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The Fallacy of Global Decoupling
October 30, 2006 (Stephen S. Roach - Morgan Stanley)
Surely, there must be more to a $46 trillion global economy than the American consumer and the Chinese producer. Not only is that the current verdict of financial markets, but it is consistent with the sentiment I have been picking up from a broad cross-section of our clients -- business executives, investors, and senior government officials -- as I travel the world this fall. While they concede the possibility that these two engines of global growth may, indeed, slow in 2007, there is a general belief that other economies are now perfectly capable of filling the void. Hope springs eternal that such a global decoupling would allow an increasingly vibrant global economy to keep growing while barely skipping a beat. My advice: Don’t count on it.
Given the dominant role that the US consumer has played in driving the demand side of the world economy and the equally important role played by the Chinese producer in shaping the supply side, decoupling won’t be easy. By our calculations, China and the US collectively have accounted for an average of 43% of PPP-based global GDP growth over the 2001-06 period -- well in excess of their combined 35% share of world output. Globalization makes decoupling from such a concentrated growth dynamic especially difficult, as ever-powerful cross-border linkages have become increasingly important in tethering the rest of the world to these dominant engines of growth. Decoupling requires economies to cut the cord and develop new sources of growth. In my view, for an economy to be classified as a “decoupler” it must satisfy three conditions: First, it must have self-sustaining domestic demand -- especially private consumption. Second, it needs to have a diversified export mix -- both in terms of products and destinations. And third, it must have policy autonomy -- the ability to establish independent settings for monetary, fiscal, and even currency policies.
AntiSpin: This sounds more like the Stephen Roach we're used to, the one who doesn't ask us to suspend disbelief and buy into weak arguments to rationalize rosey assessments of the US and global economy. Roach turned bullish in May when the markets were coming out of what turned out to be a brief period of turbulance. Roach was so bullish, in fact, financial writers like David Berman started to wonder, "Even Roach is bullish, so is it time to sell?" (May 6, 2006 National Post):
But Roach wasn't making a market timing call, although if you'd read it that way you'd have done well: the markets have rallied pretty hard since then. Instead, he was saying that the global economy is actually in pretty good shape. Now he appears to be saying the opposite, that it's set up for a fall if and when the US consumer starts to slow down:
Roach expects the slowdown to come from the US consumer. He says:
If Roach is right, then the net global result of a US recession is a stronger dollar and weaker commodity prices.
This seems unlikely. One key factor not mentioned by Roach is the dependence of US consumers on borrowing the savings of exporting countries to finance current consumption. True, "In 2005, US consumption totaled about $9 trillion -- 20% larger than consumer spending in Europe, 3 1/2 times that of Japan, nine times the size of China’s consumer." But add up Europe, Japan, China and everyone else, what do Asia and Europe get in aggregate export demand without the need to finance it with domestic savings?
De-coupling may be driven less by a gradual process diversifying export demand as a forward-looking policy by the export/savings block than the result of the need for the US to repay its dollar debts with bonars once the US economy goes into recession.
October 30, 2006 (Stephen S. Roach - Morgan Stanley)
Surely, there must be more to a $46 trillion global economy than the American consumer and the Chinese producer. Not only is that the current verdict of financial markets, but it is consistent with the sentiment I have been picking up from a broad cross-section of our clients -- business executives, investors, and senior government officials -- as I travel the world this fall. While they concede the possibility that these two engines of global growth may, indeed, slow in 2007, there is a general belief that other economies are now perfectly capable of filling the void. Hope springs eternal that such a global decoupling would allow an increasingly vibrant global economy to keep growing while barely skipping a beat. My advice: Don’t count on it.
Given the dominant role that the US consumer has played in driving the demand side of the world economy and the equally important role played by the Chinese producer in shaping the supply side, decoupling won’t be easy. By our calculations, China and the US collectively have accounted for an average of 43% of PPP-based global GDP growth over the 2001-06 period -- well in excess of their combined 35% share of world output. Globalization makes decoupling from such a concentrated growth dynamic especially difficult, as ever-powerful cross-border linkages have become increasingly important in tethering the rest of the world to these dominant engines of growth. Decoupling requires economies to cut the cord and develop new sources of growth. In my view, for an economy to be classified as a “decoupler” it must satisfy three conditions: First, it must have self-sustaining domestic demand -- especially private consumption. Second, it needs to have a diversified export mix -- both in terms of products and destinations. And third, it must have policy autonomy -- the ability to establish independent settings for monetary, fiscal, and even currency policies.
