Pssst. SSShhhh. A Roach for the new pope...; is he, perchance a pinball wizard too?
Global: Tilt!
Stephen Roach (New York)
An unbalanced global economy is at risk of becoming unhinged. Beset by record imbalances between current account deficits and surpluses, it doesn’t take much to derail a system that is already in serious disequilibrium. Such a possibility now seems less remote in the face of a confluence of powerful blows -- an energy shock, threats to European unity, an outbreak of overt hostility between China and Japan, and the rising tide of US-led protectionist sentiment. Meanwhile, steeped in denial, global policymakers are asleep at the switch. With an unbalanced world lacking the inherent resilience needed to overcome these mounting tensions, the global expansion is now at risk. That conclusion does not seem to be lost on stretched and still overvalued financial markets.
It’s always easy to get swept away by the emotions of the markets, and last week’s sell-off in global equity markets offers many temptations in that regard. The markets are understandably unnerved over the possibility of another growth disappointment. And, on the surface, the March data flow certainly supports these concerns. The softness was global in scope -- not just for the usual suspects like Europe and Japan but also for the two stalwarts in the global growth chain, the United States and China. The US labor market data were lousy (again) and the latest retail sales reports were especially disconcerting. Even in China, import demand has tailed off in the first three months of this year -- expanding at just a 12.2% y-o-y rate in 1Q05, literally one-third the 36% growth pace of 2004. Sure, this could be noise as well, but a softening of import demand is also a classic warning sign of a slowdown in Chinese domestic demand.
Of course, weak incoming data could be just an excuse for the markets’ latest spasm. There’s always a lot of noise in the numbers -- especially with this year’s early Easter. Meanwhile, the so-called energy shock seems to be vanishing before our eyes, with oil prices now threatening to pierce the $50 threshold on the downside just two weeks after it looked as if there would be no stopping the markets on the upside at $60. Sure, there is still a very compelling case as to why energy product prices will continue to rise -- especially gasoline, as many parts of the world now head into the peak seasonal driving season. But the oil price bet has become something of a crapshoot -- there are good grounds to take either side of the market at this point in time. By definition, energy shocks are two-way events -- providing both agony and ecstasy as mean reversion eventually follows most price surges. A reversal of the recent energy price spike could turn the current global slowdown into nothing more than another temporary soft patch. If that’s the case, equities should rebound and bonds sell off. Any such market reversal could be short lived, however, if political risks continue to mount. What’s particularly disconcerting, of course, about the recent equity market sell-off is that it has been concentrated in a period when oil prices have been falling -- not rising. That’s a hint there could be a deeper meaning to all this.
That deeper meaning, in my view, is tied to very worrisome signs of a potential failure in the global policy architecture. Around the world, politicians and policy makers have become a source of increased instability. For an already unbalanced global economy, that’s a very dangerous combination. The interplay between mounting global imbalances and rising political risks raises the odds of a more disruptive strain of rebalancing -- complete with a dollar crisis and a wrenching sell-off in both tocks and bonds.
Cracks in the policy architecture are opening up at a fast and furious pace. The risks associated with the French 29 May vote on the European constitution are a big deal. A rejection -- a little more than a 50-50 possibility at this point -- wouldn’t necessarily spell the end of the European Monetary Union (see Eric Chaney’s various missives on this topic). But a French “non” would serve to underscore what has long been the weakest link in the vision of a United States of Europe -- a centralized monetary policy working at cross-purposes with a politically fragmented fiscal policy. The politicians have already trashed the Stability and Growth Pact -- all but obliterating the notion of a pan-regional budgetary constraint. The French vote could take fragmentation one step further and raise serious questions about the likelihood of a harmonized legal structure -- long viewed as a linchpin of the “straight jacket” that would drive pan-regional efficiencies. This underscores the most basic contradiction of European integration -- politics and economics do not mesh.
