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World economy: major bear suddenly turning optimistic

by Jerome a Paris Wed May 3rd, 2006 at 06:07:54 AM EST

Stephen Roach, for a very long time a very bearish observer of the world economy, and a fellow worrier about global imbalances and the great liquidity bubble of the past few years, has suddenly turned moderately optimistic.

I'll comment his text below, but I'll say two things upfront:

  • I do not share his optimism;
  • even if he is right, it means little good for the general population.

From the diaries - whataboutbob



It was back in 1999 when I argued that "Global Healing" would allow the world to make a stunning comeback from the ravages of the worst financial crisis in 60 years. My enthusiasm was short-lived, however, as the cure led to the mother of all liquidity cycles, multiple asset bubbles, and an unprecedented build-up of global imbalances. While an unbalanced world has yet to shake its hangover from global healing, I must confess that I am now feeling better about the prognosis for the world economy for the first time in ages.

The reason: The world is finally taking its medicine -- or at least considering the possibility of doing so. Central banks are carefully adjusting the liquidity spigot -- taking advantage of the luxury of low inflation to move very slowly in doing so. This delicate normalization procedure is necessary to prevent wrenching financial market crashes that would spell curtains for an asset-dependent world. Meanwhile, the stewards of globalization -- especially the G-7 and the IMF -- have finally come to grips with the imperatives of facing up to the perils of global imbalances. They are now hard at work in developing a multilateral solution to a multi-economy problem. At the same time, orderly currency adjustments appear to have resumed -- and this time, in the right direction. Ever so slowly, the dollar is being managed lower -- in keeping with the relative price shift that a long-overdue US current account adjustment needs. As always, there are still plenty of serious risks -- especially oil, geopolitics, fiscal paralysis, and protectionism. But the world now appears to be getting its act together, and that encourages me.

Basically, he is optimistic because he sees the Central Banks finally acknowledging the problem (of excess liquidity), announcing they will do something about it, and talking about global cooperation to do it in an orderly fashion.


Central banks have been aided in their post-bubble tactics by an unexpected ally -- a persistent disinflation. Courtesy of a rapidly spreading globalization of both tradable manufactured activity and once nontradable services, powerful structural headwinds have dampened inflationary pressures that might have normally arisen from a cyclical recovery in the world economy. This has provided monetary authorities with the luxury of moving slowly in weaning economies from their post-bubble medicine. Had inflation responded more to the traditional pressures of the closed economy -- namely, domestic unemployment rates and capacity utilization rates -- monetary policy would have been forced into a more activist post-bubble tightening mode. Instead, the ongoing disinflation of increasingly open economies has transformed the role of central banks. Rather than playing the destabilizing function of leaning against the inflation cycle, the authorities have been given license to focus more on a goal of "normalization" -- seeking to put policy rates on a neutral setting that is neither too tight nor too easy.

Central Banks are able to move in a slow, purposeful fashion because they do not have to fight inflation. Thanks to globalisation (read - China's massively disruptive entry into world markets), wages have been kept down, and so has inflation.

With all the benefits of the bubble staying in the financial and corporate worlds, and not creating that messy inflation (usually caused by consumers getting paid better, and spending their hard earned money on their neighbor's/co-citizens' wares), no need to tighten things up.

In other words, as workers never benefitted from the recent (unbalanced) growth in the first place, there is no need to punish bankers for having too much fun and lending recklessly (i.e. investing too much and overpaying for it).


Another important part of that solution is the end of the US housing bubble and the wealth-dependent excesses of consumer demand this bubble has supported. For that reason, I am also encouraged that the froth now seems to be coming out of the US housing market; recent blips in the monthly data on home sales run against this conclusion, but the trend has been decidedly lower since last summer. Moreover, the latest data on the Employment Cost Index underscores a persistent deficiency on the labor income side of the equation. Consequently, as the wealth effects from asset bubbles fade, I continue to believe that pressures will build on income-short American consumers -- setting in motion the only realistic fix to America's gaping current account deficit.

In other words: the US consumer never benefited from the binge in the form of investment, jobs and wage increases, but only through the possibility of going into debt further and further. And this is about to end - but slower than feared (which is, for Roach, the bit of good news he is focusing on today).

