[lbo-talk] Fwd: Roach on Global Economic Recovery

[joanna bujes]

>Dreamcatchers
>
>Stephen Roach (New York)
>Global Economic Forum, Morgan Stanley
>
>
>The dream merchants are hard at work peddling the tale of another
>economic revival. The magic of postwar relief is widely billed as
>the catalyst. A veil of uncertainty will be lifted — so goes the
>argument — prompting businesses and consumers, alike, to unleash
>the animal spirits of pent-up demand. Just as America led the
>charge to Baghdad, the US economy is now presumed to lead the way
>to global recovery. Prewar malaise will give way to postwar
>healing, and presto — world financial markets will unwind many of
>the trades that have been in place for the past six months. Just
>like that.
>
>To me, this is a leap of faith of Herculean proportions. While I
>certainly concede it is possible to get from Point A to Point B,
>I am hard-pressed to believe that the path will be seamless or
>expeditious. As I see it, there are five myths to the recovery
>call of 2003, each of which draws the postwar healing scenario
>into serious question:
>
>First and foremost, is the myth of another US-led recovery in a
>lopsided global economy. I fully realize that’s precisely the way
>it’s been for so long, that most now take this American-centric
>growth dynamic for granted. Yet global imbalances have now
>reached the point where another burst of US-led growth would be
>inherently destabilizing. Reflecting a US economy that accounted
>for fully 64% of the cumulative increase in world GDP over the
>1995 to 2001 interval, the US current-account deficit hit a
>record $548 billion in the final period of 2002, or 5.2% of GDP.
>If the world stays the path of its US-centric growth dynamic and
>if America’s federal budget goes deeper into deficit, as
>certainly seems likely, the US current-account deficit could
>easily surge toward 7% of GDP. These are external imbalances that
>the global economy has never before had to face, let alone
>finance. Yet the postwar healing scenario presumes that massive
>and ever-widening external imbalances don’t matter at all — and
>that they can be easily financed at current exchange rates and
>other relative asset prices. I don’t buy that. The only way out
>of this trap, in my view, is for a long overdue global
>rebalancing — less growth in the United States and more growth
>elsewhere around the world. Unfortunately, there are no signs
>that such a rebalancing is in the cards.
>
>The notion of a capex-led recovery in the United States is a
>second myth of the global healing scenario. I don’t doubt for a
>moment that balance sheet repair is well advanced for Corporate
>America. What I have a problem with is the belief that such
>progress will spark an imminent revival in business capital
>spending (see my 5 March dispatch, “Capital Spending Myths”).
>There are three serious flaws to this argument, in my view:
>First, most US businesses are still lacking in pricing leverage.
>That means, reflective of a world awash in excess capacity, the
>risks are still biased more toward deflation than inflation. In
>keeping with this depiction, the capacity utilization rate for US
>manufacturers fell to 72.9% in March 2003 — more than seven
>percentage points below the 30-year average of 80.2% recorded
>over the 1972 to 2002 interval. A capex-led revival would only
>exacerbate this overhang of excess supply — the last thing a
>deflation-prone world needs. Second, history tells us that
>capital spending never leads a US cyclical recovery — it responds
>to perceived improvements in end-market demands, mainly for
>consumers. Such demand visibility is not exactly evident these
>days. Third, since information technology now accounts for fully
>55% of total real spending on US capital equipment, many hold the
>view that long-deferred IT upgrades will spark a capex-led
>recovery. This overlooks the enormous consolidation occurring in
>the IT user community, suggesting that there will be fewer buyers
>if and when the IT replacement cycle turns. The notion of an
>IT-led upsurge also sweeps away one of the most painful remnants
>of the bubble-induced excesses of the late 1990s. All in all, I
>suspect that Corporate America will remain quite cautious in
>committing to a new wave of IT projects.
