November 27, 2000, The latest views of Morgan Stanley Dean Witter Economists
Global: Stall-Speed Perils by Stephen Roach
The slowdown in the industrial world is coming sooner and faster than that implied by our baseline forecast. As a result, global economic growth now appears to be nearing its "stall speed" -- too sluggish a growth rate to withstand a serious exogenous shock, should one arise. This fits the script of our 40% hard-landing alternative to a tee. It is a classic set-up for outright recession. Whether or not that’s where the world is headed, is still a very close call.
The changing growth dynamic is especially pronounced in the United States. It was just a year ago, that the US economy was expanding at an 8.3% annual rate in 4Q99. Our US team believes that real GDP growth in 3Q00 will probably be revised downward from 2.7%, as initially stated, to below 2%; moreover, they are beginning to hint that the pace of economic activity will remain at that subdued pace through the first half of next year. If that’s the case, the year-over-year growth rate in the US economy could go from 6.1% in mid-2000 to about one-third that pace, or around 2%, by mid-2001.
That’s an extraordinary deceleration by any standards. By way of comparison, in the final four quarters of the two previous long-cycle expansions in the US -- that of the 1960s and that of the 1980s -- real GDP growth slowed, on average, to 2.5% -- two percentage points below its pace over the previous year. That’s literally half the slowing that now seems to be in the cards. In each of those earlier periods, there was deep conviction that a soft landing was at hand. But each of the landings was derailed by a shock
-- an auto strike in late 1969 and an energy shock in mid-1990 -- that triggered recession. That’s why I keep coming back to the notion of a stall speed -- a sluggish growth rate that effectively denies an economy any cyclical immunity from the proverbial exogenous shock. In retrospect, the US economy was inching ahead at its stall speed in the late 1960s and the late 1980s, highly vulnerable to a shock. The US is now moving into that same zone of vulnerability.
On the surface, a similar transformation appears to be under way in Europe. Our Euro team is now warning of downside risks to their growth estimates in the second half of 2000 and to their forecast for 2001. GDP data for France, Italy, and the Netherlands came in weaker than expected in 3Q00, and there are strong hints of a similar shortfall in Germany. But the downside for Europe seems better contained than that for the US. Yes, the all-important German Ifo survey of business sentiment is on a five-month downslide; however, this barometer is still at around the "97" level, well above readings in the low 90s and high 80s that were associated with earlier periods of more pronounced cyclical weakness in the German economy in the 1990s. For the third quarter as a whole, our Euro team now concedes that pan regional GDP growth may have been as weak as 2.7%, a shortfall of 0.8 percentage point from their previous estimate of 3.5%. However, that would represent a relatively modest slowing from peak-of-cycle growth rates (around 4%), and it would still leave Euroland expanding by more than one percentage point faster than the US. In short, the growth deceleration dynamic in Europe seems far more benign than is presently the case in the United States.
The story in Japan is more comparable to Europe than the United States. The growth dynamic appears to be moderating yet again, although the slowdown from sluggish to anemic growth is barley detectable. After a decade of stagnation, the Japanese growth dynamic remains confined to a relatively narrow range. Our Japan team estimates that real GDP growth was around 0.9% in 3Q00; while that’s a sharp slowing from the statistically-distorted 7% pop in the first half of the current calendar year, it’s roughly in line with the economy’s trailing four-quarter growth rate. Elsewhere in Asia, we are most focused on Taiwan and Korea, the two countries that seem most vulnerable to a downturn in the US IT cycle. On both counts, the latest news is disconcerting. Export orders growth is now slowing sharply in Taiwan, with the bulk of October’s deceleration traceable to reduced demand from the US. And Korea’s third quarter GDP report -- a 9.2% surge -- was entirely export led, according to Andy Xie; needless to say, should global trade now begin to falter -- and that’s precisely what our industrial world forecast implies -- Korea, with its lack of domestic growth underpinnings, would be especially vulnerable.
On balance, the US economy clearly emerges as the weakest link in the industrial world growth chain. That’s especially the case in light of the powerful growth dynamic the US has imparted to the global economy over the past four years: By our estimates, US GDP growth has averaged 4.8% over the 1997 to 2000, interval; that directly accounted for 1.1 percentage points of world GDP growth, or close to 30% of total global growth, over this four-year period. That’s well in excess of America’s 22% share in world GDP. Moreover, adding in the export linkages to non-Japan Asia, America’s NAFTA partners -- Mexico and Canada -- and export linkages elsewhere in the world, it is quite conceivable that the US has accounted for close to 50% of all global growth since 1997. That brings us full circle to the implications of the stunning deceleration now under way in the US economy: The US-led growth dynamic for the global economy is now clearly at risk.
Notwithstanding these concerns, it is important to stress that the notion of a stall speed is quite complex. As such, one should not mechanistically generalize on the basis of past episodes of cyclical vulnerability. Each cycle is different, and each one is brought to an end with its own set of excesses. For example, the unwinding of the long expansion of the 1980s was very much influenced by the US real estate bubble and the exposure of banks and S&Ls to that bubble; the cash flows required to service the excessive indebtedness quite simply could not be met in a slow-growth climate. That may have been decisive, in conjunction with an oil shock, in undermining the self-sustaining dynamic of an expansion that had reached its stall speed. While those excesses are not in play today, a different strain is -- the telecom financing bubble and the related IT overhang. Could they be the functional equivalent
of the financial excesses a decade ago? Time will tell. In the meantime, there’s no getting around it -- stall-speed perils are now at hand.
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