Sop the middle class did not see the boom, but will bear the bust - but it's a good thing because if the bust touched the financial bubble, it would be catastrophic!

So the choice is between catastrophic crisis, or a slow motion crisis bearing only on debt-laden consumers. I guess the latter is indeed less bad, but isn't it strange that those that benefitted most from the boom (the financiers and the rentiers) are the first that need protection and care for their fate in bust times ? Is that what capitalism is all about? (yes, I know, rhetorical question)

And in any case, Roach is still hedging his bets...


I assure you that I am still mindful of the ever-present risks that beset a very fragile world. Oil prices above $70 are especially worrisome for the world's oil consumers. The income- and saving-short American consumer concerns me most in that regard -- especially as the wealth effects from the US housing bubble now start to fade. The mounting geopolitical risks associated with the "Iran problem" -- all too reminiscent of the build-up before the Iraq War -- only compound my fears that oil-related disruptions of the world economy are here to stay. Nor do I dismiss the politically-induced backlash to globalization that has raised the distinct possibility of an outbreak of protectionism; Washington-led China bashing remains the biggest risk in that regard. And speaking of Washington, the US is rapidly becoming the global poster child for fiscal irresponsibility -- not exactly a constructive development for the world's biggest borrower.

Altogether, color me skeptical that anything good is going to happen to the middle classes in the near future.

Display:

New oil shock ahead as $100 spike looms

The growing international crisis over Iran's nuclear programme could trigger a catastrophic oil price spike, sending crude prices over $100 a barrel, senior Wall Street analysts are warning.

(...)

A single political shock could be enough to send oil markets into panic, said Adam Sieminski, senior energy economist at Deutsche Bank in New York. 'If we have one more big problem we are going to have triple-digit oil prices.' Sieminski points to confrontation with Iran, a worsening of the situation in Iraq or a recurrence of devastating hurricanes in the Gulf of Mexico as potential catalysts for a major rise.

Prices rose by as much as $1.20 in late trading on Friday after the United Nations inspector Mohamed El Baradei said Iran had not complied with demands to disclose the extent of its uranium enrichment programme. Iranian President Mahmoud Ahmadinejad later said he 'did not give a damn' about the UN's opinion.

In a report, Sieminski argues that with the world consuming some 85 million barrels of oil a day, a supply disruption of 2 million barrels a day (60 per cent of Iran's exports) 'can only be rebalanced through an extraordinary rise in prices.'

But he believes any breaching of the $100 level would be short-lived, and that prices would fall to between $30 and $60 as increased investment brings new production and refining capacity on stream in oil-producing nations.

(There is no "new production", because there is no "new investment", because there is nowhere to invest in.)


Crude hits new high on Bolivia worries

Brent crude oil touched yet another record high on Tuesday after Bolivia's decision to seize control of foreign-owned gas fields added to market concerns about disruptions to global supplies.

IPE June Brent peaked at $74.97 a barrel while Nymex June West Texas Intermediate hit $74.89. West Texas hit its record high of $75.35 a barrel in April.

Saudi Arabia's oil minister warned that further terrorist attacks on the country's oil facilities were likely but that the world's largest producer was committed to ensuring 1.5m to 2m barrels a day of spare capacity.

This move to calm fears over the market's ability to cope with any further supply squeeze contradicted earlier comments from Iran's deputy oil minister.

He warned that crude could reach $100 a barrel as supplies could not be increased in the short term, raising the pressure in the stand-off with the West over Iran's nuclear ambitions.

I think my question is - what will be the title of my next countdown series? Countdown to $200, $500, or $1,000 oil?

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue May 2nd, 2006 at 06:05:05 PM EST
If the dollar is going to tank $100/bbl is way too easy.  Switch to yuan.

I'm so glad the Roach thinks there is a reasonable chance the financial and corporate elites can party on. Possibly they can all move to one continent; having only one private army would save money.

by tjbuff (timhess@adelphia.net) on Tue May 2nd, 2006 at 08:51:22 PM EST
[ Parent ]
Bankers have been lending recklessly, just to firms in the M&A (mergers and acquisitions) business. I still fail to understand how market share is a relevant measure of anything. Unless you are a monopoly (Microsoft) you still can't set prices independently of the competition, regardless of whether you have 25% or 35% of the market.

