March 30, 2003

Stephen Roach Says (Economic) Doom Is at Hand

Morgan Stanley's Stephen Roach says that economic doom is at hand--that the most likely scenario for the world economy over the next four years is stagnation. I wish his arguments weren't so strong, and his scenario wasn't so believable:


Morgan Stanley: ...America?s current-account deficit surged to an annualized $548 billion in the fourth quarter of 2002, a record 5.2% of GDP. The financing of such a shortfall requires $2.2 billion of capital inflows each business day -- hardly a trivial consideration for a low-return, post-bubble US economy. Nor is this a stable situation. As America?s federal budget goes deeper into deficit, the country?s net national saving rate -- consumers, businesses, and the government sector, combined -- could easily plunge from a record low of 1.6% hit in late 2002 toward ?zero.? If that occurs, the US current-account deficit could approach 7% of GDP -- requiring about $3 billion of foreign financing each business day.

History is pretty clear on what happens next -- a classic current account adjustment. This will entail a very different macro outcome for the United States -- namely, a weaker dollar, higher real interest rates, and a slowdown in domestic demand. That?s precisely the scenario that a dysfunctional world is completely unprepared for. A weaker dollar spells a higher yen and a stronger euro -- outcomes that would undermine the externally-led growth that Japan and Europe have grown accustomed to. A slowdown in US domestic demand growth would exacerbate that problem -- providing far less impetus to the world?s major source of external demand. That would also spread the pain to the trade-dependent economies of Asia ex Japan. As the one-engine global economy starts to sputter, the world will have no choice other than to come up with a new recipe for global growth -- the essence of what I have called ?global rebalancing.?

But can it? There are two key ingredients to global rebalancing. The first is a current-account adjustment that forces the US economy to start living within its means again --- as those means are delineated by domestic production and income generation. But equally important is for the rest of the world to press ahead on the structural reforms that are required to unlock domestic demand. This could be the toughest nut to crack. Japan has had little appetite for reform for over a decade. And Europe has deferred its reforms for far too long. But now as the business cycle turns and unemployment rises, political constraints could create new headwinds for reforms. Fighting for their own jobs, politicians can hardly be expected to put voters out of work by embracing the noble pursuit of structural reform.

And so it may well be that a dysfunctional world remains stuck -- unwilling or unable to uncover new sources of growth and, therefore, waiting by default for yet another kick-start from the now dormant US growth engine. But that kick may be a long time in coming. Not only does America need slower domestic demand in order to narrow its current-account deficit, but it also faces the negative wealth effects of a post-bubble hangover.

Posted by DeLong at March 30, 2003 08:22 AM | TrackBack

Comments

Hey ho. Not to worry. All we have to do now is get that tax cut passed and the economy will bloom. Cut cut cut those stock dividends. Hey ho. Look in the envelope when you dividend check comes from Citigroup or Verizon or or or and find a nicely written letter to the Senator of choice asking for a vote for the stock dividend tax cut. Hey ho. Not to worry, the lobbyers are lobbying all for you and me, at least for me, and soon as we can say cut those dividends all will be abloom. Cut cut cut. There will be more where this comes from. Hey ho.

Posted by: anne on March 30, 2003 09:33 AM

Anne Anne Dear Anne,

I just turned 102 years old and all I have left to live on and on on are 100 shares of Citigroup. Would you tax my dividends? Double tax my precious dividends? Triple tax? Go for a home run of taxing? Have you no mother, my dear?

Rebuttal

Posted by: anne on March 30, 2003 09:48 AM

Who loves ya, Sandy -

Bill Moyers - NOW
3/28/03

Carol owns 266 shares of Citigroup stock and with the proposed tax cut she would earn an additional $32 in dividend income each year.

Contrast that with Citigroup's CEO Sanford Weill. He owns nearly 23 million shares of Citigroup stock. If the tax cut passes, he would earn seven million, thirty three thousand dollars....

Posted by: anne on March 30, 2003 10:29 AM

Wow. Economic doom is approaching. Military doom is already here. This place is getting depressing.

I'm going to go away for a while ... maybe spend some time at pangloss.com.

Posted by: Jim Glass on March 30, 2003 10:52 AM

I used to watch Fox News for the laughs, now I watch them it for comfort... "W knows what he's doing"... If we repeat that enough times maybe it will become true.

