Global: The World's Biggest Excess
Stephen Roach (New York)
Global rebalancing has quickly turned into the global blame game. “It’s the other guy,” exclaim Asians, Europeans, and Americans, when the issue of responsibility comes up. America’s Bush Administration views the rest of the world as suffering from a growth deficiency, largely brought about by under-consumption and excess saving. Conversely, Asians and Europeans view the United States as suffering from a saving deficiency brought about by over-consumption and government budget deficits. Who’s got it right?
The truth is, they probably all do. There can be no mistaking the extraordinary disparities in the global consumption dynamic in recent years. Over the 1996 to 2004 period, annual growth in US personal consumption expenditures averaged 3.9% -- nearly double the 2.2% pace recorded elsewhere in the so-called advanced world. Americans, for their part, have spent well beyond their means -- as those means are delineated by the US economy’s internal income generating capacity. Over the 1996 to 2004 period, annual growth in real disposable personal income averaged 3.4% -- fully 0.5 percentage point slower than average growth in consumer demand. As a result, the personal saving rate plunged from an already-depressed 4.6% level in 1995 to just 0.2% in September 2004. At the same time, the consumption share of US GDP surged to a record 71% by mid-2002 -- an extraordinary breakout from the 67% share that prevailed, on average, over the 25 years from 1975 to 2000. Never before has an advanced economy taken consumerism to such excess.
There’s no deep secret as to how the American consumer pulled it off. It’s all about the emerging power of the asset economy -- namely, how US consumers have turned increasingly from income generation to wealth creation in order to sustain current consumption. At work since 1995 has been the strongest and most sustained surge of above-trend growth in real household sector net worth of the modern-day, post-World War II era. American consumers were quick to make use of this windfall as an increasingly important supplemental source of purchasing power.
Moreover, there has been an important shift in the asset economy that took the US consumption dynamic to excess in recent years. The first wave came from the stock market, as household equity holdings surged from about 13% of total assets in 1991 to 35% at the peak in 2000. During the final stages of the equity bubble, individual stock portfolios supplanted real estate as the US household sector’s most important asset. By early 2000, residential property had fallen to less than 25% of total household sector assets, more than ten percentage points below the equity portion. It was only after the equity bubble popped that the asset economy took its most extraordinary twist. The increasingly wealth-dependent American consumer never skipped a beat. In large part, that was because the equity bubble immediately morphed into an even more powerful strain of asset appreciation -- a sustained burst of US house price appreciation that has continued to this very day. As a result, the real-estate share of total household assets rose back to 30% -- recapturing its role as the consumer’s leading asset class. According to Alan Greenspan, American households currently own some $14 trillion in real estate -- almost double their total equity holdings (see his February 23, 2004 speech, “Understanding Household Debt Obligations,” at the Credit Union National Association 2004 Governmental Affairs Conference, Washington, D.C.).
This multi-bubble syndrome was largely an outgrowth of the Federal Reserve’s aggressive post-equity-bubble damage containment tactics -- some 550 bp of monetary easing from early 2001 through mid-2003. Housing markets benefited handsomely from the support of 45-year lows in interest rates. And consumers, who had first discovered the joys of asset-driven wealth effects during the stock market bubble of the late 1990s, quickly put their newfound skills to work in reaping the gains of the housing bubble. Not only did they benefit from the psychology of feeling wealthier, but US homeowners were aggressive in taking advantage of breakthroughs in the technology of home mortgage refinancing. It wasn’t just the reduction in interest expenses, but the so-called cash-outs from rapidly appreciating housing assets enabled consumers to uncover a new and important source of incremental purchasing power. Freddie Mac puts the peak rate of equity extraction and second mortgages from residential property at $224 billion in 2003 -- almost 3% of the total value of home equity investments. Over the 2001-04, annual cash-outs appeared to average around 2% of aggregate home equity -- suggesting that households may have liquidated as much as 8% of their equity in real estate in order to fund current consumption. For an aging US society that needs to build saving in order to fund the not-so-distant retirement of some 77 million baby-boomers, even this partial liquidation of asset-based saving is disturbing, to say the least.
The asset economy does not just have its origins in America. It is very much a by-product of support from global investors and policy makers. One of the outgrowths of an increasingly asset-dependent economy is a shortfall in income-based national saving. America has taken this shortfall to an unprecedented extreme. The net national saving rate -- the combined saving of consumers, businesses, and the government sector after deducting for the depreciation of worn-out capacity -- fell to a record low in the 1-2% range in 2003-04. Lacking in domestic saving, American has had to import foreign saving from abroad -- and run massive current account deficits to attract that capital.
