Global: Looking Backward from Morgan Stanley
Stephen Roach (New York)
Looking Backward: 2000-1887, by Edward Bellamy, was the most celebrated utopian novel of the 19th century. Written
in 1888, Bellamy framed a vision of a pristine future set in Boston in the year 2000. It was premised on the logical
culmination of the emerging industrial revolution -- a celebration of the triumph of technology over the human condition
that only a socialist system could offer. Unfortunately, as one historian put it recently, Bellamy suffered from "the same
blind spots (that) commonly afflict utopian predictions." He erroneously concluded that the past was prologue for what
was about to unfold.
Are we guilty of the same sins today? Such is the dilemma now gripping world financial markets. Yes, at one level, the
recent past paints a truly glorious picture of the next utopia. That?s especially the case in the United States, widely deemed
to personify all that is perfect about the future. Inflation has been down and is presumed likely to stay so. Growth has been
vigorous and is expected to remain so. Riding a powerful wave of technological change -- the sustenance of earlier utopian
dreams -- the productivity miracle of the past several years is expected to continue indefinitely. Wage inflation is
considered to be a malady of a different past. The dollar?s recent strength is taken as a given for the foreseeable future,
reflective of a global groundswell for anything American. Hard-won Fed credibility is believed to be a near-permanent
feature of the financial landscape, effectively putting a ceiling on interest rates. And so on.
Notwithstanding such deep convictions, there is now good reason to draw each of these suppositions into serious question.
The presumed permanence of the productivity miracle is a case in point. Once any economy hits a zone of full
employment, productivity gains invariably fade. The reason -- the pool of productive workers simply gets depleted. Maybe
that?s the lesson of the just-released 1Q00 productivity report -- a 2.4% annualized gain, less than half the 5.5% pace of
the preceding two quarters. Recent stirrings on the wage front pose a similar challenge to utopian like investor
expectations; that?s the clear message from the 4.3% annualized increase in the Employment Cost Index in the 12 months
ending in March 2000, a sharp acceleration from the 3% pace of a year earlier. The same is true of the steady updrift in
core CPI inflation that has occurred over the past seven months. Moreover, the recent surge in the dollar has convinced
many that external imbalances -- such as America?s record current-account deficit -- simply don?t mater. Watch the flows,
they tell me -- forget about the fundamentals. That?s the type of call that always works -- until it doesn?t. When the flows
turn -- and I remain convinced they will -- all of sudden, the fundamentals quickly start to matter again.
It?s also quite possible to raise the same objections to utopian-like expectations regarding Fed policy, interest rates, and the
economic growth outcome. The Fed is now clearly in motion, and the debate is increasingly focused on the speed and
magnitude of coming rate hikes; this is a far cry from long-standing expectations that the central bank had little work to do.
The bond market is now responding accordingly to this rethinking of the Fed path. And then there?s the great growth
debate -- soft landing or hard? Either case is, of course, arguable. But the bottom line is that financial markets are now
increasingly focused on the downside risks to US economic growth -- very much at odds with our own prognosis of
ongoing vigor. With the Fed on the move, investors increasingly believe that the authorities will want something to show
for their efforts. A weaker growth outcome could well be that trophy. In short, there are plenty of early warning signs that
the other side of the American utopia bet is about to come into play.
I don?t mean to single out the United States. Utopian forecasting techniques are alive and well elsewhere in the world. In
statistical parlance, they show up in the form of autoregressive investor expectations, heavily influenced by the inertia of
recent outcomes. For example, the recent weakness of the euro is now widely expected to persist -- a reflection of all that is
presumed to be inherently flawed about EMU. Japan?s stagnation of the past ten years is still thought to be the operative
force in restraining economic growth for some time to come. In short, the new world order that has emerged in the past
several years -- one that seems to have violated many of the macro rules of the past -- is widely believed to be a precursor
of what lies ahead. Just like Bellamy.
Yet, there is an alternative explanation that can account for many of the same outcomes. Rather than a new utopian-like
paradigm, it may well be that the world was simply subjected to a huge deflationary shock from the global currency crisis
of 1997-98. That suggests that the world economy simply bought more time on the cyclical clock. With such a deferral of
cyclical pressures coinciding with a burst of powerful technological innovation, it?s easy to see why the utopia bet was put
on. But with the cyclical clock now ticking once again, that position could well be at risk.
The key lesson from Bellamy is to look ahead, not backward. Alas, that?s easier said than done, especially if it forces
investors to make valuation concessions. To the extent that the business cycle is now coming back to life, the hopes and
dreams of yet another utopia could be shattered. In the end, Julian West, the main protagonist of Looking Backward
finally exclaimed, "I have had an extraordinary dream, that?s all ... a most extraordinary dream."
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Global: Foreign Investment and the U.S. Consumer
John Montgomery (New York)
Much has been written about U.S. preeminence in technology and the importance of that for driving foreign investment in
U.S. companies. I have spilled some of the ink on this subject. I think, however, that it is easy to exaggerate the importance
of the New Economy in driving foreign investment in the United States. A look at recent announcements of cross-border
M&A suggests that another factor may be more important: the importance of accessing the U.S. consumer market. Many
of the targets have been consumer product companies. Even last year's biggest deal, the acquisition of a U.S. cell-phone
company, was arguably driven by the attractiveness of the U.S. market.
As Dick Berner has written, we are in a "golden age" for the U.S. consumer. U.S. consumer spending grew 5.3% in real
terms last year, and he expects growth to exceed 5% again this year. Overall, the U.S. economy grew 4.2% last year, and
should grow 5.1% this year. And estimates of long-run potential growth have ratcheted up from around 2 1/4 % to 3 1/2%.
Other countries have not seen that kind of expansion in underlying growth. All this makes the U.S. an attractive market,
and foreign direct investment is an important means of serving that market.
U.S. consumption (and business investment) has created heavy demand for imported goods, and that's a big reason for the
growing U.S. trade deficit. The strong dollar also contributes by making foreign goods cheaper. Direct investment may
help substitute for some of this, but that's not likely to make a big dent in the near term in the rising current account deficit
(the trade deficit's cousin that also includes investment income). Over time, the U.S. will see outflows of income payments
on the investment. Before that, however, continuing direct investment, while it won't substitute for imports, is providing
much of the financing for the current account deficit, and contributing to the strong dollar.
Direct investment is helping to support the U.S. market, and the U.S. market is helping to support U.S. consumption. The
dollar is a beneficiary of this virtuous circle. But a virtuous circle can turn vicious. One break in any part of the chain -
foreign investment, U.S. consumption growth, or the stock market - could reverse the whole process. Than would help put
downward pressure on both the dollar and U.S. markets. That's a risk, and U.S. technological strength wouldn't prevent it. |