Posted by: john mcKinzey on March 30, 2003 11:27 AM

I think I can sum up Mr. Roach's thinking:

The world is going to hell if the trade deficit corrects.
The world is going to hell if the trade deficit doesn't correct.
There is going to be painful deflation.
There is going to be painful inflation.
It will also be horrible if inflation stays the same.
In general, it is always horrible. If it is not, then horrible things will occur soon.

I don't know why he cares if the people who like to spend live in the same place and those who like to save live in the same place. He doesn't seem to believe at all in supply and demand. When someone else spends, the US will have to stop. Why is that such a big deal anyway? Are Americans so poor that they cannot live with 10% less and work a little harder? Anyway, until then, the US can spend as it wishes and get some good bargains. When it comes time to correct, those who invested in this unbalanced situation might find that they have made a mistake.

Was this guy hired to provide accurate insight or to give pessimists someone to listen to?

Posted by: snsterling on March 30, 2003 11:51 AM

Come on Anne. Isn't it better for Weill add to his art collection rather than having the government throw away money on things like schools and veterans' benefits?

Liberals! Unbelievable!

Posted by: Bernard Yomtov on March 30, 2003 11:54 AM

The guy sounds strident. Has he always been a Democrat?

Posted by: zizka on March 30, 2003 12:38 PM

I have to admit that I don't quite understand the nature of the current-accounts deficit problem. Am I correct in thinking that a current account deficit is when a country spends more on imports than it earns in exports?

Why is that a bad thing, exactly? It's not as though the federal government is spending the money for imports, or getting the money when people invest in the US (it does of course gain in taxes for imports and foreign investment-- is that the problem?).

But the transactions are individual and balanced on their own: we've sent a trillion dollars overseas and gotten back a trillion dollars worth of stuff. That sounds pretty even to me, even if we've also sent only half a trillion dollars worth of goods overseas in exchange for a half-trillion dollars worth of Euros and Yen.

Posted by: verbal on March 30, 2003 01:06 PM

"I have to admit that I don't quite understand the nature of the current-accounts deficit problem."

At some point foreigners tire of investing their money in the US.


Posted by: richard on March 30, 2003 02:25 PM

Dooooooooooooooooooooom!

Posted by: Invader Zim on March 30, 2003 03:23 PM

Prof deLong -
Its always entertaining to look at worst-case scenarios. Not that they NEVER come true (which is why you have to consider them), just that they rarely do. What about you lay out your best-case scenario to try and cheer us all up in these awful days?

Posted by: derrida derider on March 30, 2003 03:58 PM

Prof deLong -
Its always entertaining to look at worst-case scenarios. Not that they NEVER come true (which is why you have to consider them), just that they rarely do. What about you lay out your best-case scenario to try and cheer us all up in these awful days?

Posted by: derrida derider on March 30, 2003 04:00 PM

Richard -

So what? We don't "need" foriegn investment in any sense. Foriegners want to save more than they can invest at home, and they don't want to run the deficits in their own currencies that would be necessary for this to happen. So they save dollars instead, by selling us more than they buy from us. (You could say that the primary export of the US these days is demand...) If they ever wise up and start running proper deficits, they won't need to do this and the currencies will adjust to make up the difference. If they don't, it won't. Either way, who cares?

Posted by: jimbo on March 30, 2003 04:15 PM

Mr.deLong,
I dont see where such large deficit numbers are coming from...are they merely a forecast? According to other sources, the budget deficit stands at sub-400bn number for fiscal 2003 and 2004, which is still quite large. However, when adjusted to the size of the economy, the budget deficit is hardly of an alarming magnitude ( i think somewhere of 3.5-4% tops). What that means, basically, is that despite a dollar growth the "relative to GDP" deficit isn't outrages.

CBO last week also provided a similar to the aforementioned numbers' baseline, but I dont think it included the cost of war and its general growth estimate is too optimistic @ 2.5% GDP this year....(yeah, they wish), and still I dont see Roach's "gloom" and "doom" materializing. Having said that, he did call for a prolonged recession and called for 'excess purging' in the economy even at the beginning of the cycle in early spring 2001...and he was spot on in his extreme "bear" (Wayne Angel-like) scenario.

