I realize that macroeconomics is not this board's raison d'etre but it has huge political implications. In this regard, Stephen Roach of Morgan Stanley has penned yet another masterful piece:
Global: Rebalancing Broadens Out
Stephen Roach (New York)
There are many paths to global rebalancing. I continue to believe that a long overdue consolidation of the American consumer will be an important piece of the equation. But there is now good reason to believe that other pieces are falling into place as well -- namely, meaningful improvements in Japan and Germany, the second and third largest economies in the world. This is unambiguously good news on the road to global rebalancing.
My fixation on global rebalancing dates back a little over three years (see Global Rebalancing, May 20, 2002). Since that time, I have placed a good deal of emphasis on the likelihood of a US-centric fix for an unbalanced world -- a fix highlighted by an eventual pullback of the over-extended American consumer. This, in my view, continues to be an unavoidable ingredient of America’s increasingly urgent current-account adjustment. With the US current account deficit widening from 4.6% of GDP in mid-2002 to 6.4% in early 2005, I remain unwavering in my conviction on this aspect of global rebalancing (see Beneath the Surface, August 15, 2005). Yet my emphasis on a US-led global adjustment has been due, in large part, to the absence of alternative candidates to drive the process -- underscored by lagging growth in domestic demand in other major economies of the world. While I have long noted that it is theoretically possible that the rest of the world could, in effect, rise up to meet the US part way, the odds of such an outcome have been exceedingly low over the last several years.
Those odds are now shifting. Japan and Germany -- the world’s second and third largest economies -- now appear to be reawakening from interminably long slumbers. Our Japan team has just made its most meaningful upgrade on Japanese economic prospects in over a decade (see From Bug to Butterfly, August 16, 2005), and there is an increasingly intriguing case supporting the view that Germany could now be next. Our Euro-zone team does not quite share my optimism with respect to Germany but they continue to be hopeful that further important progress is likely on the structural reform front in the aftermath of the upcoming national election (see Elga Bartsch’s, Come Election Night…, August 18, 2005). The significance of these potential developments should not be minimized. It now appears distinctly possible that Japan and Germany could regain more dominant positions as engines of global growth than is the case today.
There is, of course, a long way to go for that to happen. At current exchange rates, Japan and Germany collectively account for only about 18% of world GDP -- about 10 percentage points below America’s 28% share. By way of perspective, it should be noted that it wasn’t all that long ago -- 1995, to be precise -- when there was actual parity at about 25% between the US share of world GDP and the combined shares of Japan and Germany. But a once-balanced global economy then went down an extraordinarily unbalanced growth path. Over the seven-year, 1995 to 2002, interval, the United States accounted for fully 98% of the cumulative increase in world GDP at market exchange rates. Over the same time, the combined shares of Japan and Germany fell to 20-year lows, as Japan became mired in a corrosive post-bubble deflation and Germany sagged under the weight of reunification and an increasingly powerful cocktail of structural rigidities. A surging dollar, and the concomitant weakening of the yen and the Deutsche mark / euro, only served to reinforce this dramatic shift in the mix of world GDP as calculated at market exchange rates. The result was the opening up of a record disparity between the world’s current account deficits (mainly the US) and surpluses (mainly Asia, but to a lesser extent, Europe). With a lopsided world economy on an increasingly unstable path, rebalancing has been the centerpiece of my global macro view since mid-2002.
I have long argued that there are two major dimensions to global rebalancing -- a narrowing of the growth spreads between real economies and a realignment of the world’s relative price structure (i.e., foreign exchange rates). To date, the only real progress that has occurred on the rebalancing front has been concentrated on the currency axis -- namely in the form of a 12% decline in the broad trade-weighted dollar over the past 3 1/2 years. With US economic growth remaining relatively solid, especially in comparison with persistent sluggishness in most other major economies, there has been no meaningful narrowing of growth spreads. Nevertheless, the currency realignment has been sufficient to spark an important first leg to global rebalancing; by our reckoning, the US accounted for an average of only about 15% of global GDP growth in 2003-04 -- about half its share in the world economy and far short of the 98% cumulative contribution over the preceding seven years.
