Global: Twilight Zone
Stephen Roach (New York)
Morgan Stanley
Mar 10, 2003
As the world moves on a slow-motion collision course with war,
the wheels of commerce are grinding to a standstill. Financial
markets sense the angst and are hunkering down for the duration.
Of course, we’re all trained to look beyond the shock -- to focus
more on upside of the postwar climate than on the downside of a
prewar paralysis. Yet it seems tougher than ever to make that leap
of faith. That’s because this war could either end the uncertainty or
compound it. It’s as if we’re caught in the twilight zone between
two worlds -- hopeful of a return to a familiar equilibrium but
fearful of the pitfalls of a new disequilibrium. That lingering
uncertainty is not exactly a comforting outcome for financial
markets.
There’s nothing like a quick spin around the world to provide a
different perspective to an increasingly tough global climate. Having
just returned from a 10-day jaunt to Asia and Europe, I found the
world in a very difficult place. The theme I picked up at the recent
World Economic Forum in Davos continues to ring true: A
US-centric global economy is now almost desperate for another fix
from the American growth machine. At the same time, however,
the world is increasingly uneasy with US geopolitical hegemony,
especially with war looming on the not-so-distant horizon. This
asymmetry of global power remains one of the great paradoxes of
our times (see my 27 January 2003 essay in Investment
Perspectives, “The Asymmetries of Globalization”). Nor do I see it
being resolved at any point in the foreseeable future.
On the economic front, the world now appears to be in the early
stages of a fairly predictable shock-induced downturn. America’s
labor market data leave little doubt as to the direction of the next
move in the economy -- down, not up. The only questions, in my
view, pertain to severity and duration. February’s outsize job
losses totaling 308,000 workers cannot be dismissed as
weather-related statistical noise. As indicated by sharply rising
jobless claims data over the past three weeks, conditions in the US
labor market are deteriorating markedly. An oil shock always hits
corporate hiring; the accompanying confidence shock only
compounds the problem. As jobs and income generation come
under intensified pressure, further consolidation of the
over-extended American consumer seems likely. And without the
consumer, the US economy will fold. I reiterate my view that odds
of a recessionary relapse in the United States are high and rising.
Meanwhile, the rest of the world feels the pain even more acutely.
Lacking in domestic demand, a loss of support from America
eliminates the key driver to the externally-driven global growth
dynamic. Barring the immediate emergence of a new source of
global growth, the broader global economy could find itself in real
trouble quite quickly. Asia, in particular, is starting to feel the
impacts of a peaking in the global trade cycle. Korea’s KOSPI
index -- an excellent lead indicator for the global economy in recent
years -- is falling sharply and now is down some 25% since early
December 2002 (with more that 70% of that drop having occurred
since the start of 2003). In my meetings in Japan and Singapore,
there was a growing sense of foreboding. The mood was even
more downbeat in Europe. There’s a growing sense of fear that
Germany -- fully one-third of Euroland GDP -- has already entered
a recession that could infect the remainder of continental European
economies. The Asia and Europe that I saw in the past two weeks
wasn’t just fearful over the war. If anything, they were more
concerned over current and prospective trends in the only true
engine of global growth -- the United States. Unfortunately, that’s
precisely what you would expect in a lopsided, US-centric world.
To be sure, there’s always a case to be made for the upcoming
rebound. In fact, the worse it gets on a near term basis, the more
compelling the case that the business cycle coil will tighten like a
spring. All it would then take to trigger an upturn would be some
form of resolution to the shock. Lower oil prices would follow, the
functional equivalent of a tax cut for the oil consuming industrial
world. Policy stimulus and another inventory cycle would then
reinforce the upside. The global business cycle would then embark
on the time-honored transition from recession to recovery. And the
worst would then be over for bruised and battered financial
markets.
There’s one critical catch to this postwar global healing scenario --
the concept of resolution. No one has a clue as to how this will all
play out. Few doubt America’s military supremacy. But to the
extent that an urban battle is in the cards, collateral damage to the
Iraqi civilian population seems more likely than not. Yet America’s
superior technology works better in the open spaces of a traditional
battlefield (land and air) than it does in the close confines of city
streets. Remember the accidental bombing of the Chinese embassy
in Belgrade in 1999? In my view, the possible loss of civilian lives
would only serve to inflame already hostile anti-war, anti-American
sentiment around the world. Concomitant risks of an Islamic
backlash, to say nothing of further terrorist strikes, can hardly be
ruled out under such circumstances. That hardly speaks of
resolution.
But the biggest risk to the coming war could well be its aftermath --
the stability (or lack thereof) of a postwar Iraq. Little is known
about plans for a post-Saddam regime. Given the largely unilateral
military campaign that looms ahead, the odds favor a
predominantly US-administered effort. The precedent of the
post-World War II occupation of Germany is often mentioned as a
model of success. But the record of history is quite clear on how
the United States consistently under-estimated the burden of a
German occupation. When queried in 1943 as to how long
American soldiers would remain Germany after the war, President
Roosevelt stated, “For at least one year. Maybe two” (see The
Conquerors: Roosevelt, Truman and the Destruction of Hitler’s
Germany: 1941-45 by Michael Beschloss, Simon and Schuster
2002). Despite the desire to bring American troops home quickly
after a likely victory in Iraq, the risk of a prolonged presence in the
defeated nation seems quite likely. Lasting American military
presence in the Middle East could well be a lightening rod for
further backlash and terrorist activity -- hardly the stuff of
resolution either.
Without a decisive postwar resolution, recovery dynamics in the
global economy are likely to be impaired. The downside to oil
prices could be limited. The uncertainly factor could persist --
leaving businesses reluctant to hire and consumers unwilling to
spend. While the case for war is being framed publicly on grounds
of national security, I have little doubt that these economic
concerns also creep into political discussions in Washington. Yes,
there are also logistical considerations (i.e. Middle East weather
and troop morale) that appear to be affecting the rush to battle. But
there are also more mundane economic considerations: The longer
the delay, the greater the chance of recession -- and an economy
that backfires for yet another Bush Administration. On that latter
count, I can’t help but think that the President’s economic plan is in
serious trouble. If national unemployment now starts to rise as the
economy falters, the idea of offering tax relief to wealthier
Americans (i.e., cutting dividend taxes) simply won’t fly in the
Congress. It will then be back to the drawing boards on fiscal
policy -- a bitter pill for the White House to swallow.
It is far too presumptuous for any of us to claim to have the
answers in this twilight zone before war. But the economist can and
should weigh in on matters of the business cycle and on the policies
that can impact the cyclical outcome. In my mind, business cycle
risks are now almost unidirectional -- to the downside. That’s true
of the US and also for a US-centric global economy. A shock has
come at a point of maximum vulnerability in the cyclical climate -- a
combination that has almost always produced recession (see my 5
March essay in Investment Perspectives, “When Shocks Matter”).
This same framework has been equally successful in guiding the
prognosis for the inevitable post-shock recovery. By definition, all
shocks fade -- they either acclimate us to new conditions or there
is a fundamental reversal of the circumstances that led to the shock.
I do not believe that this shock will be the exception to that rule.
But I do sense that the now imminent war in Iraq is not your
average shock. Postwar norms could be very different than prewar
norms. The rules of globalization may well get re-written before our
very eyes. If that’s the case, uncertainty could linger -- an outcome
that would continue to hobble economic growth. We may
understand the business cycle. We may even understand the
structural forces that shape the context in which the business cycle
fluctuates. But we probably don’t have a clue as to how the biggest
risks are likely to play out in this climate of rising geopolitical angst.
And we may not know the answer for a long time. |