I think oil will not go much higher because at these prices it is already starting to put a damper on economic activity. GM and Ford both announced lower sales because of less interest in SUV's. We already discussed the large cash reserves firms now are holding, so it seems they are preparing for a slow down and refraining from new investments.

There should be some canary in the mine that signals the down turn. Perhaps some pseudo-luxury like bottled water or shoes. Seeing a decline in non-essentials could point to the loss in buying power.

Unfortunately I'm not smart enough to figure out what the indicator is, or to know what to do about the coming economic decline. The last one I watched closely (1970's) was bad for all types of investments, stocks and bonds.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Tue May 2nd, 2006 at 09:45:30 PM EST
Galbraith. Porter.

Threshold market share allows you to join the oligopolistic competition on "quality" and "marketing" rather than price.

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 06:07:17 AM EST
[ Parent ]
In that connection, seldom are two products equivalent to the extent that only price matters. Ordinary supply-and-demand-curve analysis applies at best to commodity trading, not to general retail.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 06:15:38 AM EST
[ Parent ]
Indeed.

And to pick a nit with myself, this reading of Galbraith/Porter (throw in a few others if desired) is by no means universally accepted as valid or empiracally correct. It is however common currency in a lot of large corporations.

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 07:14:29 AM EST
[ Parent ]
The question I have is:

If the debt-laden consumers are the ones hit by Roach's scenario, how do the bankers and rentier's remain unaffected? Surely a large part of the financial boom has been borne out of the borrowings of these "ordinary people?"

I know each individual borrowing provides nothing like the volume of profit of one "M&A deal" in a merchant bank, but most of the system is bound together. When the retail arm of banking suffers, then doesn't the industry as a whole tends to come under pressure?

Not to mention that as consumers buy less, companies come under pressure too, hence their banking trade can be volatile also?

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 06:10:27 AM EST
But when banks fail because of their irresponsible lending, the government bails them out at taxpayers' expense, so no need to worry.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 06:14:22 AM EST
[ Parent ]
Ah yes. Silly me.

Along similar lines, the safest investment in the world these days is in the largest hedge funds as they are guaranteed a bail out, because without one the shockwaves will really throw the world economy into chaos.

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 07:16:12 AM EST
[ Parent ]
Hedge funds... Er... do you have $1M handy to invest in those?

How big are the big "global-macro" hedge funds and how many of them are there?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 07:17:52 AM EST
[ Parent ]
Well, I wasn't advocating it for people like me! ;-)

I think the best investing I'll manage is probably a stout pair of walking shoes for the incoming oil crisis.

Hmmm, This link indicates that hedge funds only total around 1 trillion dollars. (Roughly $750 bn concentrated in the top 200 and $75 bn in the top 5.)

That's a bit smaller than I had heard.

I'm not sure how leverage plays into these figures either.

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 07:25:38 AM EST
[ Parent ]
How about inflation-indexed government bonds?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 07:29:06 AM EST
[ Parent ]
I was just snarking really, I'm fairly positive a good investment strategy is "see what Metatone does and then pick something, anything else.."

However, prseumably inflation indexed bonds of a government you believe will still be here at the end of the crisis are one of the safest ways to store money?

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 07:32:45 AM EST
[ Parent ]
The only reason I'm lukewarm about the idea is that I'm pretty confident our governments are cooking the inflation statistics. But at least if the going gets rough and the government decides to inflate their way out of the mess, your investment is protected. Now, is it?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 07:37:17 AM EST
[ Parent ]
Well, they are doing their best to keep energy and housing out of the inflation statistics in various places.

So, I guess it depends on how much energy and housing matter to you... ;-)

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 07:39:08 AM EST
[ Parent ]
Even beyond that, they are cooking the books.

