Joel,
The dollar dm at 3.25....what is your reasoning for this?
Global: A World in Recession
Stephen Roach (from Hong Kong)
We have been warning of this possibility since the start of the year. But now it’s time to make it official. The global economy is in recession. Yet as day follows night, recovery follows recession. It’s always tough to figure out how and when. But, in my view, the most daunting challenge to the forecaster pertains to the quality of the coming upturn -- its shape as well as its durability. In the end, nothing will be more important for the world economy or financial markets.
According to IMF convention, the global economy is technically in recession when world GDP growth pierces the 2.5% threshold. And that’s exactly the outcome of the adjustments we are now making to our baseline forecast of the world. This latest cut is driven by a significant downward revision to our prognosis for non-Japan Asia (NJA) -- we’ve sliced about 0.5 percentage point off our 2001-02 NJA growth estimates to 5.0% and 6.0%, respectively. That, in turn, translates into a cut in our 2001 world GDP growth estimate to 2.4% (from 2.5%) -- the smoking gun of the global recession call. At the same time, we are shaving our 2002 global growth estimate to 3.7% (from 3.8%). Far be it from me to make too much out of cuts of 0.1 percentage point to our world growth estimates. But in this instance, I’ll make an exception. The global recession call is that important.
It’s been a long march on the road to global recession. As recently as October 2000, we were still calling for a 4.2% increase in world GDP growth in 2001. But then a series of shocks begin to take an unrelenting toll on our once optimistic prognosis. First came last fall’s spike in energy prices. Then came the most devastating blow of all -- an unwinding of the US IT boom. Another downleg in world equity markets added insult to injury, especially in wealth-dependent economies such as the United States. And the rest is now history -- an inventory correction, the earnings carnage, intensified corporate cost cutting, and global reverberations of these largely American-made shocks. It was only a matter of time before the world economy crossed into recession territory. That time is now.
In terms of assessing the state of the global business cycle, I would place the world currently about midway through a three-stage process. The first stage was dominated by the abrupt about-face in the US economy in the final six months of 2000. Wrenching adjustments in the IT and corporate earnings dynamics were at the crux of this transformation form boom to bust. While we did a good job in anticipating the US slowdown, we were not as quick to diagnose the second stage -- surprisingly swift collateral damage to the broader global economy.
In retrospect, we should have seen that one coming. Courtesy of the new connectivity of globalization -- expanded trade flows, globalized supply chains, and explosive growth of multinational corporations -- the loss of US economic leadership reverberated quickly around the world. In large part that was because the world had become overly dependent on the US as the engine of global growth -- our estimates suggest that America accounted for close to 40% of the cumulative increase in world GDP in the five years ending in mid-2000. But is was also because there was no other candidate to fill the void, once that engine screeched to a standstill. And the rest of the world tumbled like dominoes -- first non-Japan Asia, then Japan, America’s NAFTA partners, and now Europe and Latin America. The result is a rare synchronous recession in the global economy.
Alas, there’s a third phase to this global downturn, and it has yet to really play out. It will be defined by the feedback effects that could well take an additional toll on the US economy. Two such impacts loom most prominent -- the first being a likely downturn in US exports brought about the confluence of a weakening external climate and a strong dollar. Inasmuch as the US export growth dynamic has only just begun its descent, there is plenty of scope on the downside; in global recessions of the past, America’s real exports have declined by anywhere from 6% to 20%.
The other shoe about to fall in the third phase of the global downturn could be the American consumer. I fully realize that this is the most controversial aspect of the macro call. But as I see it, the case against the US consumer is more compelling than at any point since the early 1970s. Saving-short, overly indebted, and wealth depleted, consumers are about to get hit by the twin forces of layoffs and reduced flexible compensation (the year-end payouts granted in the form of stock options, profit sharing, and performance bonuses). Tax rebates notwithstanding, I believe that this confluence of forces will finally crack the denial that has kept the American consumer afloat. In my travels around the world, the wherewithal of the American consumer is at the top of everyone’s worry list. A US-dependent global economy needs the American consumer more than ever. I fear that the world is about to be in for a huge disappointment.
Recovery will, of course, come. It always does. But the real issue is the character, or quality, of the coming global upturn. Hope springs eternal on that score. Financial markets are lined up on the optimistic side of the 2002 outcome -- yield curves have steepened, equity cyclicals have rallied, and earnings expectations are brimming with optimism. Our own forecast -- a rebound to 3.7% world GDP growth in 2002 -- hardly throws cold water on these hopes. But downside risks remain, in my view -- even in the face of seemingly aggressive reflationary policy actions in the United States. In particular, I fear that our 2002 growth estimates are still too high in the United States (3.0%), non-Japan Asia (a downwardly-revised 6.0%), and Latin America (4.4%) -- regions that collectively account for 53% of world GDP (based on IMF metrics). In that light, my risk assessment remains unchanged: When the dust settles, I look for our baseline 2002 world GDP growth estimate to be revised down from 3.7% into the lower end of a 3.0% to 3.5% range.
If those risks come to pass, there will be little doubt that we have entered a U-shaped world. And that -- more than anything lese -- will define the quality of the coming global upturn. By definition, a U-shaped upturn is a protracted period of subpar growth. Our current baseline prognosis of 3% average growth over the 2001-02 interval fits that description to a tee -- it depicts a world economy that falls short of its long-term growth trend by about 0.7 percentage point per annum over this two-year interval. If the downside risks play out as I suspect, the world’s potentially chronic growth deficiency will become even more evident. In such a subpar growth climate, the risk of a relapse is high. The world economy will be lacking in both the leadership and the cyclical resilience that typically cushion unexpected blows.
But there is a deeper and more profound meaning to this U-shaped world. On the one hand, it reflects a worrisome imbalance in the broader global economy -- the world has simply become too dependent on the United States. Structural reforms are needed around the world -- especially in Japan, non-Japan Asia, and Europe. The list of such reforms is long, but it must include long overdue fixes to dysfunctional banking systems, intensified corporate restructuring, enhanced labor market flexibility, improved corporate governance, and enhanced shareholder-value cultures. Only through efforts such as these can the world unlock the efficiencies that would create new and autonomous sources of domestic demand. That’s what is required for the global economy to stop riding on the back of the American consumer and the US IT cycle. But a U-shaped world also poses a major challenge to the United States: America must now begin the heavy lifting that is needed in order to come to grips with the painful legacy of a popped financial bubble. Rationalizing the great IT capacity overhang is at the top of that agenda, followed by a long overdue need to rebuild personal saving and to reduce a massive current-account deficit. The bubble took America to excess, and those excesses must now be purged.
This global recession is different. It is both the first recession of the Information Age as well as the first recession in the modern era of globalization. As such, it should be viewed as critical wake-up call to investors and policy makers, alike. Hopefully, it will trigger structural reforms that will rejuvenate domestic demand in the broader global economy. Hopefully, it will also force America to come to grips with many of its own excesses. If progress is made on those counts, a high-quality upturn in the global economy will ensue. If, however, the world sidesteps the challenge and squanders the opportunity for meaningful reform, a low-quality rebound will occur. That, unfortunately, would be a set-up for an even more painful day of reckoning. The stakes are enormous for a world now in recession.
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