AntiSpin: This sounds more like the Stephen Roach we're used to, the one who doesn't ask us to suspend disbelief and buy into weak arguments to rationalize rosey assessments of the US and global economy. Roach turned bullish in May when the markets were coming out of what turned out to be a brief period of turbulance. Roach was so bullish, in fact, financial writers like David Berman started to wonder, "Even Roach is bullish, so is it time to sell?" (May 6, 2006 National Post):
This week, Stephen Roach, chief economist at Morgan Stanley, at last acknowledged that things are actually looking okay. This unexpected 180-degree turn came after years of warnings when he essentially said that all that separated us from a nasty and prolonged economic downturn was a thin veneer of misplaced hope.
"It seems like eternity since I was last optimistic on the world economy," he said in his bullish note to clients. "I must confess that I am now feeling better about the prognosis for the world economy for the first time in ages."
David Berman was following the Last Bear Standing Theory of market timing–when the last bear throws in the towel, and every short has been sent home yelping like an injured dog, it's time for the market to collapse. "It seems like eternity since I was last optimistic on the world economy," he said in his bullish note to clients. "I must confess that I am now feeling better about the prognosis for the world economy for the first time in ages."
But Roach wasn't making a market timing call, although if you'd read it that way you'd have done well: the markets have rallied pretty hard since then. Instead, he was saying that the global economy is actually in pretty good shape. Now he appears to be saying the opposite, that it's set up for a fall if and when the US consumer starts to slow down:
"...contrary to popular perception that heralds the birth of the young and vibrant Asian consumer (see the cover story in the 21 October issue of The Economist, “America Drops, Asia Shops”), private consumption has actually been a drag on economic activity in this key region of the world. That shows up most clearly in declining consumption shares of Asian GDP -- the best way to measure the growth impetus of any sector. By IMF estimates, consumption shares in all of emerging Asia fell from around 70% of GDP in 1970 to less than 50% in 2005. In particular, China’s private consumption share fell to a record low of 38% of GDP in 2005 and most likely has fallen further in 2006. Nor is Japan an exception to Asia’s anti-consumer mindset; the consumption share of Japanese GDP fell from 58% in early 2002 to 56% in mid-2006. The message here is inescapable: Euphoria over the emergence of the Asian consumer is premature, at best; this region’s growth story is still very much dominated by surging exports and fixed investment."
Global de-coupling is the idea that in the next global recession, the old rules of a US-centric demand model no longer hold, that when the US economy sneezes the rest of the world will only sniffle, but not catch cold. We tend to agree, that Economic M.A.D. still dominates global trade, but disagree on the strain of virus.Roach expects the slowdown to come from the US consumer. He says:
If, as I suspect, the US consumer now enters a sustained slowdown in a post-housing bubble climate, there will be unmistakable reverberations on US-centric export flows in many major regions of the world. Lacking in internal demand to fill the void left by a US-led shortfall in external demand, and with only limited policy options available to counteract such a development, America’s slowdown could quickly become a global slowdown. Meanwhile, Beijing’s increasingly determined efforts to cool off a runaway Chinese investment boom could transmit an equally powerful downshift through its pan-Asian supply chain and the world’s commodity complex.
Here he effectively repeats his prediction of in a decline in aggregate demand and thus prices of commodity prices. What about policy options to counter a global recession?"Policy autonomy is the final piece of the global decoupling puzzle, and I‘m afraid there is not much ground for optimism on that score either. Insofar as fiscal policy is concerned, budget deficits are already excessive in most parts of the world -- suggesting little further latitude for stimulus. The policy mantra in G-3 central banking circles is “normalization” -- aimed at bringing an end to an era of excess monetary accommodation. The recent cyclical deterioration in inflation underscores the imperatives of such a policy campaign. While it may make sense for America’s Federal Reserve to ease monetary policy in 2007 if the US economy starts to fade, such actions would not be appropriate either for the European Central Bank or the Bank of Japan."
In other words, when the US sends its economic flu overseas, the Fed can print away with impunity but EU and Asian central banks can't. If Roach is right, then the net global result of a US recession is a stronger dollar and weaker commodity prices.
This seems unlikely. One key factor not mentioned by Roach is the dependence of US consumers on borrowing the savings of exporting countries to finance current consumption. True, "In 2005, US consumption totaled about $9 trillion -- 20% larger than consumer spending in Europe, 3 1/2 times that of Japan, nine times the size of China’s consumer." But add up Europe, Japan, China and everyone else, what do Asia and Europe get in aggregate export demand without the need to finance it with domestic savings?
De-coupling may be driven less by a gradual process diversifying export demand as a forward-looking policy by the export/savings block than the result of the need for the US to repay its dollar debts with bonars once the US economy goes into recession.
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