NYT -- Stephen Roach piece on "bursting bubbles" / deflation.
September 22, 2002
The Costs of Bursting Bubbles
By STEPHEN S. ROACH
LONDON - A year after terrorism dealt a seemingly lethal
blow to America, talk of resilience and economic recovery
is in the air. The nation's inflation-adjusted gross
domestic product has risen for four consecutive quarters
following a mild downturn in the first nine months of 2001.
While the estimated 3.2 percent growth rate over the past
year is subdued when compared with the more vigorous
rebounds of the past, the hope is that it's a down payment
on bigger and better things to come.
But while Sept. 11 was a defining event for America, it was
not a defining event for the economy or the financial
markets. That role belongs to the stock market bubble of
the late 1990's that finally popped in March 2000. There
was far more to the excesses of the 1990's, however, than
an asset bubble. The bubble expanded high enough, and for
long enough, to have infected the behavior of consumers and
businesses alike.
The equity bubble helped to create other bubbles - most
notably in the housing market and in consumer spending.
Their continued existence poses a serious threat to lasting
expansion - and yet, puncturing them raises the grave risk
of deflation. This suggests the economy will prove as
challenging to America's political leadership as any other
issue in the year ahead.
There is good reason to believe that both the property and
consumer bubbles will burst in the not-so-distant future.
If they do, there is a realistic possibility that the
United States, like Japan in the 1990's, will suffer a
series of recessionary relapses over the next several
years. Yet denial remains deep, just as it was when the
Nasdaq composite index was lurching toward 5,000. Few want
to believe that this economic expansion may be built on
such a shaky foundation.
The evidence in support of a housing bubble is compelling.
The 27 percent increase in inflation-adjusted American
house prices since 1997 represents the sharpest five-year
increase since 1945. This surge is about three times the
increase in real housing rents over this period. (The
divergence of home prices and rents, which usually move in
tandem, is one measure of the speculative element of the
housing market.) As their property values rise,
hard-pressed consumers have been quick to extract
purchasing power from their homes, taking advantage of low
interest rates to refinance their property and use the
savings to buy cars, furniture, appliances and other luxury
goods. Thus the ever-expanding property bubble has become
central to the culture of excess that is now driving the
United States economy.
The consumer-spending bubble will undoubtedly be the last
to pop. Short of savings and long on debt, an aging
American population must begin to come to grips with the
looming realities of retirement. Yet it must now do so in
an era of defined contribution pension plans whose
performance has been battered by a devastating bear market
in equities. We all know that Americans are addicted to
shopping. Yet we also know that, if they want to retire
with any kind of financial security, they must increase
their savings and rein in their spending.
What might cause the consumer-spending bubble to burst?
It's hard to say, although several realistic possibilities
come to mind - a spike in oil prices, a surge of
white-collar layoffs or a collapse of the property bubble.
Any one of those developments could send a wake-up call to
the American consumer, thereby denying the United States
and the broader global economy its main source of support.
But it gets worse. The saga of the post-bubble United
States economy doesn't stop with the bursting of the
housing and consumer bubbles. Since these events are likely
to occur when inflation is already running at a very low
rate, they could push the United States into a period of
outright deflation - a decline in the nation's overall
level of prices for goods and services.
This is a rare and worrisome condition for most economies.
The impact of deflation would be most acute for wage
earners and debtors. To stay profitable, companies would
have to cut jobs or wages, eventually inhibiting consumer
purchasing power. And the fixed obligations of indebtedness
would have to be paid back in deflated dollars, squeezing
overextended borrowers all the more.
America is already on the brink of deflation. Our broadest
price gauge, the G.D.P. price index, recorded just a 1
percent annualized increase in the second quarter of 2002.
That's the lowest inflation rate in 48 years. Prices of
goods and structures - covering nearly half the economy -
are already contracting at an annual rate of 0.6 percent.
Only in services, where price statistics are notoriously
unreliable, are prices still rising.
The hows and whys of America's deflationary perils will
long be debated. Two sources seem most likely. First, the
bubble-induced boom of business capital spending led to an
overhang of new information technologies and other forms of
capital equipment in the late 1990's. The result was excess
supply, a textbook recipe for lower prices.
Also at work are the unmistakable effects of globalization.
The modern-day American economy now has a record exposure
to global competition. In the second quarter of 2002,
America imported a third as many goods as it produced, well
in excess of the 20 percent ratio prevailing at the onset
of the last recovery in the early 1990's. Significantly,
more and more of these goods are coming from highly
competitive Asian producers who have much lower cost
structures than their American counterparts.
Moreover, with the exception of Korea, every major Asian
economy is now in the throes of its own deflation.
Consequently, courtesy of ever-expanding trade relations
with Asia, America is now buying more and more from
countries like China and Japan that are already in
deflation. The growing share of these increasingly cheap
foreign goods helps drive down prices of products made at
home, thereby deepening deflationary pressures.
History tells us that when major asset bubbles burst,
deflation is often the result. That was true of the United
States in the 1930's and Japan in the 1990's. Most are
quick to claim that America is not Japan - that its more
flexible, dynamic economy stands in sharp contrast to
Japan's economic inertia. But the United States is already
a lot closer to the deflationary edge than most concede -
and it could go further.
Deflationary risks can never be taken lightly in a
post-bubble economy. Yet that's precisely what American
investors and policy makers now seem to be doing. If the
housing and consumer bubbles pop, then the risk of outright
deflation will only increase. It's time to stop pretending
this can't happen in the United States.
Stephen S. Roach is chief economist and director of global
economics at Morgan Stanley.
Copyright 2002 The New York Times Company. |
