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Just to add a supporting dose of reality to this argument, India
recently announced that it would be converting some of its foreign
currency reserves, most of which is currently kept in US Treasuries,
into cash to be used for national infrastructure development.
Regards
DanG
Ben wrote:
Subject: Roach: Global Economic Forum: Global Cracked Facade
-----Original Message-----
From: Roach, Stephen (Equity Research)
Sent: Sunday, October 24, 2004 10:57 PM
To: globalecon
Subject: Global Economic Forum: Global
Cracked Facade
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 is
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 are now corroborating 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.
Stephen Roach (New York)
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