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Subject: Roach: Global Economic Forum: Global -- Cyclical Rebalancing
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> -----Original Message-----
> From: Love, Beverly (Research) On Behalf Of Roach, Stephen (Research)
> Sent: Friday, September 29, 2006 11:01 AM
> To: eranlsts; erassocs; Warrick, Judith (IBD); globalecon; econmail;
> equitydistribution; europeansales; emall
> Subject: Global Economic Forum: Global -- Cyclical Rebalancing
>
> Cyclical Rebalancing
>
> KEY POINTS
>
> * What's new
> A US consumption adjustment could well be under way - providing
> meaningful cyclical relief to a gaping US current account deficit.
> While this is good news in sparking a temporary correction to the
> world's largest imbalance, it is not sufficient to sustain a lasting
> global rebalancing.
>
> * Conclusions
> There is a mismatch looming between America's contribution to global
> rebalancing and that of the rest of the world: (1) A
> post-housing-bubble consolidation of the American consumer should reduce
> US import demand and boost national saving - key reasons to look for
> meaningful cyclical improvement in the US current account deficit. (2)
> Elsewhere in the world, consumer-led growth remains inhibited by strong
> precautionary saving motives. (3) Consumption in the developing world
> should remain sluggish until these nations make greater progress in
> funding safety-net institutions - especially social security and
> pensions. (4) Consumption in the non-US developed world - especially
> Europe and Japan - should continue to be restrained by the headwinds of
> corporate restructuring imparted by headcount reductions and real wage
> pressures.
>
> * Market implications
> The post-housing-bubble retrenchment of the US consumer is likely to be
> far more immediate than any pickup of consumers elsewhere in the world.
> That would limit the magnitude of any US trade and current account
> improvement and constrain the scope of global rebalancing. But it could
> be an important cyclical down-payment in any case.
>
> * Risks
> The ever-resilient American consumer will eventually bounce back from a
> bubble-related shortfall. If the rest of the world hasn't succeeded in
> boosting private consumption by then, global imbalances will start
> deteriorating once again.
>
> DETAILS
>
> Long the engine of global consumption, the American consumer should
> retrench in a post-property-bubble climate. While this could take a
> cyclical toll on US and global economic growth, it could also provide
> meaningful relief for a massive US current account deficit - the
> principal imbalance of an unbalanced world. And if consumers elsewhere
> in the world finally step up, there might be a powerful and lasting
> impetus to global rebalancing. Sweet dreams for now, but ultimately the
> only way out for a US-centric global economy. What would it take to
> turn those dreams into reality?
>
> The American consumer has slowed. Over the three quarters ending 2Q06,
> annualized growth in real personal consumption has averaged 2.7%. This
> is hardly a collapse. It does, however, represent a meaningful
> deceleration from the 3.7% average growth trend of the past decade - the
> most prolonged and vigorous burst of consumption in the modern-day
> history of the US economy. For ten years, spending by increasingly
> asset-dependent US consumers has exceeded growth in real disposable
> personal income by 0.5 percentage point per year. I suspect the recent
> downshift of US consumption growth is only the beginning. As the wealth
> effect fades in a post-housing-bubble climate and as a meaningful
> downturn now unfolds in the residential construction sector, I look for
> the relationship between income and spending to reverse - with
> consumption growth falling below the underlying pace of income
> generation for at least a couple of years. For the rational consumer,
> this is just another way of saying that the sources of saving will shift
> away from asset appreciation back to labor income. From time to time,
> growth could well accelerate back above the subdued pace of the past
> three quarters; that appears to be occurring right now, as real
> consumption appears to be tracking a 3.5% annualized gain in the current
> quarter on the back of the sharp recent decline in energy prices. But
> with the headwinds imparted by negative wealth effects likely to be long
> lasting and a cumulative contraction in homebuilding activity likely to
> unfold over a couple of years, it will take steady and sharp further
> declines in oil prices to keep the US consumption boom going. That is
> not a bet I am prepared to make.
