Roach year-end, sorry if it was posted before. It's a great read. Excellent thesis, even if it has a (wisely) hedged forecast.
Closing paragraph is great; I especially like the following:
Equally worrisome is the magnitude of the current state of disequilibrium ? and the distinct likelihood that these unprecedented imbalances can only be vented by big movements in asset prices. My deepest fear is that the longer the venting of these tensions is deferred, the larger the ultimate adjustments and the greater the chances of a hard landing.
Happy holidays!
BC
morganstanley.com
Global: Global Venting
Stephen Roach (New York)
The world economy, as I see it, remains very much in a state of fundamental disequilibrium. A US-centric global growth dynamic has given rise to extraordinary external imbalances around the world. America, the world?s unquestioned growth engine, is facing unprecedented imbalances of its own; the national saving rate, current account, Federal budget deficit, and private sector debt ratios are all at historical extremes. And an increasingly powerful global labor arbitrage continues to keep high-wage developed economies mired in jobless recoveries. The result is a unique confluence of tensions that have left the global economy in a state of heightened instability. The venting of those tensions could well be the main event in world financial markets in 2004.
The case for global rebalancing has been an overarching theme of our macro call over the past year. The urgency of such a realignment in the mix of world economic growth has never been more compelling. Over the 1995?2002 period, the United States accounted for 96% of the cumulative increase in world GDP ? basically three times its 32% share in the global economy. This was, by far, the most lopsided strain of global economic growth that has ever occurred in the modern-day post-World War II era. Two sets of forces have been at work in creating this unsustainable condition ? a US economy that has been living beyond its means as those means are delineated by domestic income generation, and a non-US world that is either unwilling or unable to stimulate domestic demand. As a result, an unprecedented disparity has opened up between those nations with current-account deficits (the United States) and those with surpluses (Asia and, to a lesser extent, Europe). Such an unbalanced global growth paradigm is not sustainable, in my view. The debate is over the terms under which the coming rebalancing occurs.
The macro fix for a lopsided economy is very simple ? it mainly entails a shift in relative prices. For a US-centric global economy, that implies a realignment in the dollar ? the world?s most important relative price. In that vein, a weaker dollar needs to be seen as the principal means by which the tensions of an unbalanced global economy are vented. The broadest trade-weighted index of the US dollar is currently down about 11% in real terms over the past 23 months. History tells us that global rebalancing will undoubtedly require a good deal more dollar depreciation ? perhaps twice as much as that which has already occurred. That poses the important question as to who bears the brunt of the dollar?s adjustment. The Europeans and Japanese believe they have suffered enough and are pointing the finger at others ? mainly China ? to pick up the slack. US politicians are also sympathetic to this line of reasoning. Consequently, the role that China plays in venting global imbalances is also likely to be a key issue in the year ahead. For what it?s worth, I think this debate overlooks a critical consideration: Europe and Japan are wealthy countries that have dragged their feet endlessly on reforms, whereas China is still a very poor country that has been aggressive in embracing reforms. Why should China be called on to compensate for adjustments that Europe and Japan are unwilling to undertake?
America must also bear its fair share in the coming global rebalancing. And the problem is that the US economy is not in the best shape to cope with the requisite adjustments. That?s because it has a record low saving rate, sharply elevated debt burdens, and massive trade and current-account deficits. Nor is growth alone likely to be a panacea for America?s shaky fundamentals. In fact, there are good reasons to worry that another surge of US economic growth could well exacerbate many of these imbalances The pivotal tension point in this regard is America?s anemic net national saving rate ? the combined saving of households, businesses, and the government sector adjusted for depreciation. This key gauge measures the saving that is left over to fund the net expansion of productive capacity ? the sustenance of any economy?s long-term growth potential. Unfortunately, in the case of the United States, there isn?t any ? America?s net national saving rate fell to a record low of 0.6% of GNP in the first three quarters of 2003. To the extent that domestic income generation continues to lag ? precisely the outcome in America?s lingering jobless recovery ? another burst of private consumption, such as that now under way in the second half of 2004, can only push saving lower. That, in turn, puts greater pressure on foreign saving to fill the void ? giving rise to increased trade deficits and private sector indebtedness.