That could be a real setback for Europe, especially since some of its stars were finally starting to come in alignment. To its credit, Old Europe has taken some big strides in the area of structural reform in recent years -- especially in coming to grips with the stranglehold of labor market rigidities. France is in the process of dismantling the 35-hour workweek, and in Germany, not only is the workforce more flexible -- with employment growth shifting dramatically to part-time and temporary workers -- but the unions are but a shadow of their former selves. Couple these changes with a long overdue step-up in IT-enabled capital deepening by European businesses and it’s even possible to get optimistic about a possible improvement in European productivity growth. These changes will not vanish into thin air in the event of a French “non.” But if the cohesion of pan-European political will is shaken on 29 May, the case for further momentum on structural change gets harder to make. Little wonder the dollar has been well bid over the past month.
Politics have also turned nasty in Asia. Over the past few years, most of us have been pleasantly surprised by a positive shift in the long tense relationship between China and Japan. As recently as two and a half years ago, Japanese officials were leading the charge in blaming China for Japan’s deflation and the hollowing out of its corporate sector (see the 1 December 2002 op-ed piece in the Financial Times, “Time for a Switch to Global Reflation” by Haruhiko Kuroda, then MOF Vice Minister for International Affairs). Japan has come full circle since then -- embracing China as a growing market for its exports as well as a low-cost offshore production platform that has become a critical ingredient of new efficiency solutions for Corporate Japan. That détente is now at risk. The recent outbreak of political hostilities between the two nations -- exacerbated by a dispute over oil drilling rights in the East China Sea -- unmasks one of Asia’s deepest fault-lines: the ultimate struggle for pan-regional leadership. A China and Japan that pull together provide Asia with a positive-sum outcome. If they grow apart, even a zero-sum result may be wishful thinking. Nationalism is the stuff of political and economic fragmentation -- very much at odds with what financial markets are looking for. That’s the case in Europe and is also increasingly evident in Asia.
Nor is the US body politic exactly an anchor of stability in this increasingly dysfunctional world. Congress has thrown down the gauntlet in its frustrations over an ever-rising trade deficit. The scapegoating of China has become a favorite sport in both the Senate and the House (see my 13 April essay, “Protectionist Perils”). The Bush Administration has now joined the fray, with Treasury Secretary John Snow suggesting over this past weekend that the days of patiently waiting for China to move on the currency front are over. Suddenly, the world is coming to a very different conclusion on China: Once viewed as an unparalleled opportunity, the Chinese miracle is now being viewed as a threat by both the US and Japan. Even in Europe, the China issue has become a source of political conflict -- underscored by debate over ending the arms embargo as well as mounting concerns over an uncompetitive Chinese currency.
The stewards of globalization are nowhere in any of this. Another G-7 meeting has come and gone, and I ask myself, Why do they even bother? The 16 April communiqué was as vacuous as ever. As the world economy lists to the downside, the G-7 states, “…the global expansion has remained robust and the outlook continues to point to solid growth for 2005.” Their primary focus on energy is to, “…welcome efforts to improve oil market data.” And they barely paid lip-service to the “elephant in the room” -- ever-widening global imbalances. The US succeeded in having any references stricken regarding its rapidly exploding current account deficit. The Wise Men appear to be smitten with Fed Governor Ben Bernanke’s recent whitewash of this problem, explaining away America’s external imbalance as an innocent outgrowth of a global saving glut (see Bernanke’s 14 April 2005 Homer Jones Lecture, “The Global Saving Glut and the U.S. Current Account Deficit”). A G-7 having its head in the sand says it all -- the managers of globalization don’t have a clue as to how to cope with the real-time problems of globalization.
Little wonder world financial markets are reeling. An unbalanced global economy is not in great shape. The global growth engine -- the United States -- continues to derive its sustenance from asset markets and the unsustainably low real interest rates that support a wealth-driven impetus to aggregate demand. Not surprisingly, the Bernanke thesis conveniently celebrates the result without looking in the mirror and acknowledging the bubble-prone Fed’s culpability in creating this moral hazard. In the absence of another global consumer, I guess the rest of the world is willing to put up with a lot in order to keep the music going. Policy blunders are bad enough. History warns us that political risks are always the most destabilizing force of all. Those risks are now rising around the world. Beset by record imbalances and mounting political perils, a precarious global economy doesn’t have much to fall back on.
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