>
> As the US consumer goes, so goes America's demand for imports. With
> goods imports at a record 14% of real GDP and personal consumption still
> accounting for a record 71% of real GDP, there can be little doubt as to
> the impetus of America's seemingly voracious demand for foreign produced
> goods. And with goods imports fully 77% larger than goods exports, the
> same excess consumption is obviously central to the gaping US trade and
> current account deficits. Moreover, if saving shifts back from being
> asset- to income-based, the national saving rate will also rise. That,
> in turn, reduces America's need to import surplus saving in order to
> grow - and to run massive current account and trade deficits in order to
> attract the foreign capital. For a rebalancing fanatic like myself, a
> consolidation by the asset-dependent American consumer - as long as it
> is orderly and contained - is just what the good doctor ordered.
>
> Yet America can hardly fix global imbalances by itself. The ideal
> rebalancing scenario has to involve consumers elsewhere in the world. I
> am actually quite optimistic that day will come. I just don't think it
> will happen quickly. For most of the past decade, the American consumer
> has provided the only real source of consumption dynamism in the world.
> Europe and Japan have been trapped in structural malaise, and the
> rapidly growing developing countries have relied much more on export-led
> growth models than support from internal private consumption. That's
> especially the case in emerging Asia, where IMF estimates show
> consumption shares of GDP falling from around 70% in 1970 to less than
> 50% in 2005.
>
> The global shortfall of non-US consumption hasn't occurred in a vacuum.
> In the developing world, I suspect that consumers are inclined toward
> what economists call "precautionary saving" - holding back on spending
> and setting aside funds out of fear. That arises because developing
> nations are lacking in the "safety nets" that are so essential to
> instilling consumer cultures. China is an important case in point.
> While it has a 35% household saving rate, a Gallup tally indicates that
> the Chinese have become increasingly dissatisfied with their saving
> positions. With massive layoffs arising from state-owned enterprise
> reforms - headcount reductions totaling at least 60 million since 1997 -
> and without social security, pensions, unemployment insurance, and
> worker training programs, fear-based precautionary saving in China is
> certainly understandable. The good news is that China's newly-enacted
> 11th Five-year Plan makes provisions for funding many of the
> institutions of a safety net. The bad news is that it will take time
> for the programs to take hold, and quite possibly even more time for
> households to trust the security a newly constructed safety net may
> offer.
>
> In the developed world, a different type of precautionary saving motive
> may be at work - especially in the restructuring economies of Europe and
> Japan. Headcount reductions, which are central to corporate
> cost-cutting strategies, instill a deep sense of job and income
> insecurity - inhibiting consumption in the process. That was very much
> the case in the US during the early 1980s and again in the early 1990s
> when restructuring imparted stiff headwinds to both income generation
> and personal consumption. Yet when restructuring finally stabilizes and
> the bulk of the work force comes to the realization that they will be
> spared, workers breathe a collective sigh of relief and consumption then
> springs back to life. That also happened in the US around 1983 and
> again in 1994. Here, as well, the consumption response to the
> restructuring all-clear signal response takes time - deep-seated
> insecurities over job loss and income pressures don't disappear into
> thin air. As I see it, restructuring constraints are still very much a
> factor in Europe - continuing to put a damper on any revival in consumer
> demand. Japan, which is more advanced than Europe in the restructuring
> sweepstakes, has a somewhat greater structural chance for a sustained
> pickup in personal consumption.
>
> All this points to an asynchronous global rebalancing over the next
> couple of years. The post-housing-bubble retrenchment of the US
> consumer is likely to be far more immediate than any pickup of consumers
> elsewhere in the world. That, in turn, suggests more relief on the
> import side of the US trade equation than on the export side. That
> would limit the magnitude of any US trade and current account
> improvement and constrain the scope of global rebalancing. But it would
> be an important cyclical down-payment in any case. The big risk is that
> the rest of the world draws a false sense of comfort from this temporary
> reduction in the US external deficit and fails to make progress on its
> own consumption challenge. If that's the case, once the ever-resilient
> US consumer rebounds from a post-housing-bubble consolidation, global
> imbalances will then start deteriorating all over again.
>
> Stephen S. Roach (New York)
> --------------------------------------------------------
>
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