>
>A third myth of recovery is that America has fixed its saving
>problem, thereby removing one of the key impediments to sustained
>economic revival. Nothing could be further from the truth. Sure,
>the US personal saving rate has now moved up to 4.0% — well off
>the rock-bottom level of 0.3% hit in October 2001 but still only
>about half the 9.0 % pre-bubble average that prevailed over the
>1970­94 interval. But that’s beside the basic point. The modest
>rebound in personal saving has been funded by a massive reversal
>in the government’s saving position, as the federal government’s
>budget has swung from a surplus of 2.3% of GDP in early 2000 to a
>deficit of 2.3% in late 2002. As seen though the lens of the
>national saving rate — the combined saving of households,
>businesses, and the government sector — the United States is in
>terrible shape. America’s net national saving rate — which also
>subtracts the depreciation charges associated with the
>replacement of worn-out capital — fell to an all-time low of 1.3%
>in the second half of 2002; by way of comparison, this same
>metric averaged about 5% in the 1990s and considerably higher in
>recent years. This is a proxy for the domestically-generated
>saving left over to fund investment, the sustenance of any
>economy’s longer-term economic growth potential. Lacking in such
>domestically-generated saving, America has no choice other than
>to import surplus saving from abroad and run a massive current
>account deficit in order to attract such capital. But that’s not
>all. As the US federal budget now plunges far deeper into
>deficit — reflecting the combined impacts of a weak economy, war
>and postwar spending commitments, and ill-timed multi-year tax
>cuts — America’s net national saving can fall only further.
>Another myth of the global healing scenario is to presume that
>this just doesn’t matter.
>
>A fourth myth of recovery is to pretend that the deflationary
>scare is over. After all, this was a low-probability scenario
>from the start, goes the argument. And as global healing
>presumably sparks a turn in the business cycle, it seems
>appropriate to revert to the time-honored fixation on inflation.
>A bit of a reality check is in order here. In case you haven’t
>noticed, America is still sliding down the slippery slope toward
>deflation. Sure, a war-related surge in energy prices is boosting
>headline inflation. But the core rate of inflation is receding
>sharply. Excluding food and energy, the US Consumer Price Index
>was unchanged in March 2003 and was up at only a 0.8% annual rate
>in 1Q03; that’s well below its cycle peak of 2.8% in late 2001
>and sufficient to bring the year-over-year comparison in March
>down to 1.7% — nearly a 40-year low. There are three ingredients
>to the case for deflation — a weak cyclical climate that
>continues to restrain aggregate demand, a post-bubble legacy of
>excess supply, and the unrelenting pressures of globalization
>which are leading to intensified competition in both tradable
>goods and services. The perils of global deflation, which first
>reared their ugly head in Asia, still pose considerable risks to
>America and Europe, in my view. This is not the time to sweep
>those risks under the rug.
>
>A fifth myth of recovery is the notion that postwar healing in
>the US is about to spark an economic revival elsewhere in the
>world. Unfortunately, the world is still headed the other way.
>Our European and Japanese teams still see little, if any,
>positive growth in 2Q03. The recent data flow on the Euro-zone
>production front wasn’t quite as bad as we had thought, but the
>trend remains consistent with only fractional GDP growth, at
>best. Moreover, while the just-released annual revisions to the
>Japanese industrial production data were on the upside, as
>expected, the underlying trend still looks quite stagnant.
>Meanwhile, SARS-related downside risks seem to be cropping up
>everywhere in Asia ex Japan. Hong Kong’s economy has come to a
>virtual standstill. Singapore’s government recently noted that
>tourist arrivals are down some 61% (YoY) in the first 13 days of
>April. And Taiwan, Korea, and Malaysia are all bracing for
>SARS-related impacts. China remains the outlier in the region,
>especially on the heels of its stunning 9.9% increase in 1Q03
>real GDP growth. However, in a weakening regional and global
>climate, even the sustainability of China’s growth dynamic can
>now be drawn into question. Total trade — exports and imports,
>combined — hit a record 61% of GDP in the first period of this
>year; that’s up from 50% in 2002 and essentially double the 32%
>reading of a decade ago. Moreover, the growth in exports, alone,
>accounted for 71% of overall GDP growth in the four quarters
>ending in 1Q03; this not only underscores China’s extraordinary
>dependence on the combination of external demand and surging
>outsourcing activity but it also reveals a notable lack of
>autonomous support from domestic demand. In short, there’s little
>reason to believe in the myth that the non-US world is about to
>provide its own spark to the global growth outlook.
>
>The basic problem with the postwar healing scenario is that the
>world was facing many of these problems long before the war in
>Iraq. War, and the stunning victory that has since ensued,
>changes none of that. After all these years, a US-centric world
>now makes for an increasingly dysfunctional global economy.
>Moreover, courtesy of SARS, runaway US budget deficits, and
>lingering structural problems in Japan and Europe, the major risk
>is that the imbalances are about to get worse — possibly a lot
>worse. There’s nothing like the romance of postwar recoveries and
>cyclical revivals. For those of us who choose instead to remain
>cold, calculating, and unemotional, the world still looks like a
>very treacherous place. Call me a dreamcatcher.