Barring an outright collapse in the dollar -- unfortunately a non-trivial possibility, given America’s outsize current-account deficit -- the next leg of global rebalancing will need to involve a convergence of global growth spreads. There are two extreme developments that can force such a realignment -- a slowing of the US or an acceleration of growth elsewhere in the world. And, of course, there is an intermediate strain of rebalancing that would involve a combination of these two extremes. For the longest time, it seemed as if a US slowdown was the only likely path to global rebalancing. A persistent sluggishness in most other quarters of the world ruled out the alternative. China was a possible exception to this trend, but its 4% share in world GDP underscored the relatively small role it could play in sparking a major shift in the mix of world GDP.
But now Japan and Germany could well be about to enter the rebalancing equation, and that’s a different matter altogether. From the standpoint of their lagging performance over the past decade, there is nothing but upside from here. I could easily envision a scenario whereby the combination of sustained improvement in the growth of both economies, in conjunction with a further appreciation of the yen and the euro, take the collective share of Japan and Germany from 18% of world GDP in 2004 back into the 22% range over the next three years or so. If such a realignment comes to pass, that would be welcome news for the global economy. The persistence of a US-centric rebalancing would have been dominated by the downside perils of a sustained shortfall in US economic growth. By contrast, a more diversified strain of rebalancing that involves improvement in Japan and Germany would temper the growth drag from the US and minimize the disruption to the global economy at large.
That’s why the calls on Japan and Germany are so critical for the rebalancing endgame -- both with respect to impacts on the global economy as well as on world financial markets. Our Japan team believes that the end of the country’s long economic nightmare is finally in sight. Their forecast of 2.5% average GDP growth over the 2005-06 period is sufficient to produce a fractional increase in the GDP deflator by 2006 -- bringing an end to a persistent deflation that has been evident since 1997. The key ingredient to this upbeat prognosis is new hope of a sustained pickup in domestic demand -- not just private consumption but also a significant increase in business capital spending. That is an especially critical development in the rebalancing context. Externally dependent growth in China and other Asian economies that is directed mainly at sourcing the excesses of the American consumer only exacerbates global imbalances. It follows that any adjustment in US consumption -- still a distinct possibility, in my view -- will take a disproportionate toll on externally-dependent Asian economies. Conversely, new sources of autonomous increases in domestic demand are required to alleviate global imbalances. Our newly revised Japanese economic outlook is especially hopeful in that regard.
A turnaround in Germany would reinforce that same outcome. For now, that’s a possibility embraced mainly by the German stock market -- the DAX is up 18% over the past four months and has outperformed MSCI Europe by 3.5% since early July. By contrast, our economists are holding to their forecast of only 1.3% average GDP growth in the German economy over the 2005-06 period. Our European equity strategists are especially intrigued by the micro restructuring story in Germany (see their August 18 Euroletter, “Too Early to Give Up on Germany”). I also find the macro case increasingly compelling. In large part, that’s because German labor markets -- still probably the most rigid in the world -- are less rigid today than they were just a few years ago. Labor unions have lost their industry-wide bargaining power; shortened workweeks are being dismantled; and “flexi-workers” -- part-timers and temps -- now make up more than 30% of the total German workforce. Moreover, with Corporate Germany finally moving aggressively on the IT-enabled capital spending front, productivity prospects look increasingly encouraging. Against that backdrop, micro restructuring is an added plus. In that vein, our bankers tell me that our German deal pipeline has never been deeper; private equity buyers tell me they can’t enough of German assets.
Germany’s upcoming national elections on September 18 could well be the icing on the cake. While Mrs. Merkel’s lead seems to be narrowing, a change in government is still widely expected. Elga Bartsch cautions us against linking political change to dramatic breakthroughs on the structural reform front. Recent history teaches us, however, that shifting political winds matter most when the die is already cast on structural reforms. Such is the legacy of Ronald Reagan, Margaret Thatcher, and possibly even Junichiro Koizumi. The best news for Merkel is that the wind of reform may already be at her back.
The global economy still faces some very formidable problems. Sky-high energy prices are a clear and present danger in the summer of 2005. The excesses of the American consumer remain a serious systemic risk in this unbalanced world. But there are new grounds for encouragement -- especially in Japan and Germany. The world’s second and third largest economies both appear to be at critical junctures in their own long-awaited restructurings. A broadening out of global rebalancing is now a distinct possibility. That is a welcome and encouraging development for the global economy. |
