Global: A Different America
Stephen Roach (from Singapore)
America has spoken. And while the election outcome was close, the verdict was decisive. The recent past could well be prologue for what now lies ahead. Moreover, given Republican gains in the House and the Senate, a second Bush Administration will have a much better chance of converting its activist policy agenda into action. From my perch as an economist, there is a deeper meaning to all this. A very different America has emerged that will put new pressures on itself and on the broader global economy. This will likely have profound and lasting implications for world financial markets.
Since September 11, 2001, Bush Administration policies have been increasingly ideologically driven. That’s true of foreign policy and economic policy, alike. The election outcome points to more of the same. With respect to the US economy, that offers little chance of a traditional about-face on fiscal policy. Instead, under the guise of tax reform, temporary tax cuts are likely to become permanent. On the spending side of the equation, ongoing expansion of outlays for defense and homeland security are likely to swamp any cosmetic reductions in the nondiscretionary components of government expenditures. In that context, federal budget deficits of at least 3% of GDP are likely for as far as the eye can see. For a US economy that is lacking in private saving, this implies a chronic shortfall of overall domestic saving. And that, of course, spells an equally chronic US current-account deficit problem and all of its associated stresses and strains -- namely, foreign financing imperatives, dollar risks, and protectionist perils.
The only hope for meaningful relief from such daunting imbalances is for the US to grow its way out of this mess. This, of course, would be consistent with one of the basic tenets of supply-side economics -- the so-called self-financing nature of reductions in marginal tax rates. And that takes us squarely to what I believe will be the centerpiece of the economic strategy of a second Bush Administration: Courtesy of the election outcome, I see a new pro-growth consensus emerging in Washington. This will come to be seen as the only means by which the US can finesse its imbalances -- fiscal, current account, debt, and saving. But the next Bush Administration can’t pull this off alone. At home, it will need the cooperation of the Federal Reserve and, overseas, it will need the support of politicians, other policy makers, and major central banks.
All this spells the possibility of a world that is about to up the ante on the US-centric global growth paradigm that has now been in place since the mid-1990s. And that raises the most important question of all: Is this gambit likely to work? In examining the feasibility of such an approach, it pays to ponder what it would take for America and the world to deliver another several years of US-centric global growth. As I see it, there are three key requirements for the world to execute such a strategy:
First, America must stay the course of rapid productivity growth -- in effect, holding to the elevated 3% annualized trend that has been in place sine 1995. Only then can the Fed, in all good conscience, maintain its pro-growth policy bias -- holding interest rates lower than might otherwise be the case for a rapidly growing US economy. Such a lasting productivity dividend would also be a powerful magnet in fostering sustained foreign buying of dollar-denominated assets -- key to the external funding of America’s massive current account deficit. If the US succeeds in remaining the world’s greatest productivity story, private foreign investors will most assuredly want a piece of the action.
Second, the rest of the world will have to remain content in its role as suppliers and financiers of excess American consumption. By inference, this implies that non-US domestic demand growth must remain subdued, especially private consumption. Were that not to be the case, there would be a draw-down of surplus overseas saving, leaving less available to be recycled into dollar-based assets. That would temper Asian currency intervention -- pushing their currencies higher, putting their export-led recoveries at risk, and effectively dismantling the interest rate subsidy that Americans are currently enjoying. Feeling the heat from a surge in interest rates, overly-indebted US consumers would quickly be in serious trouble.
Third, the world must up the ante in embracing a pro-trade growth strategy. Growth in global trade -- which has averaged 6.5% since 1985 -- will need to keep expanding well in excess of growth in world GDP, which has averaged 3.5% over the same period. That will require a Herculean effort in the current climate. In particular, it basically means the dollar can’t fall. Or if it does start to weaken, the depreciation has to be managed with exquisite precision in order to produce a long and drawn-out soft landing. The world must also be more than willing to accept record current account and trade imbalances without turning protectionist. To the extent that the Asian bloc maintains its quasi dollar peg, that means Europe will have to be unusually tolerant in bearing a disproportionate burden of any dollar weakness that does emerge. Acceptance of persistently large US trade deficits will also require great patience from newly-empowered American politicians.
