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To: Jim Willie CB who wrote (1673)	10/8/2003 8:02:26 PM
From: Jim Willie CB	Respond to of 108699

Global: America's Political Gambit Stephen Roach (New York) Oct 3, 2003 Keep your eye on politics. As I see it, the struggle for control of America’s White House -- and all the policy options that spin out of this struggle -- could well be the single most important factor shaping world financial markets over the next 13 months. I fully realize how parochial this statement sounds. But we live today in an extraordinarily US-centric world. One number says it all: Over the 1995 to 2002 interval, the United States accounted for fully 96% of the cumulative increase in world GDP (at market exchange rates). For a world lacking another engine of growth, the economic repercussions of the US political cycle could have a hugely disproportionate impact on the rest of the global economy. Other nations may not like being put in that position. But having abdicated control of their own economic destiny by failing to stimulate domestic demand, those are the cards they have been dealt. Timing is everything in Hollywood and Washington. Given the well-known lagged impacts of traditional stabilization policies, actions being taken today could bear critically on the environment a year from now -- precisely the time frame when presidential politics will be most intense. In my view, that could have been the decisive consideration behind the Bush Administration’s efforts to bring currency policy into play at the recent G-7 meeting in Dubai. The fiscal and monetary instruments of America’s policy arsenal were already fully engaged. Runaway federal budget deficits and a 1% federal funds rate don’t exactly lay open the possibility of much further stimulus from these avenues. Foreign exchange policy is the third leg of the macro policy stool, but one that works in mysterious and often unpredictable ways. Since the start of 2003, the Bush administration has been tinkering with America’s so-called “strong dollar policy” -- a mainstay of the Clinton administration. The Dubai G-7 communiqué represented a wholesale shift away from this stance -- an action that I believe was orchestrated by the US to have maximum impact on the upcoming presidential election campaign. The logic behind this strategy is not hard to fathom. While the US economy is growing very rapidly at the moment, an incumbent Bush administration cannot afford to take the risk that this newfound vigor could give way to a relapse by mid-2004. Another growth scare at that juncture would be the worst of all possible outcomes for a sitting president embroiled in a tough reelection campaign. As is the case in financial markets, the political calculus is all about probabilities -- in this case, weighing the risks of the major macro forces that are likely to be shaping the economic climate a year hence. In that vein, incumbent politicians cannot afford to dismiss the case for a relapse. As I see it, there are two big risks to just such an outcome, the first being a payback from the current growth spurt. That’s a distinct possibility in light of this summer’s surge of consumer spending on durable goods, especially motor vehicles. These items are called “durable” for a reason; they are long-lasting items that tend to be purchased infrequently. As such, any unusual bursts of durable goods spending invariably bring forward demand that borrows from future sales -- the core of the classic “stock-adjustment” models of economics. Over the next few months, the risks of just such a payback are hardly inconsequential. Driven by the combination of tax cuts and aggressive sales incentives of hard-pressed producers, motor vehicles sales surged to an astounding 19.4 million unit annual rate in August. On the back of that binge, the durables component of real personal consumption rose in August to an annual rate 35% above the 2Q03 average -- pointing to one of the sharpest quarterly gains on record. Not even the overly indulgent American consumer can sustain such an explosion of buying for long, and the September reading of a 16.7 million unit annualized selling rate for vehicles seems to be the first sign of a fairly normal payback. Bush Administration officials have boasted that their latest fiscal stimulus was “front-loaded” -- guaranteed to provide a quick boost to the US economy. The risk is that the spring has now been sprung. If that’s the case, the encore of the payback effect could shift the odds back toward a relapse -- an outcome that would have important policy and political consequences. The second risk is jobs -- the defining issue of our times. If America’s jobless recovery doesn’t come to an end by the time the presidential campaign gets under way in earnest, the Bush administration will be facing one of its worst political nightmares. There is hope in many quarters, of course, that hiring is set to rebound, especially now that GDP growth has turned more vigorous. But those hopes are critically dependent on the time-honored linkages between aggregate demand and domestic labor input. The structural overlay of what I have called the “global labor cost arbitrage” challenges that key presumption. IT-enabled outsourcing in goods and services provides low-cost offshore options for US-based multinationals that could crimp hiring indefinitely. Such employment leakages also threaten the sustainability of the current growth upsurge -- constraining wage income generation and thereby eroding the traction that normally converts policy stimulus into the cumulative dynamic of sustainable recovery. The currency lever does address one aspect of America’s job shortfall. Taken to its extreme, it has the potential to affect relative cost comparisons between domestic and foreign labor input. But problems arise with respect to both long lags and the order of magnitude of the dollar depreciation required to make US labor rates more attractive. Those shortcomings of the “weak-dollar cure” are what have opened the door to the dangerous alternative of protectionism. Politicians believe it is now up to them to take explicit action to deal with unfair competitive pressures that are impeding US job creation. Both houses of the US Congress have already taken such initiatives, targeting China and its currency policy as the culprit. Senate legislation to impose steep tariffs on China has six co-sponsors, and a comparable bill in the House has over 60 co-sponsors. Lacking the patience to wait for market-based currency realignments to rebalance the world, America’s short-sighted politicians have made China bashing the new sport in this jobless recovery. Where this stops is anyone’s guess. But unless there is quick and meaningful relief on the US job front, pressures for the political fix will only grow. The most worrisome aspect of this possibility is that there is no effective counterweight anywhere in the political spectrum. That is not the way politics normally work in America. Usually, Congress threatens to go over the cliff and the White House steps in at the last minute and prevents disaster. The Reagan administration’s resistance to Japan bashing in the 1980s is a classic example of how these checks and balances work. That’s not the case today. Political support for actions against China is broad-based -- by party, ideology, and geography. Nor does today’s White House seem philosophically and pragmatically prepared to take a stand in opposition to such actions. Indeed, by leading the charge on steel tariffs in 2002, the Bush administration has already laid its protectionist cards on the table. In a jobless recovery -- and this one is unlike anything the modern-day US economy has ever experienced -- politics take on a new importance in shaping financial market outcomes. For America and the rest of this US-centric world, I fear the political gambit has only just begun.