A Lopsided World, by Stephen Roach (New York)
Sept 27, 2002
The growth dynamic of the global economy continues to be amazingly US-centric. When America boomed in the late 1990s, the world was quick to follow. The reverse has been the case in the past two years, as a slump in the US economy has been more than matched by growth shortfalls elsewhere in the world. Lacking an alternative growth engine, an unbalanced global economy is now on increasingly precarious footing. What will it take to rebalance the world?
The numbers speak for themselves: At market exchange rates, the United States accounted for fully 64% of the cumulative growth in world GDP from 1995 to 2001. That’s essentially double America’s 32% share of current-dollar world output in 2001. And that’s only the direct contribution. A US-led global trade cycle has also played a powerful role in driving world growth since the mid-1990s. The surge in global exports over the 1995-2001 interval explains 51% of the cumulative growth in world GDP over that period. To be sure, some of this outsize growth contribution reflects the impacts of an appreciating dollar. Using the IMF’s purchasing power parity (PPP) metric, which attempts to adjust for currency fluctuations, our estimates suggest that the US accounted for approximately 40% of the cumulative growth in PPP-based world GDP since 1995 (direct US GDP effects plus trade impacts, combined); that’s also about double America’s 21% share in PPP-based world GDP. Consequently, no matter how you cut it, it’s safe to say the US has been the sole engine of global growth for over seven years.
This conclusion has been validated once again by this summer’s pronounced slowdown in global growth. America’s flirtation with a double-dip recession -- an anemic 1.1% increase in 2Q02 real GDP -- has reverberated quickly around the world. A surprising vulnerability in the European growth dynamic has been unmasked. With domestic demand accounting for a mere 0.1 percentage point contribution to Euroland GDP growth in 2Q02, a weakening in the external growth climate has brought the region to the brink of its own double-dip scare. Since stabilization policies are lined up in a disturbingly pro-cyclical fashion, European growth risks are skewed very much to the downside. The lagged effects of an earlier strengthening in the euro won’t help matters either. Nor will politically inspired setbacks to reforms.
Meanwhile, the Japanese economy is also feeling renewed pressure. Long lacking support from domestic demand, a US-led deterioration in external demand is worrisome, to say the least. Japanese exports fell for a third consecutive month in August, with shipments to the US especially weak. Moreover, while the cyclical growth climate has improved elsewhere in Asia, there are increasing signs that export and production comparisons are now in the process of peaking out. All in all, it didn’t take much to expose the fault lines in a US-centric global economy this summer. Which, of course, raises an obvious question: If the world weakens so much in response to a mere double-dip scare in America, what would happen if the dreaded double dip actually came to pass?
As I travel the world, I find that most investors would be delighted if this US-centric global growth dynamic were to be sustained. They’re happy to have their respective economies grow by exporting products to America and her suppliers. Who needs domestic demand if you have access to the richest and deepest markets of all, as well as the opportunity to tap the voracious appetite of the overly indulgent American consumer. My answer: Such a lopsided global growth dynamic is simply not sustainable. It leads to huge imbalances in the world economy that can only end in tears. That’s certainly the message from America’s massive current-account deficit, a direct by-product of this global misalignment. With America’s external gap already at a record 5.0% of GDP in 2Q02, another surge of US-led global growth could easily take the current account shortfall to 6.0% over the next year. That, in turn, would compound an already huge external-financing burden on the US -- taking it up to close to $2 billion of capital inflows per day by 2003. While that wouldn’t be such an onerous requirement if Nasdaq were back at 5,000, at Nasdaq 1,200 it could well be a different matter altogether. It raises the distinct possibility of a correction in relative asset prices -- with a weakening of the over-valued US dollar at the top of my list.
In its latest assessment of world economic prospects, the IMF sends a clear warning about this ominous build-up of global imbalances (see the IMF’s World Economic Outlook, September 2002). Three data points drive the message home: First, there is now an extraordinary gap amounting to 2.5% of world GDP between the current-account surplus economies (mainly Europe and East Asia) and the deficit countries (led by the US). Second, as scaled by the trade flows, America’s current-account deficit and Japan’s current-account surplus have, in the IMF’s words, "risen to levels almost never seen in industrial countries in the postwar period." Third, and a by-product of the first two points, the US economy is now importing 6% of total world saving, whereas Japan is exporting about 1.5%. The IMF goes on to conclude that the biggest risk of these extraordinary imbalances "is the possibility of an abrupt and disruptive adjustment of major exchange rates." This is policyspeak for sounding the alarm on the vulnerability of an overvalued dollar.
In my opinion, the imbalances of a lopsided world are a by-product of a fundamental misalignment in relative prices. This shows up in the form of an overvaluation in the world’s most important relative price -- the dollar. At the start of 2002, our currency team estimated that the dollar was overvalued by at least 15%, maybe more. While the trade-weighted dollar fell by 6% in the first half this year, it has since recouped half that decline and currently stands just 3% below its peak. Moreover, in a climate of heightened uncertainty -- both economic (double dip) and geopolitical (Iraq) -- the dollar could well move further to the upside. That would leave the world’s most important relative price as overvalued as ever. Given the imbalances this currency misalignment has fostered, I continue to favor a weakening of the dollar as a major policy initiative of US authorities.
My suggestion for a weaker dollar has been met with great consternation in official quarters. I have been accused by some of endorsing a strategy of competitive currency devaluation that could lead to ever-treacherous beggar-thy-neighbor trade policies -- smack out of the 1930s. That is the furthest thing from my mind. But I am struck by the obvious: An unbalanced world needs a realignment of relative prices, and a weaker dollar is the most sensible way to achieve this, in my opinion. It also happens to be the one option with the greatest potential to stave off America’s deflationary endgame by arresting the ongoing deflation of US import prices. But a rhetorical shift in America’s "strong-dollar policy" may not be enough. Aggressive Fed rate cuts, possibly on the order of 75 basis points, may well be required to trigger and reinforce this long overdue adjustment in the US currency. Such an easing would also be helpful in putting a floor on American domestic demand -- yet another advantage in the battle against deflation. Which takes us to the biggest risk of all: Global imbalances are all the more treacherous for a world on the brink of deflation. A lopsided world is in increasingly desperate need of a policy fix. That won’t happen, in my view, without a weaker dollar.
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