Stephen Roach testimony - OUTSTANDING READ!
Have you been writing speeches for this guy? <g>
Now how does someone with so much intelligence and candor actually end up a managing director?
This is long, but worth every line. Truly one of the best articles I've ever seen. Apologies if it's already been posted; it's too important to miss. Evidently I have to post in two pieces.
senate.gov
Senate Banking Committee
Subcommittee on Economic Policy
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Hearing on "Risks of a Growing Balance of Payments Deficit"
Prepared Testimony of Mr. Stephen Roach
Managing Director
Morgan Stanley
10:00 a.m., Wednesday, July 25, 2001 - Dirksen 538
Mr. Chairman, I commend you in the Congress for looking at the US economy’s problems through a global lens. America’s gaping balance-of-payments deficit is but one symptom of the stresses and strains of globalization. The angst of Genoa is another. Yes, there are unmistakable benefits of an increasingly integrated world economy, especially the opportunity to bring less-advantaged developing countries into the tent of global prosperity. But we can do a better job in managing our collective journey. The United States is hardly an innocent bystander in the momentous transformation that is now reshaping the global economy. We must take a leadership role in facing the challenges of globalization head-on. These hearings are an important step in that direction.
The world is in the midst of what could well go down in history as the first recession of this modern era of globalization. It’s a recession whose seeds were sown in the depth of the financial crisis of 1997-98. Under the leadership of Treasury Secretary Rubin, the United States played a key role in staving off what he called the world’s worst financial crisis since the 1930s. It is an honor to share this platform with him this morning. But just as America moved aggressively to save the world nearly three years ago, it has paid a steep price for those noble efforts. That rescue mission fostered a climate that took the US economy to excess -- resulting in a destabilizing asset bubble, an overhang of excess capacity, and an extraordinary shortfall of consumer saving. It also left the United States with its largest balance-of-payments deficit in modern history. As you probe the implications of America’s unprecedented external imbalance, I urge you to do so in this broader context.
A world in recession
It’s been a long march on the road to global recession. As recently as October 2000, the global economics team that I head up at Morgan Stanley was 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 boom in information technology (IT) spending. 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.
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 we now anticipate. Over the past nine months, we have slashed our once optimistic 2001 growth estimates repeatedly for the United States, Europe, non-Japan Asia, and Latin America. And we have pared further our long-cautious prognosis for Japan. As a result, we are now estimating a 2.4% increase in world GDP in 2001 -- 0.4 percentage point slower than the crisis-induced outcome of 1998. Like it or not, 2001 is likely to go down in history as another year of global recession.
This is the fifth global recession since 1970. All of these recessions have one thing in common: They were triggered by a shock. The global recession of 1975 was a by-product of the first oil shock. The downturn of 1982 was driven by the shock therapy of the US Federal Reserve’s anti-inflationary assault. The global recession of 1991 came about in the aftermath of another oil shock -- this time the brief spike that led to the Gulf War. The downturn of 1998 -- the mildest of the lot -- came about when a global currency crisis pushed most of East Asia into depression-like contractions. And the global recession of 2001 certainly stems, in large part, from America’s IT shock.
The world economy is currently about midway through a three-stage downturn in the global business cycle. The first stage was dominated by the abrupt about-face in the US economy in the final six months of 2000; as recently as the middle of last year, the economy was still surging at a 6.1% annual rate, whereas by year-end it had slowed to about 1%. Wrenching adjustments in America’s IT and corporate earnings dynamics were at the crux of this transformation from boom to bust. While the forecasting community was quick to lower its sights on the US economic outlook in early 2001, it was not as swift to diagnose the second stage of this cycle -- surprisingly serious 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. The global trade dynamic has been especially important in transmitting this new contagion. By our estimates, the volume of world trade currently amounts to almost 25% of world GDP, essentially double the share prevailing in the 1970s. That reflects over 30 years of 6% annualized expansion in global trade volumes, fully 60% faster than the 3.7% average growth in world GDP over this same period.
Moreover, the world’s dependence on cross-border trade became even more pronounced in the 1990s. Over the 1989 to 1997 interval, growth in global trade averaged 2.3 times the growth in world GDP. By contrast, over the preceding 17 years, the growth in global trade was only 1.4 times the growth in world GDP. With global trade accounting for a much larger portion of world GDP today than it did in the not-so-distant past, it exerts far greater leverage over the global business cycle. Out of that leverage has come a new strain of global contagion -- linking the world economy more closely than ever before.
But now global trade, the glue of globalization, is screeching to a standstill. Our latest estimates point to just a 4.3% increase in world trade volumes in 2001, a deceleration of 8.5 percentage points from the record 12.8% increase in 2000. This outcome represents the steepest year-to-year decline in global trade growth on record, setting in motion a "negative accelerator" effect that is wreaking havoc on industrial activity around the world. If anything, our latest estimates may be understating the downside to global trade in 2001. Outright declines in the first half of this year -- especially in the United States -- suggest it will be a real stretch to hit our projected 4.3% increase for the year as a whole. That, in turn, underscores the downside risks to our global recession forecast.
The sharp deceleration in global trade is symptomatic of a world that 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. The US-led slowdown in global trade also unmasks the world as being without an alternative growth engine. Once the US economy slowed to a crawl, it quickly became apparent that there was no other candidate to fill to the void. The rest of the world has 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, one that 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 by 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 well be the American consumer. This judgement is not without controversy. 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.