Such an outcome only heightens the tension already bearing down on the US economy. A lasting recovery cannot be built on a foundation of ever-falling saving rates, ever-widening current-account and trade deficits, and ever-rising debt burdens. These tensions must also be vented if America?s nascent upturn is to make the transition to sustainable expansion. The bond market, in my opinion, offers the principal means by which this venting can occur. And the outlook for bonds is not good. A confluence of three bearish forces are at work ? the Fed?s eventual exit strategy from a 1% federal funds rate, a weaker dollar, and America?s fiscal train wreck. Ironically, under these circumstances, you don?t have to be worried about inflation to be negative on bonds. At the same time, if financial markets ever did get a whiff of inflation, a real rout in bonds might ensue. Higher long-term real interest rates do not temper all the imbalances that are on America?s plate. But they could help ? possibly a lot. The key impact would be a reduction in the growth of the credit-sensitive segments of aggregate demand. That would enable a long overdue rebuilding of domestic saving, which would then act to reduce America?s current-account and trade deficits. A lower pace of consumption growth would also go hand in hand with a reduced expansion of indebtedness. A tough bond market may be just the medicine an unbalanced US economy needs.
The global labor arbitrage is a third major source of tension bearing down on today?s global economy. The accelerated pace of replacing high-wage jobs in the developed world with low-wage workers in the developing world reflects the interplay of three mega-forces ? the first being the maturation of outsourcing platforms in goods (i.e., China) and services (i.e., India) on a scale and with scope never before seen. The second factor at work is the Internet ? providing ubiquitous real-time connectivity between offshore outsourcing platforms and corporate headquarters. In goods production, the Internet forever changes the efficiency of supply-chain management. But for services, the Internet is a transforming event ? effectively converting the once non-tradable sector into a tradable global marketplace. With the click of a mouse, the knowledge content of white-collar workers can now be delivered anywhere in the world on a near-real time basis. The unrelenting push for cost control in a no-pricing-leverage world is the third leg to the stool of the global labor arbitrage. Such environmental imperatives only heighten the incentives for IT-enabled ?offshoring.?
While the global labor arbitrage continues to push costs and pricing lower, it does have its dark side. Significantly, it continues to put pressure on job creation and income generation in the high-wage developed world. Largely as a result, consumers in the high-wage developed world end up defending their lifestyles by drawing increasingly on alternative sources of purchasing power, such as asset-driven wealth effects, increased indebtedness, and tax cuts. In my view, vigorous consumption cannot be sustained in the context of the profound income leakage that stems from the global labor arbitrage. That underscores yet another source of disequilibrium that must be vented. In this instance, the venting appears to be exacerbating the pressures bearing down on an unbalanced world. That?s because it has taken the form of heightened trade frictions and growing protectionist risks ? developments that only intensify pressures on the dollar and the US bond market.
The means by which this confluence of tensions gets vented will likely be key for global economy and world financial markets in 2004. There are two conceivable paths to resolution, in my view ? the benign soft landing and the ever-treacherous hard landing. Macro is not good at making the distinction between these two modes of adjustment. Instead, it basically identifies the forces that have given rise to disequilibrium and then depicts the possible adjustments that must take place to reestablish a new equilibrium. As always, the outcome is more dependent on exogenous shocks. In the current instance, the shocks that worry me the most would be those that might shake foreign confidence in dollar-denominated assets; intensified protectionist actions from Washington would be especially disconcerting in that regard. Equally worrisome is the magnitude of the current state of disequilibrium ? and the distinct likelihood that these unprecedented imbalances can only be vented by big movements in asset prices. My deepest fear is that the longer the venting of these tensions is deferred, the larger the ultimate adjustments and the greater the chances of a hard landing. |
