Despite What The Administration Says, Bush Has Put The Whole World Economy At Risk

Global: Sputtering - Stephen Roach (New York)

A global slowdown was inevitable in 2005 -- in my view, it was just a question of degree. The 4.8% spurt of world GDP growth in 2004 -- equaling the sharpest increase in 20 years -- was an outgrowth of the extraordinary stimulus that was put in place in 2003 as the world veered dangerously toward deflation. That stimulus obviously achieved considerable traction in 2004, but in doing so undoubtedly borrowed from gains in the future. That future is now. Unfortunately, the payback could well be exacerbated by two new global headwinds -- sharply elevated energy prices and the coming normalization of real interest rates.


An unbalanced global economy is a vulnerable global economy. As the world’s imbalances have continued to mount -- underscored by the sharp recent widening of the US current-account deficit -- those perils have only grown larger. A serious pitfall was averted in 2003 when the authorities opted for a major reflationary policy gambit. But the impacts of those efforts have now worn off. That leaves an unbalanced world with little choice other than to face up to the imperatives of global rebalancing. A slower US growth dynamic is an integral part of that rebalancing. It is up to the rest of the world as to whether there are any compensating offsets. For the time being, that does not appear to be the case. And so an unbalanced global economy is now beginning to sputter.

So where was I when the world was at risk for deflation? Since I don't read the Wall Street Journal, it seems there wasn't much press about the risk that occurred in 2003. At the worst point of the recession we are still scratching our way out of, deflation was a real risk. It in fact is occurring in Japan even now.
With America so far in debt, personally and as a government, deflation would be a risky prospect indeed. The average American with significant mortgage and credit card debt would see their equity shrink and their real debt increase even though their still making payments. I can't think of a better way to kill off demand. House prices, already high, could head downward. Incomes would begin to drop, but house payments would stay the same. Defaults on loans would increase. Investment would fall with little promise of profit. We could very quickly find unemployment skyrocketing. Of course, Bush's "base" would the least hurt by deflation. But as Roach points out, the tax cuts and deficit spending of 2003/4 continuing in 2005 have just postponed a downturn. As Roach says, "I remain in the “old school” that insists savings, deficits, and debt matter."


