Source Sabri Oncu
Date 03/04/21/18:54


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
1970-94 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.

[View the list]

InternetBoard v1.0
Copyright (c) 1998, Joongpil Cho