As far as the real rates...I distinctly rememebr the June '02 Fed paper analyzing the possibility of Japan-style scenario unfolding in the US and the indication I got is the since the Fed has more experience combating inflation, rather than deflation, it'll sooner err on the the side of the former.

Posted by: Dima on March 30, 2003 05:12 PM

Mr.deLong,
I dont see where such large deficit numbers are coming from...are they merely a forecast? According to other sources, the budget deficit stands at sub-400bn number for fiscal 2003 and 2004, which is still quite large. However, when adjusted to the size of the economy, the budget deficit is hardly of an alarming magnitude ( i think somewhere of 3.5-4% tops). What that means, basically, is that despite a dollar growth the "relative to GDP" deficit isn't outrages.

CBO last week also provided a similar to the aforementioned numbers' baseline, but I dont think it included the cost of war and its general growth estimate is too optimistic @ 2.5% GDP this year....(yeah, they wish), and still I dont see Roach's "gloom" and "doom" materializing. Having said that, he did call for a prolonged recession and called for 'excess purging' in the economy even at the beginning of the cycle in early spring 2001...and he was spot on in his extreme "bear" (Wayne Angel-like) scenario.

As far as the real rates...I distinctly rememebr the June '02 Fed paper analyzing the possibility of Japan-style scenario unfolding in the US and the indication I got is the since the Fed has more experience combating inflation, rather than deflation, it'll sooner err on the the side of the former.

Posted by: Dima on March 30, 2003 05:13 PM

Mr.deLong,
I dont see where such large deficit numbers are coming from...are they merely a forecast? According to other sources, the budget deficit stands at sub-400bn number for fiscal 2003 and 2004, which is still quite large. However, when adjusted to the size of the economy, the budget deficit is hardly of an alarming magnitude ( i think somewhere of 3.5-4% tops). What that means, basically, is that despite a dollar growth the "relative to GDP" deficit isn't outrages.

CBO last week also provided a similar to the aforementioned numbers' baseline, but I dont think it included the cost of war and its general growth estimate is too optimistic @ 2.5% GDP this year....(yeah, they wish), and still I dont see Roach's "gloom" and "doom" materializing. Having said that, he did call for a prolonged recession and called for 'excess purging' in the economy even at the beginning of the cycle in early spring 2001...and he was spot on in his extreme "bear" (Wayne Angel-like) scenario.

As far as the real rates...I distinctly rememebr the June '02 Fed paper analyzing the possibility of Japan-style scenario unfolding in the US and the indication I got is the since the Fed has more experience combating inflation, rather than deflation, it'll sooner err on the the side of the former.

Posted by: Dima on March 30, 2003 05:14 PM

jimbo wrote "We don't 'need' foriegn investment in any sense ... and the currencies will adjust to make up the difference."

Ummm ... combine this statement with the one a few weeks ago about one solution to the long-run budget deficit being to 'print' more money and you can see why economists would be worried. Perhaps it is a variant of Gresham's Law but people like storing their savings in a hard currency (even if fiat) to preserve purchasing power. Now once an appreciable fraction of these fiat savers see that the US is unilaterally debasing its debt, I suspect the 'currency adjustment' you refer to might be a little choppier than you might desire. Of course, then economists like Paul would be happy as they would have another example for their textbooks but otherwise I suspect there's not going to be a lot of happy shoppers.

Posted by: LL on March 30, 2003 05:16 PM

apologies for triple post.

Posted by: Dima on March 30, 2003 05:17 PM

Dima- Please don't accept CBO numbers at face value. EVERYONE KNOWS that CBO is under constrictions that skew its estimates. Currently, CBO underestimates the deficit for a variety of reasons. This is a legislative mandate. The fiscal picture for the federal government is far worse than what CBO is allowed to publish. All reasonable economists recognize this and alter the CBO figures to include events that are likely to happen such as a fix for the AMT problem.

Posted by: bakho on March 30, 2003 07:12 PM

"We don't 'need' foriegn investment in any sense ... and the currencies will adjust to make up the difference."

Less demand for US financial assets means lower prices. Not good if you like high stock prices or high bond prices. Among other things, high bond prices means low interest rates. So less foreign investment leads to higher interest rates, which might be considered a bad thing.

The currency adjustment means higher prices for US consumers, which also might be considered a bad thing if you're a US consumer.

Lower US currency prices might be a good thing for US exporting companies (depending on their costs of goods), but not so good for foreign exporters. See Roach's column for more detail.

