This is the latest article by Mr. Roach I could find,
if you have any recent one, please post. Thanks.
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morganstanley.com
Feb 25, 2003
Global: Rethinking the World
Stephen Roach (New York)
With war looming, oil prices surging, and confidence sagging, a rethinking of our view of the world economy is in order. We are mindful, of course, that the circumstances are very fluid. But the collective judgment of Morgan Stanley’s global economics team is that damage has already been done by the confluence of recent geopolitical developments -- damage that we believe will endure even after a likely war ends. Should these critical assumptions turn out to be incorrect, we will reconsider this assessment. At this point in time, however, it seems prudent to subject our view of the global economy to a much tougher reality check.
This tilt in the world has prompted us to cut our baseline forecast of global GDP growth in 2003 by 0.4 percentage point from 2.9% to 2.5%. At the same time, we are trimming our 2004 estimate of world growth from 4.0% to 3.8%. That brings the cumulative downward revision to global growth to 0.6 percentage point over the two-year period -- one of the largest cuts we have ever made. The downward revision for 2003 has the effect of transforming what we had previously depicted as an anemic recovery in the global economy into a world that is right back on the brink of its official recession threshold (2.5%). Such an outcome would follow two years of unusually sluggish global growth that averaged only 2.4% over the 2001-02 interval. As a result, our forecast implies that the global economy will have experienced a 3.5 percentage point cumulative shortfall from its longer-term growth trend of 3.6% over the 2001-03 interval -- a large “output gap?by any standards. While we continue to project an improvement in the world economy in 2004, our downwardly revised 3.8% growth estimate is only 0.2 percentage point above trend -- a weak recovery by conventional cyclical metrics and hardly sufficient to make much of a dent in a wide global output gap. For that reason alone I think it makes sense to remain in the deflation camp -- even in the face of higher oil and other commodity prices (see my February 21, 2003 dispatch, “One Recession Away from Deflation?.
Our forecast revisions are spread fairly evenly throughout the world. While America is expected to remain the most resilient economy in the industrial world, we have cut our GDP growth estimates for the US economy to 2.1% in 2003 (from 2.5%) and to 4.1% in 2004 (from 4.4%). By Dick Berner’s latest reckoning, growth will be at its weakest in 2Q03 (+0.6%) before the combination of policy stimulus and postwar healing leads to a more vigorous outcome in the second half of this year (+4.5%). Recession-like conditions are expected in early 2003 in most other regions of the industrial world. That’s especially the case in Europe, where we have lowered our growth estimates to just 0.8 % in 2003 (from 1.2%) and to 2.3% in 2003 (from 2.6%). Our Euro team now expects the European economy to contract in the second period of this year after recording only a fractional increase in the first quarter. With year-over-year growth rates expected to hold below 1% in the second half of 2003, Europe emerges as the new weak link in the global growth chain. Shifting geopolitical conditions have also prompted us to pare our Japanese growth estimates, but the downward revision for 2003 is largely offset by a stronger “base effect? stemming from a surprisingly firm 4Q02 GDP estimate (+2.0% annualized). The combined impact from these two sets of considerations leads us to trim our estimate of Japanese GDP growth to 0.6% in 2003 (from 0.7%) and to 0.5% in 2004 (from 0.7%).
In the developing world, where growth remains very much dependent on the global trade cycle, we have cut our forecasts for Asia ex Japan to 5.0% in 2003 (from 5.3%) and to 5.8% in 2004 (from 5.9%). China is expected to remain the most rapidly growing economy in the world, but our downwardly revised 7.0% forecast for the Chinese economy in 2003 (versus our previous estimate of 7.2%) should not be taken lightly in the context of ongoing reforms, restructuring, and associated downsizing of state-owned enterprises. Nor is Latin America expected to be spared from shifting geopolitical risks. Not only have we pruned our 2003 Mexican growth forecast to 3.1% (from 3.5%) in response to a weaker US outlook, but we have also slashed our estimates for Venezuela in light of its lingering strike-related disruptions. As a result, our growth forecast for Latin America has been cut to just 1.3% in 2003 (from 2.5%) while left unchanged at 4.1% in 2004.
When making forecast changes in such volatile times, it’s absolutely critical to be transparent in revealing our assumptions. Higher oil prices are an obvious starting point. Unfortunately, current conditions in world oil markets are already being adversely impacted by low inventories in the Atlantic Basin and by a 2 million barrel per day shortfall in oil production from Venezuela. If Iraq’s shipments are curtailed for any significant period, the world oil market would be lacking another 2.5 million barrels per day. In our view, Saudi Arabia might not be able to offset this shortage immediately -- nor would the release of surplus oil from America’s Strategic Petroleum Reserves. Consequently, we now think that crude oil prices will rise further, peaking at $40 (on a Brent basis) in March with only a modest retreat in April. Thereafter, as military action is eventually successful, we have factored in a gradual decline towards $23 by the end of 2003 (which is consistent with the low end of OPEC’s announced target of $22). On average, we are now building in crude prices (Brent) of $35.40 in 1Q02 (versus a previous assumption of $30.70) and $31.80 in 2Q03 (versus $25.3 previously). Leaving our estimates for the second half relatively unchanged at around $24, that pushes our projected oil price increase for 2003 to 15.6% -- literally three times the magnitude of our previous 5.2% assumption. With crude oil prices currently running more than 85% above their early 2002 levels, it’s no longer a stretch to depict this outcome as a full-blown oil shock.
