Global: Global Rebalancing at Work
Stephen Roach (New York)
The world economy is finally getting on with the heavy lifting of global rebalancing -- albeit grudgingly and not without a new set of tensions. Currency realignments are leading the way, triggering a long overdue shift in a lopsided world’s relative price structure. But a weaker dollar can’t do it alone. Adjustments in real interest rates, a narrowing of saving and consumption disparities, and the imperatives of fiscal discipline are all ahead if global rebalancing is to succeed.
These are the major issues we ponder as we go through the annual ritual of extending our forecasting horizon. Our first cut paints a hopeful picture of tentative progress on the road to rebalancing. We are still looking for a marked slowdown in the global economy in 2005 -- a 3.6% increase in world GDP following a vigorous 4.7% surge in 2004. This represents an upward revision of 0.1 percentage point from our previous forecast of 3.5%, reflecting stronger forecasts for the US and China, partially offset by a weaker prognosis for Europe. Moreover, as we squint into 2006, we see a modest acceleration to 4.0% growth in world GDP. Keep in mind that trend growth in world GDP is 3.7%. Against that benchmark, our new baseline forecast hardly points to exceptional vigor -- just trend growth in the world economy in 2005 followed by a slightly-above-trend outcome in 2006.
Even I have to concede that a number of positives have fallen into place recently. I am on record of assigning a 40% probability to a global recession scenario in 2005 (see my 25 October essay, “Cracked Façade”). However, given recent favorable shifts in oil, the dollar, and China, I now believe that it is appropriate to reduce this risk to 25%. Don’t get me wrong, risk-assessment is not nuclear physics. The probability distribution I place around our baseline view of the world is determined by a combination of analytics, experience, and gut instinct. While it seems reasonable to reduce near-term risks, I am still not willing to go below the 25% threshold on the recession alternative. Moreover, I would stress that a 25% recession probability is more than double the 10% odds that I would normally assign to such an outcome at this point in the global business cycle.
The constructive developments should not be minimized. The recent plunge in oil prices in nothing short of stunning -- 13%, alone, for WTI quotes in the first three trading days of December. I have no idea if this move is sustainable, but it has opened up a $7.50 gap from the $50 threshold that I have long felt would pose great risks to the global economy. Moreover, the dollar’s weakness -- despite the angst of the headline writers -- fits the rebalancing script to a tee. While euro and yen cross-rates are raising discomfort levels in Frankfurt and Tokyo, the dollar’s descent still looks like a well-managed soft landing to me. In real terms, the Federal Reserve’s broad trade-weighted dollar index is down 15% from February 2002 through November 2004 -- a pace that equates to a decline of about 5% per year. That’s a measured and encouraging adjustment path -- provided, of course, the burden of currency realignment now spreads from Europe to Asia, including China.
The China slowdown call is a third encouraging development on the global scene. My early October trip to Beijing was an eye-opener (see my 8 November dispatch, “Rethinking the China Slowdown”). I was especially encouraged by the combination of administrative actions aimed at tempering the excesses of the investment cycle, in conjunction with significant progress on banking reform that appears to be reining in the credit cycle. That led me to believe that the downside to industrial output growth from the 15.7% y-o-y pace in October is far more limited than I had thought. A Chinese hard landing would be a devastating blow to Asia and the rest of the global economy. The odds of that possibility have declined. In our new global forecast, we are raising our 2005 estimate of Chinese GDP growth from 7.0% to 7.8% and pushing out the downward adjustment to 7.0% into 2006.
While I am less concerned about near-term risks, I would hardly characterize that as optimism. In my view, downside risks still outweigh those on the upside by a factor of about two to one -- a narrower spread than I had assigned several weeks ago but hardly one that sends the “all clear” sign. Caution is still in order for several reasons: For one thing, on the basis of earlier run-ups in oil prices, we continue to forecast only about 1.8% growth in industrial-world GDP in 1Q05 -- with just 0.9% growth in Europe, an outright contraction of -0.3% in Japan, and 3.2% growth in the US. Growth at such a subdued pace takes the world dangerously close to its “stall speed.” Should anything else go wrong in early 2005, it wouldn’t take much to tip a stalling industrial world into outright recession.