But help me out here. Property values have been going up by about 10% per year for a few years now [I just happened to deduce from the council tax booklet I got from the borough the alleged 1991 value of the property I rent, and compared with the current local prices...], so the mortgage payments for a newly blught property have been going up by the same amount (roughly) so rent payments for equivalent properties have also been going up by 10% a year. And about 1/3 of people's after-tax income is taken by housing expenses, so there goes over 3% inflation. Am I wrong?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 07:45:26 AM EST
[ Parent ]
Well, of course you're not wrong in principle.

But, I would guess that the cooking involves some sleight of hand about the amount of after-tax income spent on housing. That presumably is the key assumption.

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 08:49:20 AM EST
[ Parent ]
There is something definitely not right about assuming that people spend 1/3 of their income on housing and that 1/3 fraction remains constant... Unless people are also downsizing their living quarters to keep their housing expenses within bounds, which is a definite possibility.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 08:52:59 AM EST
[ Parent ]
Ah, but surely the downsizing only works properly in the rental sector (and even then there are contract restrictions.) If you are paying back a mortgage, your flexiblity to downsize is limited by the ease of selling your house?
by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 09:13:00 AM EST
[ Parent ]
Your mortgage payments are fixed and not affected by inflation (again, to a first approximation).

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 09:46:48 AM EST
[ Parent ]
I think the best investing I'll manage is probably a stout pair of walking shoes for the incoming oil crisis.

I can just see the City of London choked with bikes like Far Eastern countries are now. Just think of the air quality - ah bliss. Suddenly the thought of $100 oil just makes me think "Bring it on" - didn't somebody else say that once ?

keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Wed May 3rd, 2006 at 07:49:56 AM EST
[ Parent ]
I don't understand why anyone would want to drive in London. The other weekend we had friends visiting and they insisted on renting a car to come in from the airport (never mind the airport bus stops 15 minutes away from our home). They took two or three times as long to get to our place than they would otherwise. Then they ended up stranded on a tesco parking lot for hours at a time twice, and we took 3 hours each way for a day out in Brighton (it takes under 2 hours if you take the tube and train). A friend of mine quite aptly calls London "the black hole" as it is almost impossible to get out of it.

Why? Why?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 08:00:08 AM EST
[ Parent ]
Because you're free in a car. Independent, soaring above the masses and their public transport.
by Colman (colman at eurotrib.com) on Wed May 3rd, 2006 at 08:15:16 AM EST
[ Parent ]
Er... I'm looking down on them from the upper deck of my double decker. Our 4-year old has that all figured out, he loves it up there.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 08:16:28 AM EST
[ Parent ]
I think anyone who drives in London is mad, or drives to Brighton - get a network card for the train (£9 return).

I'm with Migeru, public transport is the only way to get around the South East.

keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Wed May 3rd, 2006 at 09:51:39 AM EST
[ Parent ]
Well, if you want to move at your leisure around the Brighton area but not in Brighton proper, a car would come in handy. But then you'd be better off taking the train to Gatwick and renting a car from there.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 09:54:29 AM EST
[ Parent ]
This scared Brad de Long...
by Colman (colman at eurotrib.com) on Wed May 3rd, 2006 at 06:24:52 AM EST
There is this vary insightful comment to his post: (my emphasis)
Oh my god.

The terminal phase of a bubble comes when the strongest doubters of the bubble start to doubt their own doubt and believe the crazy rationalisations for illogical valuations. After all, a bubble is often just a reflection of market participants changing their beliefs. If almost everyone's beleifs have been changed there is nothing left to fuel the bubble.



A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 06:30:16 AM EST
[ Parent ]
My reaction too...

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed May 3rd, 2006 at 06:44:16 AM EST
[ Parent ]
Link-hopping about DeLong's blog I came across the new-fangled concept of dark matter in economics. Has it been diaried on ET by the economics experts?

[It seems that, not content with emulating early 19th century physics, now economists want to emulate the wholly speculative physics post-1975 - sigh]

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 06:46:34 AM EST
[ Parent ]
I've seen references to that ... hadn't followed up though.
by Colman (colman at eurotrib.com) on Wed May 3rd, 2006 at 06:50:39 AM EST
[ Parent ]
It is the subject of a detailed and longish post from Brad Setser  from January.
by Deni on Wed May 3rd, 2006 at 02:40:31 PM EST
[ Parent ]
DETROIT (Reuters) - U.S. auto sales fell in April as high gas prices hurt sales of most sport utility vehicles and trucks, leading to a further erosion of market share for U.S. automakers against their Asian rivals.