The legacy of 1998
Alas, there’s a more sinister interpretation of the events now unfolding: I don’t believe that the current global recession should be viewed as merely the latest in a long string of isolated and unexpected shocks. Instead, I see it as more of a by-product of the previous crisis-induced downturn in 1998. If that view is correct, it would be appropriate to treat these two downturns as more a continuum of a drawn-out global business cycle -- one that could well go down in history as the world’s first recession of this modern-day era of globalization. Moreover, I would go further to argue that if the world doesn’t get its act together, this type of downturn could well be indicative of what lies ahead -- a more unstable and recession-prone global economy.
It all started in the fall of 1998. The global currency crisis that began in Thailand had cascaded around the world, eventually leading to Russian debt default and the related failure of Long-Term Capital Management. The result was what Federal Reserve chairman Alan Greenspan dubbed an "unprecedented seizing up of world financial markets." US President Bill Clinton and Treasury Secretary Robert Rubin went even further, both calling it the world’s worst financial crisis since the Great Depression.
The Fed swung into action to save the world, leading the way with an "emergency" monetary easing of 75 bp in late 1998. Other G-7 central banks more or less joined in, albeit on the their own terms and with something of a lag. This led the Bank of Japan, which had just about run out of basis points, to adopt its now infamous ZIRP (zero-interest-rate policy). Europe also jumped in -- belatedly, of course: First, there was a pre-ECB coordinated rate cut in December 1998 and then there was another 50 bp easing once the new central bank opened its doors in early 1999. Collectively, the authorities did what they do best -- cutting official overnight lending rates in a classic reflationary ploy.
The world economy sprang back with a vengeance that few anticipated. The out-of-consensus "global healing" scenario that we embraced in late 1998 placed us very much at odds with financial markets that were positioned for global deflation and another year of ever-deepening crisis and recession. But we felt that the world had been given the functional equivalent of a massive global tax cut. It wasn’t just the monetary easing, but it was also an IMF-led liquidity-injection of $181 billion in bailouts in Thailand, Indonesia, Korea, Russia, and Brazil, collectively worth about 0.5% of world GDP. The boost to industrial-world purchasing power brought about by cheaper Asian-made imports was icing on the cake. A seemingly resilient global economy accelerated sharply in the second half of 1999, and world GDP growth spiked by 4.8% in 2000 -- the fastest such gain since 1976. The footprints of global healing were unmistakable. So were the perils of its unintended consequences.
The downside of "global healing"
In retrospect, global healing sowed the seeds of its own demise. It led to a false sense of complacency on two critical fronts: First, it created the climate that culminated in the Nasdaq bubble. The Federal Reserve was, in effect, easing aggressively at a time when the US economy was already booming. In the midst of the Fed’s emergency easing campaign, America’s real GDP surged at a 5.6% annual rate in the fourth quarter of 1998. Far from faltering, the US economy was on a tear. I cannot remember when such an aggressive monetary easing had occurred in the context of such an outsized gain in economic growth. Although our central bank began to take back its extraordinary monetary accommodation by mid-1999, by then it was too late -- the damage had been done. Moreover, it was compounded by the Fed’s now infamous Y2K liquidity injection of late 1999. America was on the brink of a runaway boom. A Fed-induced, Nasdaq-led liquidity bubble gave rise to the great IT overhang that has since wreaked such havoc on the US and the broader global economy. Such was the legacy of global healing.
Global healing dealt another critical blow to the world economy. The tonic of vigorous growth dampened enthusiasm for reform. Asia rode the coattails of the same powerful IT-led US growth dynamic. Indeed, we estimate that US IT exports accounted for as much as 40% of non-Japan Asia’s overall GDP growth in 2000. With growth like that, who needs reform? Everything that was wrong had seemingly been fixed -- and quite quickly at that. At least, that was the implicit logic throughout Asia, as banking reform was put on hold, corporate restructuring stalled, and the old ways of crony-capitalism endured. Global healing was a powerful antidote for the region’s devastating crisis -- the cover that impeded long-overdue reforms.
The same was the case for any repair that was about to be made to the world financial architecture. Out of the depths of the crisis of 1997-98 came renewed commitment by the major industrial nations to make the world a safer place for globalization. The great powers of the world insisted they had learned a most painful lesson. Commissions were formed -- I had the pleasure of serving on one of them, sponsored by the Council on Foreign Relations. Recommendations on architectural reforms were put forth, only now to gather dust on bookshelves around the world. Sadly, the power of global healing tempered the urgency of these reforms, as well.
All this speaks of a world that has yet to come to grips with the full ramifications of globalization. The crisis of 1997-98 was, in retrospect, a warning of what was to come. In increasingly connected world financial markets, systemic risks in the emerging world loom all the more potent -- especially if the industrial world has been lagging on its own reform agenda. The current events unfolding in Argentina, along with the potential for a new round of contagion in Brazil and elsewhere in Latin America, are the latest painful reminders of just such a possibility. The quick fix of reflationary interest rate cuts is not the panacea for a Brave New World in need of fundamental reform. It is high time to face up to the heavy lifting that is needed to make globalization work. Until that occurs, I suspect the global economy will remain more recession-prone than ever.
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