A second risk comes on the currency and global financing fronts. While the dollar’s descent has generally conformed to a soft-landing trajectory, the possibility of a tougher endgame can hardly be ruled out. Our updated foreign exchange forecast now calls for a sharp depreciation of the dollar over the next six months. Relative to the dollar, we are now forecasting a 1.37 euro and a 95 yen by mid-2005 -- about 15% higher than our previous forecast and levels that could well put significant further downside pressure on externally-dependent European and Japanese economies. Moreover, given America’s record current account deficit, together with the huge dollar overweight in official foreign exchange reserve portfolios -- close to a 70% share of dollar-denominated assets versus America’s 30% share in world GDP -- the possibility of a flight out of dollars can hardly be ruled out.
Nor can I dismiss the possibility that the world flinches, with Japanese and European authorities intervening in foreign exchange markets. Depending on the degree of intervention, it is possible that the dollar’s depreciation could be aborted, or even go the other way. Should that occur, current-account adjustments will come to a standstill -- thereby perpetuating America’s persistently large trade deficit and stoking protectionist sentiment in the US Congress. Equally worrisome would be an asymmetrical response to dollar weakness -- with only Asia intervening. In that case, Europe would continue to bear the brunt of a falling dollar, heightening the possibility of trade frictions between Europe and Asia.
Chinese currency policy is a critical wildcard. If China stands alone in resisting rebalancing, it runs a growing risk of being singled out as a scapegoat by the rest of the world. China bashing could intensify in response -- very reminiscent of the Japan bashing of the late 1980s and early 1990s. The big difference is that a wealthy and relatively closed Japanese economy was able to cope far better with such pressures than might be the case for an open and still relatively poor Chinese economy.
All this is symptomatic of what I have called the global blame game -- the tendency of rebalancing to pit nations and regions against each other in a fashion that could heighten trade frictions and protectionist risks. By pointing the finger at the proverbial “other guy,” the global village will have a hard time accepting the shared responsibility for the rebalancing of an unbalanced world.
The most serious downside risk to our new baseline forecast remains concentrated in the US, in my view -- where we have raised our 2005 growth estimate to 3.7% (from 3.3%) and look for further acceleration to 4.3% in 2006. The US, in my view, remains on a dangerous and reckless course -- consuming out of asset-based saving at a point in its demographic life-cycle when it should be building up income-based saving to fund the looming retirement of 77 million baby-boomers. Record lows in the personal saving rate and the current account deficit, to say nothing of record highs in household sector indebtedness, all speak of a US that is living dangerously beyond its means. Subsidized by unusually low interest rates, in large part underwritten by equally myopic foreign investors and governments, America has managed to keep the magic alive. But there’s nothing sustainable about that arrangement.
If America stays this course, the endgame will not be pretty. The day will come when US interest rates rise -- driven by either domestic or foreign developments. That would undoubtedly spark a painful unwinding of the Asset Economy -- all the more conceivable now that the US housing market is firmly in bubble territory (see my 2 December dispatch, “Bubble Day”). Equally worrisome is America’s anemic job creation and the related shortfall of organic income generation. November’s disappointing employment report was hardly an aberration; it marked the 31st month in this now 36-month old recovery, when job growth failed to live up to cyclical standards of the past. So much for the timeworn consensus view that the Great American Job Machine is finally on the mend. Like it or not, the United States remains mired in the mother of all jobless recoveries -- making the perils of excess consumption all the more worrisome.
As I said, macro risk assessment is as much art as science. Recent developments with respect to oil, the dollar, and China temper my immediate concerns. But the heavy lifting of global rebalancing remains a tricky and perilous undertaking. It is human nature to seek the painless way out. But that’s not the way macro works -- especially for a global economy that is so dependent on an over-extended US economy. An unbalanced world needs a realignment of saving and consumption disparities. To the extent a weaker dollar triggers other adjustments that spark such a realignment -- such as higher US interest rates -- a rebalanced world will be much better positioned for sustainable growth. I’m lowering my 2005 global recession probabilities from 40% to 25%, but the odds of a nasty outcome are still far too high for my liking. |