The slower sales for the traditional Big Three immediately sparked a fresh round of consumer incentives including interest-free loans on Tuesday.

Toyota Motor Corp. posted an almost 9 percent gain and Honda Motor Co. notched a 6.5 percent rise in stronger-than-expected sales, while General Motors saw sales drop 7 percent and Ford lost 3 percent.

That must be the free market at its best, rewarding smart companies and damning short-sighted ones. Is it not?

What must a role for a government here? Should it do nothing, and then bail out only the "strategically important" companies? Or should it try harder defending big and small players from their own stupidity? Or is it enough to make making stupid decisions more difficult, softly promote measures to deal with predictable future market pressures, or diversity of management models.

by das monde on Wed May 3rd, 2006 at 07:06:56 AM EST
If they end up bailingout the strategically important companies because of their workers, they should help the workers, not the companies.

Instead of bailing out failing companies, buy them out (same money, different outcome). Then hand them over to the workers.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 07:11:14 AM EST
[ Parent ]
Or arguably put the money into training and enterprise initiatives for the workers? That kind of money could potentially make for a decent redundancy payment and some good seed loans for small businesses in affected areas?

(I say this because giving GM to the workers seems to me to be a poisoned chalice given the sheer over-capacity in global car manufacturing.)

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 07:20:22 AM EST
[ Parent ]
If GM goes bust the grounds may be redeveloped for residential/commercial use or something, and the workers will get zilch. If the workers decide they want to liquidate the company and reap the benefits from the redevelopment, more power to them. And Joelado has this theory that GM has all these workable blueprints for cool hybrids or fully electrical vehicles shelved away since the 1970's...

I just read the health and pension liabilities of GM are 4 times its market capitalization. Why not capitalize the liabilities and give the workers 80% of the resulting company? Or something like that, I'm not big on company finance, but I'm sure someone can work out the details.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 07:24:42 AM EST
[ Parent ]
Anyone know what constitutes state of the art in economic modelling these days? I'm  thinking micro stuff.
by Colman (colman at eurotrib.com) on Wed May 3rd, 2006 at 07:22:08 AM EST
Anyone know if there are public-domain sources for Leontieff input-output coefficients?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 07:25:40 AM EST
[ Parent ]
Abacus and a finger in the air, last time I looked...
by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 07:26:33 AM EST
[ Parent ]
Great.
by Colman (colman at eurotrib.com) on Wed May 3rd, 2006 at 07:31:40 AM EST
[ Parent ]
I know how to take square roots with an abacus, if you're interested.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 07:32:45 AM EST
[ Parent ]
OK, sorry for being so flippant.

What are you looking for when you say "state of the art," mathematical approaches?

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 07:36:49 AM EST
[ Parent ]
With the way economics works I wasn't sure how flippant you were being.

Mathematical would be good. I'm just trying to find a way into the literature: it's always much faster to ask people than try to work out what is and isn't valuable from Google.

by Colman (colman at eurotrib.com) on Wed May 3rd, 2006 at 07:39:39 AM EST
[ Parent ]
Well, I'm no economist, I've mostly come across it in connection with particular problems. I'll try digging around.

There is the odd reference of use in this lecture series and besides, the general topics are of interest if you're thinking about ET style stuff.

OTOH, if it's for something academic, maybe not so much.

