Global: More Global Angst
Stephen Roach (New York)
The global economy is caught in the crossfire of three powerful forces -- heightened geopolitical instability, mounting trade frictions, and the likelihood of a long overdue resolution of America’s current-account imbalance. Any one of these forces would be enough to destabilize the global economy and/or world financial markets. But taken together, the potentially lethal interplay between them could well turn any macro view of the world inside out.
The geopolitical wild card is the most ominous of these forces, to say the least. With the Israeli-Palestinian conflict lurching out of control, instability in the Middle East is the most destabilizing threat of all. But that follows in the aftermath of the war in Afghanistan and the growing likelihood that Iraq was shaping up as the next front in the ongoing US-led campaign against global terrorism. One way or another, all this spells deeper involvement of the United States in an escalating conflict between the Islamic world and the West. And the financial markets are sending a clear signal about the most obvious economic implication of this conflict -- higher oil prices. Time and again over the past 30 years, the global business cycle has been a captive of geopolitically induced fluctuations in the oil price. This may well be one of those times.
Heightened trade frictions are another sinister force looming over the global economy. Washington’s politically inspired move to protect an uncompetitive domestic steel industry is but the latest and most worrisome tilt against trade liberalization. Unfortunately, it’s not the only one. From bananas and genetically modified foods to export tax subsidies and lumber, trade disputes are now coming at a fast and furious pace. The global village is not exactly turning out to be the shining example of tranquility envisioned by the pristine models of globalization. As I see it, that’s an unfortunate by-product of a rare synchronous recession in the global economy -- one that brings out the worst behavior in nations that suddenly find themselves competing for smaller slices of a shrinking pie. With free trade giving way to trade frictions, two macro results are unavoidable -- a slower expansion of global trade and a potential upward adjustment to tradable goods prices.
Finally, there’s the seemingly unavoidable US current-account correction to contend with. By our estimates, America’s external shortfall is likely to hit 4.6% of GDP in 2002 and expand further to around 6% in 2003. Nor would it automatically stop there in the years beyond. In my view, that seals the fate of the coming reversal in the current-account deficit -- it’s just a question of when, and under what circumstances. As America’s current-account adjustment unfolds, the macro repercussions are inescapable -- a weaker dollar and slower US GDP growth are at the top of the list (see my 4 April dispatch, "On Current-Account Adjustments"). But equally important, in my opinion, is the likelihood that the rest of the world will now have to figure out how to grow on its own -- weaning itself from over-dependence on a US-led external demand dynamic. The only way to break the habit is by embracing the tactics of reform and restructuring. In the long run, this would be a distinct plus for the global economy and world financial markets. But over the next several years, a dollar correction and slower US economic growth could come as a rude awakening.
Each of these forces in and of itself -- geopolitical tensions, trade frictions, or a US current-account adjustment -- would have potentially ominous consequences for world financial markets. But that’s just the point -- in today’s climate, each of these forces can no longer be considered in isolation. Moreover, it is the interplay between the repercussions of these forces that that has the potential to be so lethal -- the combination of higher oil prices, a weaker dollar, slower US GDP and world trade growth, and higher tradable goods inflation. Ironically, for a world that had been listing toward deflation, the outcome would, instead, be painfully reminiscent of the stagflation of the late 1970s, when the confluence of a second oil shock and a dollar crisis proved devastating for world financial markets. While the fundamental macro forces driving the world economy over the past several years currently seem so far away from such an outcome, the playing field has tilted. And as tough as that might be for the global economy, it would be even rougher for world financial markets.
One of the great paradoxes of macro is that we macro practitioners tend to view the world with blinders. Understandably, we typically concoct a "baseline" view of the world by assuming away the things we know least about -- like political and military risks. Then when one of those risks comes into play, we scramble to reshape our views in accordance with our best assessment of the altered circumstances. It’s not an entirely unreasonable way to operate, as long as you understand the assumptions that are embedded in your framework. But it can be frustrating. That’s especially the case in this era of turbulence and instability, where the credibility of the baseline macro forecast seems to be drawn into question more often than not.
That’s basically the key risk to any macro prognosis right now. Several powerful forces are simultaneously bearing down on the world in a fashion that renders baseline forecasting all but irrelevant. In theory, each of these forces qualifies as a potential "exogenous shock" -- a development that, if it comes to pass, would have only a transitory impact on the macro outcome. The bad news is that the interplay between these shocks could pose a serious challenge to a baseline-driven consensus mindset. The good news is that shocks, by definition, are usually transitory events, unfolding over a finite period of time. As soon as the shock subsides, reversion back toward the baseline will occur -- enticing forward-looking financial markets to then opt for the rebound play. Unfortunately, as I see it in today’s increasingly treacherous world, that’s putting the cart well before the horse. |
