By: panarea on Lunedì 25 Ottobre 2004 21:18
il buon vecchio Roach, stavolta molto tranquillo...
Oct 25, 2004
Global: Cracked Facade
Stephen Roach (New York)
The delicate equilibrium in world financial markets may be starting to unravel. The dollar has broken out of its recent range, credit spreads are widening, equities are sagging, and riskless sovereign bonds are well bid. The message is worrisome: For an unbalanced and increasingly vulnerable world economy, the unrelenting rise of oil prices spells mounting risks of global recession in 2005. Financial markets are only just beginning to comprehend this possibility.
There are lots of moving parts to this story. But the one that intrigues me the most right now is the dollar — down 3% against the euro and nearly 4% against the yen in the past two-and-a-half weeks. In my view, this move in the dollar is a “drop in the bucket” for a US economy with a 5.7% current account deficit that could easily climb in the 6.5% to 7.0% zone in the next year. The problem, of course, is that my currency view has been a lonely one over the past nine months. The Teflon-like greenback has begun to reverse some the depreciation of the previous couple of years — unwinding about three percentage points of the 13% real trade-weighted decline that had occurred since early 2002. But in recent weeks, I have felt less lonely, as the official community — both in the US and around the world — has come out in the open in expressing concerns about America’s gaping twin deficits and what they mean for the dollar. Fedspeak has been especially focused on this issue, with at least five Federal Reserve governors and regional bank presidents weighing in on this key risk. I don’t believe in conspiracy theories, but I don’t think this collective expression of concern is an accident.
A weaker dollar has long been the centerpiece of my global rebalancing framework. Macro deals best with global imbalances by changing the world’s relative price structure. With the dollar the world’s most important relative price, depreciation is a perfectly natural way for the global economy to restore some semblance of equilibrium. But don’t expect the world to turn on a dime in response to currency changes. In fact, it has become increasingly clear over the past decade that trade flows and inflation are a good deal less sensitive to currency fluctuations than was the case earlier. In my view, a weaker dollar would, instead, be more of a signaling mechanism — sparking a back-up in US real interest rates as foreign creditors demand compensation for taking currency risk. For an overly-indebted US economy, higher real interest rates would impair credit-sensitive domestic demand, boost national saving, and reduce America’s claim on external saving. These are the characteristics of a classic current-account adjustment.
Yet the world has resisted this adjustment. That’s been especially the case in Asia. Lacking in support from domestic demand, the Asian currency bloc has basically refused to participate in the dollar’s depreciation, putting a disproportionate share of the burden on the euro. Since the dollar’s peak in early 2002, the trade-weighted euro has risen about 20% (in real terms), whereas the trade-weighted yen — a good proxy for Asian currencies — has been basically unchanged. I have referred to the Asian currency zone increasingly as a renminbi bloc, underscoring the key role that China’s currency peg plays in inhibiting other Asian economies from suffering any competitive disadvantage with the region’s super-competitive trading powerhouse. Recent warnings of renewed currency intervention by Japanese Finance Minister Tanigaki underscore Asia’s renewed conviction to resist currency-induced global rebalancing.
The authorities are now swimming upstream. Monthly data from the US Treasury reveal a sharp deceleration of foreign demand for dollar-denominated assets — $61 billion average net purchases in July and August versus a $76 billion average in the prior 10 months. This deceleration is worrisome for two reasons — the first being it has occurred against a backdrop of a dramatic widening of America’s current account deficit, which went from 4.5% in late 2003 to 5.7% in mid-2004. Second, private investors have already turned skittish on the dollar, forcing non-US policymakers to up the ante in filling the void. Over the 12 months ending August 2004, fully 33% of net foreign purchases of long-term US securities have come from the official sector — more than double the 15% share of the prior 12 months and over four times the portion over the 2000-02 period. With private inflows into dollars now going the other way at just the time when America’s external financing needs are exploding, extraordinary pressure is being put on Asian authorities to resist the inevitable.
In the end, this is a losing game. Intervention cannot neutralize the deadweight of America’s massive current-account deficit. That’s the message to take from the recent fragility of the strong dollar. For what it’s worth, I suspect that the dollar’s slide will accelerate sharply in the aftermath of the US presidential election — probably more so in the event of a Kerry victory than would be the case in a Bush win. Senator Kerry’s focus on trade and jobs puts him more in the camp of embracing market-based resolutions to global imbalances. In either case, however, the dollar’s coming depreciation will pose a great challenge for an unbalanced global economy. The flip side of a weaker dollar spells currency appreciation elsewhere — forcing the export-led economies of Asia and Europe to embrace the reforms long needed to unshackle domestic demand. If Asia continues to resist, it faces a growing protectionist threat from both Europe and the United States. I remain convinced that the world’s unprecedented external pressures will be vented in one way or another — through markets or politics, or some combination of both.
Meanwhile, the confluence of a number of other powerful forces is putting added pressure on an unbalanced global economy. Three such developments are at the top of my list. First, oil prices have now averaged in excess of $50 (WTI-basis) for six weeks — satisfying about half the three-month duration criteria that I believe would qualify as a full-blown oil shock. So far, the real side of the global economy has held up reasonably well in the face of this price spike, buying into the long-standing consensus forecast of a sharp and imminent reversal of oil prices. The longer that forecast turns out to wrong, the greater the threat to a complacent world. For this reason, alone, I continue to place a 40% probability on a global recession in 2005.
Second, the China slowdown remains the big gorilla in this unbalanced world. The latest batch of Chinese data point to further, albeit uneven, deceleration in this overheated economy. The September figures on industrial output (+16.2%) and fixed investment (+27.7%) were all a bit stronger than those in August but significantly below the peak rates of comparison earlier this year — 19.4% for industrial production and 43% for investment. The big news, in my view, was a stunning deceleration in Chinese import growth — 22% in September versus a 36% increase in August and 50% peak growth rates earlier this year. This, together with a further slowdown in bank lending, points to the early signs of a long-awaited cooling off of Chinese domestic demand. Data elsewhere from China-centric Asia now corroborate this development — underscored by renewed cyclical weakening in Korea and recent slippage in Japanese export growth. China has a long way to go on the inevitable journey to a soft landing. That will require more policy restraint and entail increased transmission of the China slowdown to its trading partners and commodity markets, in my view.
Third, is the potential unwinding of Pax Americana — a development of staggering implications for a long US-centric global economy. It’s not just the dollar-current-account dynamic described above. It also has to do with the possibility of a diminished US productivity advantage (see my 19 October essay, Productivity Convergence?). And it reflects the unrelenting backlash of re-regulation in the aftermath of the Roaring Nineties — underscored by Eliot Spitzer’s latest forays into the insurance and music industries, to say nothing of Enron-type accounting scandals, Wall Street’s travails, and the Sarbanes-Oxley legislation of 2002. All the stars were in alignment for the US economy in the latter half of the 1990s. But now, lacking in saving, encumbered with massive twin deficits, deeply in debt, and facing a very different productivity-regulatory nexus, America needs to be viewed through another lens. And so does the rest of the global economy as it weans itself from a US-centric growth dynamic.
I’ve been on this global rebalancing kick for about three years. At times, it has worked well as a guide to developments in the global economy and world financial markets. On other occasions, that hasn’t been the case. But I remain convinced that it’s only a matter of time when powerful market forces transform profound imbalances into a more sustainable state of balance. Who knows what lies ahead over the near term in the financial markets? But the message of the past few weeks points to cracks in the façade of denial. I suspect there’s more to come.
