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.