Complete Article
While a saving-short US economy keeps chugging along, the rest of the world is fraying around the edges. That’s especially the case in Europe and Japan, where the data have turned soft yet again. Nor is the developing world providing much of an offset, as strength in China is largely being offset by signs of weakness elsewhere in Asia. Our global forecast has long called for a sharp deceleration this year, with world GDP growth estimated to slow from a vigorous 4.8% gain in 2004 to a trend-like gain of 3.8% in 2005. In my view, the global economy is now sputtering, and risks to our baseline scenario are tipping to the downside.
For the US, it seems to be more of the same for the time being -- plenty of spending but not enough income. That’s certainly the message from an ever-widening current account deficit, which hit a record 6.3% of GDP in the final period of 2004. It’s also the message from the personal saving rate, which was just reported to have slipped back to 0.6% in February 2005. And it comes through loud and clear in the form of record levels of consumer indebtedness, with household sector debt-to-GDP ratios holding in uncharted territory around 85%.
These trends are all symptomatic of the same problem -- a United States that is living well beyond its means, as those means are delineated by the economy’s internal income generating capacity. That continues to show up in the form of a seemingly chronic shortfall of labor income generation; fully 39 months into the current economic recovery, real wage and salary disbursements have increased only 5% through February 2005 -- fully ten percentage points short of the 15% norm at comparable junctures of the past five business cycles. The recent pick-up in job growth has not been enough to offset the extraordinary compression of real wages. As a result, income-short consumers have turned to asset markets to fund their penchant for excess consumption, and in doing so, have drawn down saving and gone deeply into debt.
Stubborn to the end, I remain in the “old school” that insists savings, deficits, and debt matter. So far, the US has yet to flinch as pressures mount on all of these fronts. But as Fed tightening enters a new phase and real interest rates finally tip to the upside, those days may be numbered. Nor can the headwinds imparted by high energy prices be taken lightly; that’s certainly the message from the recent slippage in consumer confidence, the uptick in jobless claims, and a disappointing March employment survey. The resilience of America’s asset-driven economy may be about to meet its sternest test.
In Europe, yet another fade seems to be at hand. The business surveys in the core of Old Europe have taken a nasty turn for the worse -- especially those in Germany and France. The Ifo survey of German manufacturing activity fell to an 18-month low in March; meanwhile the jobless rate in Europe’s largest economy rose to a post-World War II record of 12.0% last month -- the third month in a row of sharp increases and fully 1.6 percentage points above the year-earlier reading. In France, a broadly-based decline in the INSEE manufacturing index in March was equally disconcerting; not only was there a sharp drop in current production, but there was a meaningful downgrading of future expectations. These trends, in conjunction with a weak ISAE business survey from Italy along with a sharper-than-expected decline in the just-reported European purchasing managers’ index for March, have led our Euro-zone team to conclude that there may well be an outright contraction in pan-regional production in 2Q05.
The latest data flow on the Japanese economy looks equally disconcerting to me. The unexpectedly sharp decline in business confidence reported in the March Tankan survey of the Bank of Japan is an especially worrisome development. It not only retraces the improvement of the past year but it also follows on the heels of February’s declines in production, household spending, and exports -- to say nothing of a renewed rise in unemployment and a surprisingly sharp decline in the CPI. Our Japan team urges me to look through the numbers -- citing distortions traceable to the Chinese New Year and last year’s leap-year effects. I wish I could be so sanguine. These latest signs of weakness in the Japanese economy are hardly an isolated event. They follow all too quickly on the heels of Japan’s “blue sky” recession of late 2004 -- an unfortunate reminder of the lingering aftershocks that are still afflicting this post-bubble, deflationary economy. Nor have the markets treated the latest numbers as noise; not only has the yen faltered in recent weeks but yields on 10-year Japanese government bonds also fell sharply in March -- down from 1.53% at the start of the month to 1.32% at month-end. I tend to agree that Japan is slowly healing -- especially at the micro, or company, level. But the macro growth dynamic in the world’s second-largest economy is still far too shaky for comfort, in my view.
Elsewhere in Asia, indications are mixed, at best. China is still running relatively hot for the moment but faces potentially serious pressures down the road in the event of a slowing of the US consumer (see my 21 March dispatch, “China Goes for Growth”). The Korean economy has softened again, as export growth decelerated sharply to 13.0% in the first three months of 2005 -- down from the 21% comparison in 4Q04 and far short of the 38% surge in the first quarter of last year. Reinforced by renewed weakening in domestic demand, Korean industrial production increased only 3.1% in Jan-Feb (y-o-y) -- less than half the 6.7% growth in 4Q04 and far short of the 10.1% gain for all of 2004. Even India seems to be decelerating a bit, with the just-reported 6.2% increase in 4Q04 real GDP the slowest gain since mid-2003. Moreover, there are recent signs of softening evident in Taiwan, Singapore, Thailand, and Malaysia. On balance, I see risks now shifting to the downside of our 6.0% GDP growth forecast for Asia ex Japan. With the region accounting for fully 27% of world GDP (on a purchasing power parity basis) -- roughly equal to the combined output shares of Europe, Japan, and the UK -- an Asian growth shortfall is hardly something to take lightly.
A global slowdown was inevitable in 2005 -- in my view, it was just a question of degree. The 4.8% spurt of world GDP growth in 2004 -- equaling the sharpest increase in 20 years -- was an outgrowth of the extraordinary stimulus that was put in place in 2003 as the world veered dangerously toward deflation. That stimulus obviously achieved considerable traction in 2004, but in doing so undoubtedly borrowed from gains in the future. That future is now. Unfortunately, the payback could well be exacerbated by two new global headwinds -- sharply elevated energy prices and the coming normalization of real interest rates.
An unbalanced global economy is a vulnerable global economy. As the world’s imbalances have continued to mount -- underscored by the sharp recent widening of the US current-account deficit -- those perils have only grown larger. A serious pitfall was averted in 2003 when the authorities opted for a major reflationary policy gambit. But the impacts of those efforts have now worn off. That leaves an unbalanced world with little choice other than to face up to the imperatives of global rebalancing. A slower US growth dynamic is an integral part of that rebalancing. It is up to the rest of the world as to whether there are any compensating offsets. For the time being, that does not appear to be the case. And so an unbalanced global economy is now beginning to sputter.