Reply #13: Global Rebalancing at Work (Roach)

[54anickel]

http://www.morganstanley.com/GEFdata/digests/20041206-mon.html#anchor0

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A second risk comes on the currency and global financing fronts. While the dollar’s descent has generally conformed to a soft-landing trajectory, the possibility of a tougher endgame can hardly be ruled out. Our updated foreign exchange forecast now calls for a sharp depreciation of the dollar over the next six months. Relative to the dollar, we are now forecasting a 1.37 euro and a 95 yen by mid-2005 -- about 15% higher than our previous forecast and levels that could well put significant further downside pressure on externally-dependent European and Japanese economies. Moreover, given America’s record current account deficit, together with the huge dollar overweight in official foreign exchange reserve portfolios -- close to a 70% share of dollar-denominated assets versus America’s 30% share in world GDP -- the possibility of a flight out of dollars can hardly be ruled out.

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Chinese currency policy is a critical wildcard. If China stands alone in resisting rebalancing, it runs a growing risk of being singled out as a scapegoat by the rest of the world. China bashing could intensify in response -- very reminiscent of the Japan bashing of the late 1980s and early 1990s. The big difference is that a wealthy and relatively closed Japanese economy was able to cope far better with such pressures than might be the case for an open and still relatively poor Chinese economy.

All this is symptomatic of what I have called the global blame game -- the tendency of rebalancing to pit nations and regions against each other in a fashion that could heighten trade frictions and protectionist risks. By pointing the finger at the proverbial “other guy,” the global village will have a hard time accepting the shared responsibility for the rebalancing of an unbalanced world.

The most serious downside risk to our new baseline forecast remains concentrated in the US, in my view -- where we have raised our 2005 growth estimate to 3.7% (from 3.3%) and look for further acceleration to 4.3% in 2006. The US, in my view, remains on a dangerous and reckless course -- consuming out of asset-based saving at a point in its demographic life-cycle when it should be building up income-based saving to fund the looming retirement of 77 million baby-boomers. Record lows in the personal saving rate and the current account deficit, to say nothing of record highs in household sector indebtedness, all speak of a US that is living dangerously beyond its means. Subsidized by unusually low interest rates, in large part underwritten by equally myopic foreign investors and governments, America has managed to keep the magic alive. But there’s nothing sustainable about that arrangement.

If America stays this course, the endgame will not be pretty. The day will come when US interest rates rise -- driven by either domestic or foreign developments. That would undoubtedly spark a painful unwinding of the Asset Economy -- all the more conceivable now that the US housing market is firmly in bubble territory (see my 2 December dispatch, “Bubble Day”). Equally worrisome is America’s anemic job creation and the related shortfall of organic income generation. November’s disappointing employment report was hardly an aberration; it marked the 31st month in this now 36-month old recovery, when job growth failed to live up to cyclical standards of the past. So much for the timeworn consensus view that the Great American Job Machine is finally on the mend. Like it or not, the United States remains mired in the mother of all jobless recoveries -- making the perils of excess consumption all the more worrisome.

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