Global: The Next Crisis -- Part II
Stephen Roach (from Sydney)
Previously, I argued that a dangerous complacency was setting in around the world (see my 27 March
dispatch, "The Next Crisis -- Part I"). Aided and abetted by frothy world financial markets and a
vigorous global recovery, the urgency for post-crisis reforms has faded. If history is a guide, hubris
and complacency is a recipe for the next crisis. While risks seem to have subsided in the developing
world, the industrial world could be the next flash point. Surprisingly, America should be at the top of
the watch list.
Indeed, beneath the surface of a seemingly perfect US economy, some disquieting signs are evident:
America?s record and ever-widening current account deficit -- now likely to move up to around 4.5%
of GDP in 2000 -- is taking on pre-crisis Asian style dimensions. The US stock market remains on a
wealth-generating tear that is boosting aggregate demand well in excess of aggregate supply. And the
American labor market is as tight as a drum, underscoring a potential build-up of inflationary
pressures that no one expects will ever occur again. These imbalances challenge the US-centric hubris
that lies at the core of the current climate. Long perceived to be the leader in the global economy,
America could quickly become the weak link in the world growth chain.
As has been the case in the past, the next crisis will invariably stem from a policy blunder. Ironically,
the rescue mission that ultimately resolved the crisis -- centered around a massive liquidity injection
by the G-7 -- could well qualify as such a blunder and set the stage for the next disruption to world
financial markets. The reason: It keeps excess liquidity sloshing around in world financial markets.
Courtesy of an unexpected oil shock, G-3 real short-term interest rates are little different than they
were in the depths of the crisis -- resulting in a strikingly accommodative monetary policy stance. A
policy misstep by America?s Federal Reserve continues to worry me in this regard. As I have noted
for some time, by relying on the blunt instrument of interest-rate targeting, the Fed could using the
wrong tactics to address the equity market excesses that are increasingly central to its concerns.
But there is a generic problem that seems to be afflicting G-3 central banks: Drawing comfort from
the absence of inflationary pressures, the authorities are pushing the envelope in their tolerance of
rapid economic growth. Yet the world economy, according to our estimates, is likely to be surging by
a 4.5% clip in 2000 -- its fastest pace in 13 years. Monetary accommodation, under those
circumstances, is both inappropriate and dangerous. In my view, that?s like pouring fuel on an already
blazing fire. The combination of complacency and misdirected policies is a warning sign on the crisis
watch that should not be ignored.
Frothy financial markets are ripe for the next crisis. The globalization of sector investing in world
equity markets could well be the final straw. Gone are the days when investors could count on the
inherent offsets of country investing. Back in the old days, if one country were to tumble,
outperformance elsewhere in the world would pay handsomely for diversified global investors. Such
diversification was a safeguard. That was then. Now, technology moves in lock-step fashion around
the world -- from America?s Nasdaq, to Euroland?s Euro-tech index, to Japan?s Jasdaq, to Korea?s
Kosdaq. A similar pattern has also shown up in the cyclicals, financials, healthcare, consumer
nondurables, and so on.
That raises an ominous warning for the technology play: Technology, media, and telecom now
account for 41% of total capitalization in global equity markets. With global investors all lined up on
the same side of the boat, a sustained drop in the Nasdaq could wreak havoc on the sectorized daisy
chain that now links world financial markets, as well as the global economy. America is at the at the
crux of this risk. A sustained decline in the Nasdaq could trigger the dreaded asymmetrical wealth
effect for an equity-dependent US economy. That, in turn, could spark fears of the first
wealth-induced recession since the 1930s. Look no further for a shot that could quickly reverberate
around the world.
And so the world comes full circle -- from crisis to healing and now back to an increasingly
worrisome vulnerability. The good news is that the next crisis is not imminent. But the bad news is
that the classic preconditions of investor complacency and rich valuations are now in place. As
always, the next crisis will be triggered by an unexpected shock. A technology "event" looms most
worrisome in this regard -- especially one centered on a Nasdaq-induced implosion. But there are
other possibilities that could also come into play -- a China accident, a Japan relapse, and a euro
meltdown are all high on my personal watch-list. But whatever the shock, rest assured -- it?s not in
the price of a market that has gone to excess.
The bottom line from Part I of this essay bears repeating: The Asian crisis has come and gone. Just
like its predecessors, it sparked cries and promises of reform. Task forces were formed, and
commissions have come and gone. I even served on one myself (under the auspices of the US
Council on Foreign Relations). But the policy follow-through has been woefully disappointing.
That?s because there is no natural political constituency in favor of acting on reforms. Until that
changes, crisis will undoubtedly beget crisis. Sadly, the world still seems destined to repeat the
mistakes of an all too turbulent past. New economy, or not. |