But it’s not just oil that prompts this revision to our global forecast. Today’s higher oil prices are emblematic of a world in considerably greater disarray than was the case during earlier oil shocks. While few doubt the outcome of the looming war in Iraq, there is great concern and uncertainty over the path to that endgame. Saddam Hussein’s possible use of weapons of mass destruction can not been ruled out, nor can collateral damage to Iraqi civilians, spillover effects to the Israeli-Palestinian conflict, and heightened global terrorist activity. Destabilizing conditions in Korea only add to the problem, as do possible linkages of Korea’s weapons supply chain to Pakistan. The split between America and her allies -- not just many key European nations but also several Asian states -- only heightens the geopolitical instability factor. Nor can we speak with any certainty about the stability of a post-Saddam administration in Iraq -- especially against the backdrop of an increasingly unilateral military action led by the Unites States. Little wonder that confidence has been so shaken.
Moreover, as I have argued previously, the world economy is in a very different place than it was at the time of the last war with Iraq in 1990-91 (see my February 10, 2003 essay in Investment Perspectives, “Two Different Worlds?. Today’s global economy has a one-engine growth dynamic -- the United States. By contrast, the world was firing on all cylinders in the late 1980s before the Gulf War, giving it much greater resilience in the face of a shock. In addition, the world’s sole growth engine is now struggling with a wide array of post-bubble aftershocks -- especially record private sector indebtedness, unprecedented lows of national saving, and a record current-account deficit. Consequently, notwithstanding aggressive policy stimulus, there’s no guarantee that renewed vigor in the US economy will provide much of a lift to a one-engine world economy.
Which takes us to the risks of our new global scenario. As I see it, the risks remain tilted to the downside of our downwardly revised outlook for the world economy. Our new forecast is now at the upper bound of what I would judge to be a 2.0% to 2.5% range for global growth in 2003. Specifically, I continue to fear that America’s authorities will be frustrated by the lack of policy traction in a post-bubble US economy. Pent-up demand, especially for cars and homes, is lacking, and the excesses of the boom have not been purged. Inasmuch as America has yet to withstand an oil shock without tumbling back into recession, I am hard pressed to believe that this will be the sole exception. Nor do I draw any comfort from Europe’s inflexible economy, weighed down by pro-cyclical stabilization policies, an appreciating currency, and the politicization of its reform process. Our Euro Team has now built in a very aggressive 100 bp monetary stimulus by the ECB in the first half of 2003 (see their February 24, 2003 dispatch, "Recession Alert -- ECB (and BoE) to Cut Aggressively"); my fear is that this move will be too late and possibly too little -- especially for Germany, whose deepening malaise questions the most basic premise of EMU that “one-size policies fit all.?/span> Japan’s record over the past 13 years speaks for itself -- the downside is a given until or unless reforms ever begin in earnest. There are those who believe that Prime Minister Koizumi is on the cusp of just such a breakthrough. But even if that’s the case -- and I personally doubt it -- his economics and financial services reform minister, Heizo Takenaka, has publicly admitted that it will take another two years for the Japanese economy to respond. In the meantime, that spells nothing but downside for the world’s second-largest economy in the face of a tough global climate.
In the context of downside risks in the industrial world, the same can be said for the developing world. Lacking in autonomous domestic demand, I continue to believe that growth in the developing world remains very much a levered play on the US-led global trade cycle. The mix of Chinese economic growth in 2002 says it all -- surging exports accounted for fully 74% of that nation’s GDP growth last year. If external demand falters, externally dependent economies will weaken -- it’s really that simple. A weaker dollar adds a new wrinkle to this equation -- trade-dependent economies also run the risk of losing their competitiveness or being increasingly singled out for running uncompetitive currency regimes. Unfortunately, this speaks of heightened global trade frictions -- the last thing a shaky world needs.
As the resident bear, it is easy to get caught up in the angst of a world on the brink. And so it is probably even more critical for me to put myself through an out-of-body experience and contemplate the upside. Yes, the war could go well -- quicker and without all the unintended consequences enumerated above. The world could then come back together in celebrating the end of a tyrannical regime. World equity markets would undoubtedly rally -- ironically, as everyone expects -- and the confidence factor would swing from negative to positive in a flash. A concomitant plunge in oil prices would follow, providing the functional equivalent of a large tax cut for the world economy that could then spark an unleashing of animal spirits. With aggressive policy stimulus the icing on the cake, the global economy could quickly morph from bust to boom. I cannot rule out such a possibility, and there is a part of me that fervently hopes it will come to pass. Unfortunately, it’s not the analyst part of me. As I currently see it, the risks on the downside outweigh those on the upside by a factor of three to one. But should circumstances change and a new wave of global healing commence, my mea culpa will be loud and clear. And we will then do an about-face and take our numbers back up. We live in uncertain and frightening times. More than ever, it may pay to be nimble. |