How realistic are these assumptions? Not very, in my view. For starters, I believe that America’s once glorious productivity miracle is about to wind down (see my 17 September dispatch, “Productivity Endgame?”). The impetus from slash-and burn-cost cutting, together with IT-enabled capital deepening, has probably hit its maximum. Increased tendencies toward re-regulation should also undermine the productivity story in the years ahead. As to the second point, reform agendas around the world -- from Asia to Europe -- are focused on dismantling structural rigidities in labor and product markets and thereby unshackling domestic demand. To the extent these actions are successful, private non-US saving will come down -- leaving less of a surplus to recycle into dollars and putting more pressure on foreign central banks to fill the void. Overseas monetary authorities can take on that responsibility -- but only temporarily. Over time, there are outsize welfare costs associated with eventual dollar depreciation to consider, let alone the potential inflationary risks associated with excess liquidity creation.
Perhaps the most worrisome risk of another US-centric growth gambit comes from its protectionist implications. Is it really reasonable to expect Europe to remain passive if Asia refuses to accept the burden of any further dollar depreciation? Similarly, is it reasonable to expect a newly-reelected US Congress to condone America’s massive trade deficits in the context of what is likely to be a lingering jobless recovery? For what it’s worth, my guess on both counts is no. Politicians don’t get macro -- they don’t understand the relationship between domestic and foreign saving, between current accounts and interest rates, between budget deficits and trade deficits, and between any deficit and jobs. Yet politicians do get the message from increasingly disenfranchised workers. To me, that could well prove to be the sternest test of all for the global body politic in the years immediately ahead. I fear that there is a growing risk that the pendulum of free trade could swing in an increasingly protectionist direction, with Asia likely to bear the brunt of the pressure.
Finally, there’s the fundamental flaw of the growth gambit, itself. To the extent that tax cuts aren’t self financing -- precisely the case with the supply-side initiatives of the 1980s -- there is the distinct possibility that the whole experiment will backfire. Depending on whether the Federal Reserve accommodates such a fiscal stimulus, ever-wider budget deficits could actually be accompanied by ever-increasing debt burdens, further reductions in personal saving, and renewed vigor in domestic demand. Given the shortfall of national saving that would imply, along with the high import propensity of incremental growth in domestic demand, there could be a significant further deterioration in already massive US current-account and trade deficits. That would only exacerbate America’s problematic dollar-interest-rate conundrum -- posing a huge risk to financial markets. Such are the perils of trying to grow your way out of an unbalanced macro climate.
These are heady days for the Bush Administration as it now looks forward to its second term. But unlike the case four years ago, the economic climate today in the US and around the world is beset with a number of profound imbalances. The ideological fervor of supply-side economics urges Washington to go for growth in attempting to finesse these imbalances. My guess is that US politicians will, indeed, play that hand. Yet it will require a new “coalition of the willing” to pull it off -- the Fed and other major central banks, as well as a broad consensus of politicians and policy makers around the world. With such a likely pro-growth gambit, the US is implicitly sending a very strong message to the rest of the world that it has no choice other than to go along for the ride. That puts Asia and Europe in the uncomfortable position of perpetuating their subservient position as suppliers of goods, services, and capital to saving-short Americans.
All this paints a tough picture of a new world order. In the years immediately ahead, the United States will be asking more and more of the rest of the global economy to keep America’s magic alive. I don’t think we in the US and those in the world at large truly appreciate the significance of this sea change. But America is now different and so is the global dynamic that spins out of a deeply entrenched US-centric paradigm. The election verdict of November 2 solidifies that conclusion beyond the shadow of a doubt, in my view. Maybe it will all work out perfectly, and those of us worried about deficits and imbalances will finally be put out to pasture. Anything is possible, but something tells me it’s not time for grazing just yet.
morganstanley.com |
