(talking down the USD)
Global: The Great Global Policy Conundrum
Stephen Roach (from Paris)
As I spin my yarn around the world, the debate always seems to boil down to the endgame. The macro I practice continues to point up the tough interplay between a post-bubble US economy and a US-centric global economy. Such tensions certainly don’t offer an easy way out. The question I get asked the most these days pertains to the issue of resolution: What policy actions might transform this increasingly vicious cycle into a more virtuous one?
The task ahead for stabilization policy is hardly simple. As I see it, policy makers are confronted with a triangulation of tradeoffs. First, there is the need for the United States to purge its post-bubble excesses. Second, there is the imperative for the rest of the world to wean itself from excessive dependence on the US economy. And, third, there is the need for global policy makers to avoid the deflationary abyss. Achieving any of these objectives is tough enough. Pulling it all off is a different matter altogether.
It’s not all that difficult to come up with policy prescriptions that might resolve each of these objectives in isolation from one another. Slow growth is the antidote for America’s post-bubble purging. A dip or two would accelerate the process -- presumably leading to a slowdown in domestic demand that would be required to boost saving, pay down debt, and facilitate a long-overdue current-account adjustment. A return to policy austerity -- both fiscal and monetary -- by US policy makers would be required to achieve such an outcome, in my view. As for the growth-starved rest of the world, the policy prescription is precisely the opposite -- pro-growth fiscal and monetary policies that would jump-start domestic demand overseas and break the unhealthy dependence of other nations on the United States. Nor is there much debate about deflationary remedies -- aggressive monetary and fiscal stimulus, and the sooner the better on both counts. The risk of being late is especially worrisome for post-bubble economies like Japan and the United States. The trick is to move early enough while there is still policy traction.
The problem comes when you put the package together. That’s because these remedies work at cross-purposes with one another. The conflict is most acute in the United States. The demand shortfall required to purge post-bubble excesses clashes with the restoration of demand vigor needed to avoid deflation. The more successful any anti-deflationary measures are, the more likely it is that a "revitalized" US economy will move further down the treacherous road of reduced saving, higher debt, and an import-led widening of an already massive current-account deficit. In that critical respect, the policy stimulus required to avoid deflation would only exacerbate America’s lingering post-bubble excesses. Maybe the perils of deflation are so serious, that it’s worth taking just such a risk. But there’s nothing lasting about such a short-term fix, in my view. It merely postpones the day of reckoning but makes the ultimate endgame all the more treacherous. In today’s climate, the tradeoff between avoiding deflation and the purging of post-bubble excesses seems just about intractable.
I see one possible way out -- a sharp depreciation of the US dollar. A realignment of foreign exchange rates is central to the "global rebalancing" that I have long believed is necessary to put the world economy on a more sustainable growth path. A significant depreciation of the dollar -- at least another 15-20% on a trade-weighted basis, in my view -- would go along way in cracking the mold of US-centric global growth. Importantly, such an outcome would enable the US to vent some of the tensions that have built up in this post-bubble era. It would allow America to shift the mix of economic growth shift from domestic to external demand. That would give US authorities more leeway to run policies that would slow the excesses of consumer demand, thereby tempering the excessive debt and lack of saving that has remains an enduring feature of this climate. A weaker dollar would also be important in countering deflationary pressures. It would spark an increase in import prices -- transforming the external contribution to domestic pricing from deflation back into inflation.
A weaker dollar, of course, also has important consequences for the rest of the world. Most importantly, it would intensify the pressure on foreign authorities to shift the mix of their growth objectives away from relying on US-led external demand and toward stimulating long-deficient domestic demand. A failure of the rest of the world to embrace pro-growth policy stimulus remains a major impediment to sustained global economic recovery, in my view. Japan, of course, has taken major steps in that direction. But they came too late -- after the Japanese economy had already tumbled into a deflationary trap. To say Europe is dragging its feet on this score would be a serious understatement. With fiscal policy stimulus closed off by the strictures of the Stability Pact and with monetary easing effectively ruled out by a central bank still fighting inflation in a deflationary world, pro-growth policies have become an oxymoron in Europe, in my view.
A depreciation of the dollar would put considerable pressure on the rest of the world to see stabilization policy in a very different light. A strengthening of the yen may well be the final straw for a long-battered Japanese economy -- forcing politicians and policy makers finally to come to grips with the imperatives of reform. A strengthening of the euro might have a comparable effect on European authorities -- forcing a rethinking of pro-cyclical fiscal policies and pushing the ECB to rethink its battle against a long-vanquished inflation. Most importantly, a weaker dollar would go a long way of putting the world on notice that it can no longer avoid the imperatives of global rebalancing. US-centric global growth can only work for so long. There comes a time when the rest of the world has to carry its own weight. Given the ominous build-up of America’s post-bubble excesses, that time is now.
The Teflon-like US dollar, of course, seems largely unsympathetic with the urgency of the world’s dilemma. After falling by about 6% in the first six months of 2002, the dollar has since retraced almost half its decent (as measured on a trade-weighted basis against the broadest possible basket of US trading partners). That leaves the dollar only 3% below its late January highs, hardly enough to spur the global rebalancing that the world so desperately needs. While our currency team continues to believe that a fundamentally over-valued dollar remains vulnerable to a sharp correction, they also stress that global angst may put any such depreciation on hold (see Stephen Li Jen’s September 12 dispatch, "The More Fierce the Storm, the Better the USD Floats"). Needless to say, that’s hardly a trivial consideration in light of intensified concerns over a US double dip and an invasion of Iraq. In a US-centric global economy, there is no "growth premium" for the rest of the world in the event of an American recessionary relapse. And a war in the Middle East and its concomitant threat to world oil supplies appears to have "safe haven" written all over it. For those reasons, alone, the dollar may prove to be stubbornly resistant on the downside -- thereby closing off the last option for an unbalanced global economy to find a new equilibrium. Should the dollar fail to adjust, global rebalancing will then have to be vented by sharp corrections in other US assets -- notably stocks and/ or bonds. One way or another, disequilibrium will force a new equilibrium.
Should the US dollar fail to correct, the noose can only tighten on a shaky global economy. America would find itself stuck between deflation and its post-bubble excesses. And the rest of the world would find itself unduly dependent on the whims of an ever-fickle US growth dynamic. Nor would there be any realistic options for global policy makers to find a benign solution to this unrelenting build-up of global tensions. In the end, a long-overdue rebalancing of a US-centric global economy is really the only way out. And I continue to believe that a significant depreciation of the dollar offers the most realistic and least painful avenue for resolution. However, if the currency alignment gets short-circuited, the ever-present global policy conundrum spells even tougher times ahead for an unbalanced global economy. |
