High Tech, Stephen is safe. He was/is in Milan as this horror of horror unfolded!
David II
His piece from today:
Global: Picking Up the Pieces
Stephen Roach (from Milan)
How can anyone make sense of tragedy? I know I can’t. The events of 11 September are truly unfathomable. The sheer pain of human suffering trivializes the business tasks we now face. Yet healing comes only by returning to what we know best. So bear with me as I ponder the macro on this morning after, attempting to discern some tentative conclusions that bear on the economic underpinnings of financial markets. I stress the word "tentative" because I may be missing something or simply getting it wrong. But in the spirit of the probing and searching that has always driven our macro effort at Morgan Stanley, I think it’s worth a try.
Impact analysis of any shock -- even one as devastating as this -- always depends on context. A negative shock can turn a booming economy into a soft one and can tip a stagnant economy into recession. It’s the latter context we start with, of course -- our below-consensus prognosis for the US and global economy. Against that backdrop, I offer three broad insights into ways the tragedy of 11 September may effect the economic underpinnings of world financial markets.
First, a cyclical point: The terrorist attacks represent a potentially severe negative shock to US consumer confidence. The vulnerability of the American consumer has been the missing link in the downleg of this business cycle so far. That’s no longer the case. As far as I am concerned, this shock seals the fate of the American consumer, who was already beginning to labor under the pressures of depleted saving, record debt burdens, negative wealth effects, and rising unemployment. The August surge in joblessness was a particularly worrisome sign in this regard. Moreover, the downside of flexible compensation -- performance bonuses, profit sharing, and stock options -- was also looming at year-end. And now a devastating shock hits. In my opinion, this shock, in conjunction with a very ominous set of fundamentals, is a lethal combination for the American consumer. Any residue of consumer support for the US and global economy -- both for discretionary spending as well as for housing-related activities -- is likely to be a victim of the staggering events of 11 September.
Second, a more secular point: My fear is that the world might turn inward in response to this tragedy. In my opinion, the lasting impacts of this shock could well challenge many of the underpinnings of globalization -- rapidly expanding trade flows, surging global financial capital flows, increasingly globalized supply chains, and the rapid expansion of transnational flows of multinational corporations. I am worried that the world in general and America in particular could well lose its appetite for cross-border connectedness. I hope I’m wrong on this point, because such a road could be most treacherous for the world -- painfully reminiscent of the events of the early 1930s. But openness requires confidence in cross-border relationships. And I worry that the private sector’s taste and appetite for global connectivity -- in businesses and individuals, alike -- may have been dealt a severe blow that could give rise to a backlash against globalization. Globalization may have worked brilliantly from an economic and financial point of view, but the social and political consequences have not gone well at all. The voices of the anti-globalists, which have grown steadily louder over the past two years, now seem almost deafening.
Third, a ray of hope: Shocks always subside. That offers a reason to look beyond what could be an even deeper valley than we originally envisioned. The sigh of relief that I believe must follow hints at the possibility of both a faster and a sharper upside to the U-shaped recovery in the US and global economy. The risk, however, is that such bounce will be either muted or short-lived. Consumers and businesses alike need the wherewithal to step up and spend. Income-short, saving-short, debt-burdened, and wealth-depleted American consumers will still lack that wherewithal once the impacts of this shock subside, in my view. The shaky fundamentals of a post-bubble US economy haven't suddenly vanished into thin air. I certainly can’t rule out a more cyclical response as healing occurs, but my best guess at this juncture is that any post-shock relief will not be enough to transform an anemic recovery into a classic V-shaped outcome.
It’s tempting to model the current set of circumstances after those that prevailed a decade ago -- before, during, and after the Gulf War. That shock, of course, toppled an already weakening US economy into brief recession. However, I would resist the temptation to draw too much from these apparent similarities. For Americans, the Gulf War was an external shock halfway around the world. The tragedy of 11 September is an internal shock that shatters a sense of security at home. The aftershocks of this latest event are likely to be far more serious and lasting, in my view.
What are the tentative conclusions that can be taken away from all this? Insofar as the world is concerned, this tragedy deepens my conviction regarding our synchronous global recession call for 2001. Our baseline scenario currently calls for world GDP growth of just 2.1% in 2001. In light of the shock, I would lower my downside risk assessment to this estimate from 2.0% to 1.5%. A world that moves to the lower end of this range would put this global recession on a par with the deep worldwide downturns of 1975 and 1982. As for 2002, I wouldn’t rule out a temporary rebound in the early months of the year, but I feel that any such bounce would be limited and short-lived. The persistence of negative fundamentals in an engineless global economy continues to point to a U-shaped world, in my view. Our baseline scenario currently calls for 3.4% world GDP growth in 2002, and I would maintain my view that the risks remain skewed to the downside -- possibly to 3.0%, or even lower.
Insofar as the US economy is concerned, I suspect that the negative shock to consumer confidence could well be the transforming event of this business cycle. It changes the cyclical dynamic in the US economy from investment-led to consumer-led. As such, it takes the fundamentals of an already weakened US economy from bad to worse. We have been out on a limb all year with our US recession call. Before the shock of 11 September, America had moved to the very brink of that outcome. This tragedy could well be the tipping point for the recession of 2001.
As for policy and the financial markets, I would hazard the following guesses: The Federal Reserve seems likely to be more predisposed toward monetary accommodation than would otherwise have been the case. The US central bank was attempting to signal that it was nearing the end of its easing cycle. I suspect it will no longer want to qualify that message. In a period of crisis, it takes its role as a liquidity provider most seriously. Fiscal policy should turn more expansionary, as spending is stepped up on defense and on internal security. Layer that on top of the lower revenue base of a weakened economy, and the budget deficit could suddenly make a comeback in the eyes of the financial markets.
Initially, I would look for global investors to seek safety in dollar-denominated assets. That would put a bid on Treasuries across the maturity spectrum, and also provide support to the dollar. As the initial shock subsides, however, the safe-haven allure of long-dated assets should fade. That, in conjunction with newfound budget deficit fears, could lead to relative under-performance of longer-term fixed-income instruments -- the stuff of a steepening yield curve.
Let me end by underscoring the note I began on -- these are tentative thoughts, at best. Like the rest of you, I am in a state of shock. I send this dispatch from a hotel room in Milan, where I have been ensconced for the past 24 hours, trying to distill some meaning out of all this. A long-scheduled European roadshow had temporarily been put on hold. My first inclination was to crawl into a shell, stare at CNN, say nothing, and go nowhere. But the human soul needs more. We find solace in community -- in collective engagement. We need to talk to our families, our friends, our colleagues, and our clients. And so it is in that spirit that we now attempt to pick up the pieces and discern what lies ahead in the macro realm.
The world is a resilient place. And America stands for a special resilience and resolve that has shaped its destiny for 225 years. I have no doubt that the United States will weather this storm and come out the other side with an even greater sense of renewal and determination. That doesn’t mean it will be easy. Yet as day follows night, healing follows pain. And recovery will eventually also follow recession. This time is no different. Sadly, it’s just a lot more painful. |