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 3rd, 2006 at 07:49:00 AM EST
[ Parent ]
Less of the abacus, I think.
by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed May 3rd, 2006 at 07:37:37 AM EST
[ Parent ]
Which finger are we talking about, exactly? "A finger" or "the finger"?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 07:38:23 AM EST
[ Parent ]
Altogether, color me skeptical that anything good is going to happen to the middle classes in the near future.
See? That's where you and Roach differ: you're thinking about the middle classes, an he, well...
This is a delicate operation, to say the least. We are in the midst of what could well be the mother of all liquidity cycles. Courtesy of an extraordinary monetary accommodation, financial markets have enjoyed open-ended support from central banks. This has been a key role reversal for the tough guys who are supposed to take away the "punch bowl" just when the party gets good. Given the power of this liquidity cycle -- evidenced not just by asset bubbles in major markets but also by an extraordinary compression of spreads on risky assets such as emerging-market debt and more traditional credit instruments -- a serious monetary tightening could prove devastating for financial markets and increasingly wealth-dependent economies. As long as inflation remains low, however, the authorities can set their sights on the more benign target of neutrality. The latest downside surprise on the US inflation front -- another weaker-than-expected increase in the all-important Employment Cost Index -- provides support for that strategy. Despite a tightening labor market, compensation growth for civilian workers slowed to just 2.8% in the 12 months ending March 2006 -- down one full percentage point from the pace two years ago. This is yet another example of the power of the global labor arbitrage and good reason to believe that central banks can stay focused on the goal of normalization rather than tightening.
Ok, let's see... Central banks have given the financial markets all the liquidiy they could dream about, and now that the bubble is about to pop, it's great news that inflation... of salaries is going down! Gee whiz, "compensation growth for civilian workers* has grown by 1% less this year than two years ago! Bring out the bubbly! This is all thanks too... labour arbitrage, the ability of capitals to move unhindered in pursuit of the lowest labour costs. You know, when I was a kid the government was very concerned about capital flights, you know, they had an interest in keeping capital tied to the home country so that, you know, there would be capital to fuel demand for workers and pay their wages. Instead we are decapitalizing our economies to such an extent that, despite a tightening labour market which would ordinarily push wages up, well, the available capital is going down so fast that there just isn't any money to pay wages anyway.

Gaaa...

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 10:26:49 AM EST
My point exactly.

Ain't the "new economy" fun...

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Wed May 3rd, 2006 at 10:39:47 AM EST
[ Parent ]
I love the bit about "asset bubbles" and "wealth-dependent economies".

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 3rd, 2006 at 10:53:21 AM EST
[ Parent ]
I've deleted the diary I put up about this.  Should have known you would beat me to the punch!

Edited version:

 Stephen Roach has been the biggest Cassandra on Wall Street.  Standing alone he decried the massive borrowing binge, asset booms and strong dollar to warn of imminent economic collapse.  Yesterday he made a U-turn, saying things are really sort of okay.

Considering the possibility of taking its medicine?!?  Is that good enough, Steve?  Which anti-depressant did Dr. Morgan Stanley prescribe with your bonus?  

Despite apparently healthy growth and job creation, home foreclosures in the USA are rising dramatically.  And that is without the full impact of interest rate hikes in all those discount, ARM and teaser mortgages feeding through yet.  Add to that continued strong building - despite falling builder margins - and you've got a recipe for a nasty downturn in housing markets.

It is particularly scary this time as it is estimated that half of all jobs created since 2001 were in construction, real estate, mortgage finance or housing related industries.    If growth stops in these industries we will see sharply higher unemployment.  From the top to the bottom of the last housing cycle, builders shed more than 30 percent of their workforce.  A similar decline from today's much higher base would mean losing over 1 million jobs.

Consider the following:

    * The dollar is falling - by 6.2 percent against the euro and 4.1 percent against the yen in 2006

    * A falling dollar will weaken foreign investor confidence in US assets - very dangerous when there's more than $800 billion in current account deficit to finance

    * Oil prices are edging toward $75 a barrel on fears over Iran, which will further crimp consumer spending and non-oil sector employment

    * Gold is at a 25 year high as investors try to find refuge from a sinking dollar, tippy-toppy stocks and another war.

Add to that a lameduck administration that is being revealed each day as corrupt and inept at whatever it does - except line its own pockets - and you've got Roach's original and longstanding predictions of US collapse all but inevitable.

You know a bull run is about to end when the very last, loudest bear makes a furtive call to his broker and puts in a buy order.  In the same way, just as all Steve's warnings are being validated by a souring domestic economy, falling dollar, $75 oil, and fed up foreign creditors, he's decided that things are looking up.  I'm going short.

by LondonYank (LondonYank (at) aol.com) on Wed May 3rd, 2006 at 11:15:23 AM EST


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