Global: Close Your Eyes
Stephen Roach (New York)
Another G-7 meeting has come and gone. And what has been accomplished? Next to nothing, in my view. The club of the world’s wealthiest nations has punted on the big issues facing the global economy — namely, unprecedented current-account imbalances, currency misalignments, mounting trade tensions, and the liquidity-prone biases of central banks. The G-7’s latest communiqué is emblematic of the increasingly vacuous rhetoric of globalization. This is a perilous course of inaction for a global economy beset with record imbalances.
Meanwhile, there is no stopping the process of globalization itself — especially insofar as the cross-border integration of the global economy and world financial markets is concerned. World trade now stands at a record 28% of world GDP —up nine percentage points alone from the share of the early 1990s. Turnover in foreign exchange markets is approaching $2 trillion per day. Courtesy of the Internet, the dissemination of information and technological breakthroughs is both instantaneous and ubiquitous. Cross-border connectivity of labor markets, product markets, and even so-called non-tradable services is occurring at a sharply accelerating rate. The hard wiring of globalization is largely in place. Yet very little progress has been made on the soft-wiring front, namely, the globalization of collective actions by national governments and policy makers.
When push comes to shove, the so-called global village is still reluctant to pull together and accept the shared responsibilities of globalization. Significantly, this reflects inherent flaws in the policy architecture — with a Euro-centric G-7 (four of the seven votes going to the UK, Germany, France, and Italy) ill equipped to cope with the imbalances of a US-centric global economy. But it also reflects the resistance to tackling the big issues of globalization. That came through loud and clear at this year’s World Economic Forum in Davos —not just in the economic debate but also in discussions over the weighty issues of global poverty and disease, the environment, debt relief, and ever-present geopolitical tensions. After all these years, while the world community talks globally, it still acts locally. To me, this remains the great paradox of globalization. The primitive policy architecture of globalization is misaligned with the fundamentals of cross-border integration. That’s a very risky way to deal with mounting global tensions.
Yet these tensions have an uncanny knack of reminding us of the fault lines in the global economy. Left unattended, imbalances have consequences. The forces of disequilibrium are invariably vented in real economies and asset markets. Markets certainly do respond to the price signals that arise from such disequilibria. That’s what the multiyear correction of the dollar has been all about. That’s also what’s behind the Chinese currency debate (see my 11 February dispatch, “China’s Choices”). And markets also put pressure on policymakers — both fiscal and monetary authorities —to cope with imbalances. The big question is the nature of the policy response. Lacking a robust framework of collective global decision making, the risk is that the “wise men” fall back on what they know best — nation-specific remedies. And that’s exactly what seems to be occurring today as an unbalanced world reverts to yet another US-centric growth gambit.
That’s certainly the message that can be taken from Washington. The Bush Administration has pledged to cut the budget deficit in half over the next four years. But with tax hikes ruled out, deficit reduction hinges largely on spending cuts focused on only the 18% of the budget that qualifies as nondefense discretionary spending (ex homeland security). And that, of course, ducks the thorny issues of supplemental funding of Iraqi-related defense outlays, to say nothing of the potentially huge transitional cost of funding Social Security privatization. The only way the math works in achieving the multiyear deficit reduction target is through a growth-induced windfall of tax revenues. In that regard, the economic assumptions of the Bush Administration resemble the “rosy scenarios” of past budgets —five years of 3.3% average growth in real GDP, with nary a cyclical shortfall in sight. Once again, America’s fiscal policy rests on the belief that growth is the rising tide that lifts the revenue boat. America’s fiscal discipline is not about tough choices —it’s a classic supply-side growth gambit.
America’s central bank also has the growth bug again. The current stance of monetary policy certainly bears that out. Five monetary tightenings later and the federal funds rate is only now just 25 basis points above the core CPI inflation rate and still some 80 bps below the headline inflation rate. Moreover, the futures markets are priced for only another two to three measured rate hikes of 25 bps each by mid-2005. The presumption, in this instance, is that that the Fed wouldn’t dare go any further in challenging the growth of the real economy. That means the markets believe that the Fed’s growth fixation won’t allow it to take the federal funds rate back to just a neutral setting —probably somewhere in the 4.25% to 5.0% zone.
We’ll know more about the Fed’s intentions this week as Alan Greenspan delivers his semi-annual policy report on Capitol Hill. But it’s fairly clear that the Chairman has rejoined the pro-growth camp. That’s certainly the message that can be taken from his early February speech on the current account, which was laced with optimism on US fiscal policy and newfound hope for a market-induced resolution of America’s gaping external deficit (see my 6 February dispatch, “Confession Time”). In this view, which has been warmly embraced by financial markets, deficits haven’t really mattered from the start. Asset-dependent American consumers don’t need income-based saving, nor should they be the least bit fearful of piling up asset-backed debt to keep on spending. After all, Asian financiers will gladly subsidize US interest rates under the proviso that Americans keep buying Asian-made products that are made all the more affordable by undervalued currencies. It’s worked for a decade, goes the logic, so why not give it another try?
Growth-starved as ever, the rest of the world seems equally delighted with this turn of events. That’s especially the case in Europe where vigorous growth remains as elusive as ever. While the cyclical shortfall in near-term European growth may not be quite as severe as we once thought, the best we can see on the upside is 2%. And European policy makers have a very different mindset when it comes to growth priorities. At the recent World Economic Forum in Davos, I asked ECB President Jean Claude Trichet point blank if he could ever contemplate a situation when European monetary authorities would be willing to provide special support to domestic demand if their externally led growth model were derailed by a further strengthening of the euro. His answer was an unequivocal “no.” For different reasons, Japanese and Chinese authorities find it next to impossible to envision circumstances that would cause them to move their foreign exchange reserve portfolios dramatically out of dollar-denominated assets. The fallout on US interest rates and the collateral damage on economic growth would make such a move “suicidal,” in the words of a senior Asian official in Davos.
And so it’s back to the well for another spate of US-centric global growth. That would represent a disappointing reversal following two years of progress on the road to global rebalancing. In both 2003 and 2004, the US accounted for an average of just 18% of the gains in world output (at market exchange rates), far less than America’s 30% share of world output. That followed a seven-year spurt of unprecedented US-centric global growth, when the US accounted for 98% of the cumulative increase in world GDP from 1995 to 2002. I have always envisioned rebalancing as a two-dimensional process — a narrowing of growth disparities as well as a realignment of the world’s relative price structure (i.e., currencies). The rebalancing of 2003–04 was purely of the latter strain — it did not arise out of a narrowing of the growth differentials between the US and the rest of the world. In fact, in 2004, US GDP growth of 4.4% was nearly two percentage points faster than the 2.5% growth recorded elsewhere in the industrial world. Instead, it was a currency realignment that drove the rebalancing of the last two years — a broad trade-weighted dollar that by the end of 2004 had fallen 16% in real terms since peaking in early 2002. But it was progress nonetheless.
That progress is now at risk. Another slug of US-centric global growth flies in the face of the rebalancing framework that continues to shape my macro view of the world economy. It now appears that the heavy lifting is being put off for another day. For this latest growth gambit to work, financial markets will need to acquiesce — containing interest rate pressures on the upside and dollar pressures on the downside. The risk remains, in my view, that some external event will crack the denial, leading to a weaker dollar and higher US real interest rates. Recent market action makes those risks seem all the more remote. A new mindset has taken hold: Close your eyes, hold your breath, and watch an unbalanced world up the ante with another growth gambit.
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