. And that’s why negotiations over world trade liberalization all but collapsed at the just-completed WTO meetings in Cancun. A still sluggish world is listing increasingly toward trade frictions and the pitfalls of competitive currency devaluation. In my view, that underscores the mounting tensions that another bout of US-centric global growth would most assuredly produce. For that reason, alone, I believe that the global economy is now nearing the end of an extraordinary seven and a half year period of unbalanced growth.
If I’m right, that means that the key to global recovery lies less in the world trade cycle and more in the prospects for domestic demand in the non-US segments of the world economy. On that count, there’s still good reason to worry. Europe remains the most important concern in that regard. Given the region’s persistently high unemployment rate (8.9% in July), tax cuts have been the main lever to stimulate domestic purchasing power. But with budget deficits in the large European countries at or above the 3% cap of the Stability and Growth Pact, there’s limited scope for such action in the future. The European capital spending cycle probably has more upside than that of the US, largely because the region avoided the investment bubble of the late 1990s. But with a globalized world still facing excess capacity, that’s a limited source of growth, as well. Persistent structural rigidities in high-cost European labor markets round out the picture of a region that is lacking in internal, self-sustaining sources of domestic demand.
Nor am I particularly excited about the prospects for Asian domestic demand. Japan’s latest upturn -- the fifth such acceleration of its post-bubble journey -- looks as fragile as ever. Capex has been leading the way recently -- a particularly suspicious growth dynamic for an economy in persistent deflation and, therefore, awash in excess supply. Moreover, the case for sustained support from private consumption remains a real stretch in light of the likely restructuring and headcount reductions of Japan’s legions of zombie-like corporations. Elsewhere in Asia, domestic demand support remains very much a hope rather than reality. There’s talk of China as an engine of pan-Asian growth, but in my view, those hopes are entirely premature. The Chinese consumer remains predisposed toward saving -- hardly surprising given the ongoing massive layoffs associated with reforms of state-owned enterprises and the lack of a safety net supported by a national social security and pension system.
All in all, the world appears to remain as US-centric as ever. And that’s just the problem. Unlike earlier periods, another such burst of unbalanced global growth would occur in the context of a massive US current-account deficit. There’s another New Paradigm being put forth to rationalize why such an outcome may be possible, but it’s starting to smack of déjà vu. As was the case during the Nasdaq-led mania of the late 1990s, this has all the trappings of a flow-driven argument being used to justify powerful momentum swings in world financial markets. Like the last time -- only a scant three and a half years ago -- I fear this bout of denial could also end in tears. |