This is where the global enablers enter the equation. First, it was private investors seeking to share in the returns of the world’s greatest productivity story. Then, when doubts surfaced on that front, foreign central banks rushed in to fill the void. Over the 12 months ending September 2004, the “official sector” accounted for 28% of total purchases of long-term US securities -- nearly double the 15% share over the prior 12 months and about four times the portion during the 2000-02 period. This was only the latest chapter in a foreign-inspired dollar-support campaign. Dollar-denominated official foreign exchange reserves surged from $1.1 trillion to $2.1 trillion over the 1998 to 2003 period (as estimated by the BIS at constant exchange rates). That left dollar-based assets with approximately a 70% weight in official reserve portfolios -- more than double America’s 30% share in the world economy and, quite possibly, the biggest overweight in world financial markets today.
Nor is it difficult to discern the motive behind this foreign dollar-buying binge. It’s all about the lack of internal demand in Asia and Europe and the related need to draw support from export-oriented growth strategies. And, of course, central to such growth tactics are cheap currencies that underwrite export competitiveness. Asia has led the way in that regard -- with hard currency pegs in China, Hong Kong, and Malaysia and soft currency pegs in Japan, Korea, India, Taiwan, Thailand, and Indonesia. Asia’s official foreign exchange reserves surged to $2.2 trillion by mid-2004 -- more than double the holdings of early 2000. With the bulk of that incremental surge going into dollars, Americans enjoy a subsidy to domestic interest rates that is very much made in Asia. It’s hard to quantify the exact magnitude of that subsidy but my guess is anywhere from 100 to 150 bp at the intermediate and long portions of the yield curve. That means, in the absence of this foreign support campaign, yields on 10-year Treasuries would have been in the 5 to 5.5% zone -- implying a rate structure that would have been far more problematic in providing valuation support to US asset markets and concomitant wealth-driven support to America’s asset-dependent consumer. With the dollar appreciating over most of the past decade, this was a win-win strategy for Asia -- providing the region with competitive currencies, as well as portfolio gains on dollar holdings. Now that the dollar is going the other way, that calculus suddenly looks very problematic.
As the world now grapples with the imperatives of rebalancing, it is important that all parties understand the roles they have played -- both in creating the problem and in forging the solution. Asset-dependent Americans truly have an excess consumption problem. It is still astonishing to me that the bursting of the equity bubble didn’t spawn a culture of prudence that weaned US consumers from the perils of an all too fickle wealth effect. With US house price inflation now at a 25-year high of 8.8% and with 15 states now experiencing double-digit house price inflation, this voracious appetite for risk is all the more disturbing. Similarly, Asian and European financiers -- be they private investors or central banks -- need to accept responsibility for the important role they have played in keeping the music going for saving-short, over-extended US consumers. They have taken the easy way out -- putting off the heavy lifting of structural reforms needed to unlock domestic demand and choosing, instead, to recycle foreign exchange reserves into dollars and rely on currency manipulation as a means to sell everything they can to America. In my view, America, Asia, and Europe are all equally guilty of opting for an extraordinarily reckless way to run the world.
Financial markets have an uncanny knack in restoring a sense of order to a dysfunctional world. The dollar is now center stage in this global wake-up call -- as well it should be, in my view. But dollar depreciation is not the endgame of global rebalancing. It is the means toward the end -- a potential trigger for a long overdue realignment in the mix of global saving and consumption. By failing to face up to the imperatives of rebalancing, the world has collectively created the ultimate moral hazard -- a US consumer that is now “too big to fail.” This is a serious warning sign. The key to a successful global rebalancing, in my view, hinges critically on facing up to the risks of the world’s most serious excesses. The over-extended American consumer is at the top of that list. And a weaker dollar could well be key in forcing the interest rate adjustments that might well temper the asset-driven excesses of US consumption. This is a shared responsibility that the world must now collectively redress.
Long ago, I learned that most of the time it doesn’t pay to bet against the American consumer. There are rare occasions, however, when that rule doesn’t apply. That was the case in the early 1970s in the aftermath of the first oil shock. Back then, as a young staffer at the Federal Reserve Board, I was chastised by Fed Chairman Arthur Burns for being too negative on the US consumer. He argued that I didn’t appreciate the unflinching cyclical resilience of the US consumer -- a resilience that, ironically, was about to give way to America’s first consumer-led recession. A lot has changed in the ensuing 30 years. But for very different reasons, I now believe that another exception is in the offing. The American consumer is an accident waiting to happen. The sooner the world comes to grips with this problem, the better the chances of a successful rebalancing. |
