*** Stephen Roach ***
Global: Eye of the Storm
Stephen Roach (New York)
March 31, 2003
There's an eerie sense of calm in the global economy. Growth in the industrial world came to a near standstill in late 2002 and has shown little signs of life since. This has led to a peaking in the global trade cycle, putting new pressure on most trade-dependent economies in the developing world -- with the notable and important exception of China. Then came the shock. The world is still in the process of absorbing the impacts of war and the uncertainty of the peace that follows. While the global economy has hardly collapsed, I am reminded of how calm it always seems in the eye of the storm. I continue to fear that this storm is far from over. I worry much more about the downside of another recession than I do about the upside of a victory recovery.
Europe remains the weak link in the global growth chain. But even here there has not been a precipitous deterioration in economic activity. After factoring in another weak set of business surveys for March, our euro-zone team estimates that pan-regional GDP growth hovered around "zero" in 1Q03. They are still looking for a fractional decline in the second period but concede that the numbers have yet to validate their below-consensus call. Germany remains the weakest economy in the region -- especially disconcerting since it accounts for fully one-third of Euroland GDP. The all-important German Ifo survey was unequivocally weak in March, as deteriorating manufacturing sentiment more than offset modest improvement in retail and construction. This drop confirmed our suspicions that the modest increases in the headline Ifo index recorded in January and February were largely spurious. With this barometer now fully 4.5 index points below its long-term average of 92.6, the very best we can say about the German economy is that it is now stagnating. More realistically, it may well be that Germany is already back in recession.
Elsewhere in Europe, the story is pretty much the same. There was a broadly based decline in Italy's ISAE survey in March, reinforcing a drop reported earlier in Belgium. But these data were dwarfed by a surprisingly steep decline in the French INSEE survey; falling to a reading of 94 in March, this key barometer of French business activity is now fully six index points below its long-term average of 100. After having recorded just 0.2% GDP growth in the final period of 2002, the French economy also looks as if it is stagnating in the first half of 2003. Unfortunately, these results in Euroland's largest economies hardly come as a surprise. Bucking the headwinds of pro-cyclical fiscal policies and a stronger euro, a grudging easing by the ECB has provided little relief. Adding in the ever-present and serious strains on the German financial system -- banks and insurance companies alike -- I continue to worry that there's more to come on the downside of an already stagnant European business cycle.
Nor is the United States -- the once-proud engine of the global economy -- providing the offset that a US-centric world has long grown accustomed to. The February data have nosedived, with broadly based declines in durable goods manufacturing activity, the long-buoyant residential construction sector, and consumer demand. The consumption weakness is obviously critical, drawing into serious question the one source of support that has always kept the US economy afloat. But with jobless claims now above the key 400,000 threshold for six consecutive weeks, the labor market may finally be turning against the American consumer. The sharp weakness in consumer confidence tends to bear that out -- although war- and weather-related distortions certainly make it hard to get a clear signal. As our US team sifts through the incoming data, they now see only 0.7% growth in real GDP in 1Q03, half the estimate they were carrying a month ago. Moreover, growth in the US economy is still expected to slip to the "zero threshold" in the second period, leaving the world's largest economy on the brink of its second recession in three years.
Japan is hardly in a position to pick up the slack. While the Japanese economy ended 2002 on a somewhat firmer note than Europe and the US, growing at a 2% annual rate in the fourth quarter, our Japan team believes that there was more noise than substance to that estimate. Meanwhile, there was a 1.7% plunge in Japanese industrial production just reported for February, marking the fifth decline in the past six months. February's weakness was especially pronounced in the motor vehicles sector, where worldwide demand has been especially soft in the face of higher oil prices and war-related uncertainties. A related back-up in the inventories-to-shipments ratio (+0.8% on a sequential monthly basis in February) is especially disconcerting.
Given the contraction in nominal worker incomes, a big surprise in Japan has been the resilience of consumer demand, where growth has remained slightly positive for six consecutive quarters. However, research by Osamu Tanaka of our Japan team reveals that this resilience has been financed by a stunning decline in personal saving; by Tanaka-san's estimates, the personal saving rate has fallen from around 10% in the late 1990s to a mere 2.5% in 4Q02. In my view, there's nothing comforting at all about saving-financed consumption -- especially for an aging society like Japan that needs its saving more than ever. This week's release of the Bank of Japan's March Tankan survey of business sentiment will provide greater clarity on the near-term cyclical outlook. Our Japan team will pay special attention to the capital spending context of this survey, where they believe recent trends have the greatest downside risks. Our near-term baseline forecast calls for only modest downside risk to the "wok-shaped" Japanese business cycle -- hardly a collapse but far from a meaningful cyclical recovery that might otherwise offset the downside risks evident in Europe and the US.
Apart from China's extraordinary resilience in early 2003 -- highlighted by accelerating growth in exports, industrial production, and foreign direct investment -- the rest of Asia is on increasingly precarious footing. That's especially the case in Korea, last year's rising star. Industrial output growth in the first two months of 2003 has slowed to a 6.6% year-over-year rate, down significantly from the 9.5% comparison of 4Q02. Moreover, with capital spending now weakening, wholesale and retail trade volumes falling in February for the first time in 50 months, and inventories backing up, the cyclical outlook for the Korean economy is rapidly deteriorating. Taiwan has also been a source of recent weakness after turning back up in 2002. Notwithstanding a slight bounce in February -- possibly traceable to Lunar New Year (LNY) distortions -- Taiwan's leading indicators have generally been weak since last fall; a recent compression in the growth of export orders is especially disconcerting. And the outlook continues to deteriorate in deflation-prone Hong Kong. February's sharp decline in exports was the latest disappointment, although LNY distortions may be exaggerating the weakness. Weakness in Singapore rounds out the picture, underscored by a surprising decline in manufacturing production in February.
But the big story in Asia today has nothing to do with economic data. The outbreak of a rare and lethal disease -- severe acute respiratory syndrome (SARS) -- transcends the vicissitudes of the business cycle. Extraordinary and extended school closings in Singapore and Hong Kong underscore the near-panic conditions prevailing in the region's two most prosperous locales. Travel warnings to China and other Asian destinations are severely crimping air travel, tourism, and other forms of commerce. Returning from Asia last week, I saw this first hand. The SARS shock, in conjunction with war- and trade-cycle-related uncertainties, could deal a severe blow to the Asian and global economy. Our current baseline forecast calls for GDP growth of 5.0% in Asia ex Japan in 2003 -- easily qualifying this region as the fastest-growing segment of the global economy. And yet now downside risks are building rapidly in this region of the world as well. Against the backdrop of a growth starved industrial world, Asia ex Japan accounts for nearly one-half of the 2.5% increase we are currently estimating for world GDP in 2003. Asia, in effect, had become the world's growth backstop of last resort. Therein lies yet another serious risk.
Putting it all together doesn't make for a very pretty picture. In my view, it's starting to seem increasingly unlikely that the world will avoid renewed recession this year. Sure, there's always a risk of getting too negative in the midst of any shock. But there's a confluence of several very tough forces at work right now. And they are coming into play at precisely the point when a US-centric world's long-standing vulnerabilities are most evident. Even if the war ends tomorrow -- and that hardly looks likely -- I worry about the quality and sustainability of recovery in an increasingly dysfunctional global economy (see my March 28 dispatch, "A Dysfunctional World"). While there's no outward evidence yet of the cumulative contraction that could be about to unfold in the global economy, it pays to be wary of being lulled into a false sense of complacency. It's always calmest in the eye of a storm.
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