Posted by: richard on March 30, 2003 07:16 PM

"Less demand for US financial assets means lower prices. Not good if you like high stock prices or high bond prices. Among other things, high bond prices means low interest rates. So less foreign investment leads to higher interest rates, which might be considered a bad thing."

May I be permitted a Delongian sigh?

"Sigh"

(Thanks - I feel better...)

Interest rates depend on two, and only two, things: what the Fed does today (Short term), and what people think the Fed will do tomorrow (long term - although the Fed could control these absolutely, too, if it decided to...). Foreign investment will only effect them if the Great and Powerful Greenspan decides that it should. Where does this superstition about "the bond market setting interest rates" come from, and why is it so persistant in the face of all the evidence to the contrary? I really can't figure it out...

Posted by: jimbo on March 30, 2003 07:59 PM

jimbo, because a collapse in the currency almost always causes a central bank to push interest rates through the roof. This is for two good reasons - the risk of cost-push inflation as import prices go through the roof, and because you need to offset the losses to foreign investors if you want their capital in the future - and one bad reason - a weak currency is seen as a loss of national prestige.

Many countries (including mine) have learned to their cost what can happen when too low savings (private and government) forces you to depend on under-informed foreigners for your investment capital.

Posted by: derrida derider on March 30, 2003 09:04 PM

jimbo, because a collapse in the currency almost always causes a central bank to push interest rates through the roof. This is for two good reasons - the risk of cost-push inflation as import prices go through the roof, and because you need to offset the losses to foreign investors if you want their capital in the future - and one bad reason - a weak currency is seen as a loss of national prestige.

Many countries (including mine) have learned to their cost what can happen when too low savings (private and government) forces you to depend on under-informed foreigners for your investment capital.

Posted by: derrida derider on March 30, 2003 09:05 PM

Bakho,
I DO take the #s with a grain of salt. My point, however, was that even Wall Street's 'in-house' economists aren't producing such huge deficit figures as Roach did.

Posted by: Dima on March 31, 2003 07:05 AM

Jimbo, while in one sense the fed has complete control over the speed of the economy in the short term, in the long run all it can do is counterbalance purchasing and investment decisions which they have no control over.

When retirees from countries with accelerated baby boom effects (Japan, Italy, Germany) decide to sell US investments to pay their rent and purchase mailnly local goods and services, they will find you just can't do that because it doesn't balance. Interest rates in those countries should rise, and those currencies will do well against the dollar. Eventually a low enough dollar will convince Americans to quit importing from those countries and encourage exports. But since the external demand has risen, the fed will have no choice but to raise rates to diminish domestic consumption (unless it declines for some unrelated reason).

Like Richard says, it is important to distinguish who this situation is bad for. American consumers will have to cut back and this could affect the companies that cater to them and their employees. But it will be good for manufacturers and could lead to new jobs. And it will be good for new savers, or those holding cash in banks while being not so good for certain bond and stock holders.

However, it is wrong to suggest that this adjustment will lead to an economic downturn because the reduced domestic demand is just making up for increased external demand. Lower investment in general might slow growth some though.

Posted by: snsterling on March 31, 2003 07:23 AM

Trouble is, Roach has only got half the story. He's still waiting for structural change in Japan and Europe to bring back the good ol'days of economic growth. I'm afraid he's going to have rather a long wait.

Posted by: Edward Hugh on March 31, 2003 09:03 AM

Dima, Bakho: Roach is looking the current-account deficit, commonly called the "Trade Deficit" in the media. He is not referring to the Federal Budget Deficit (which is smaller).

Posted by: Ethan on March 31, 2003 09:32 AM

Radical Conservatism -

http://www.nytimes.com/2003/03/30/weekinreview/30ALTM.html

March 30, 2003

The End of Taxes as We Know Them
By DANIEL ALTMAN - NYTimes

In the economy as well as in Iraq, the White House is aiming for regime change.

"The president concluded we needed a package of tax relief of sufficient size to move the needle on the economy," Pamela F. Olson, the assistant secretary of the Treasury for tax policy, said on Wednesday. "Tinkering around the edges won't do that. Small won't do that."

But tax relief does not begin to describe the fundamental changes the White House wants to make in how the economy and the government are run, and how revenue is raised. To achieve its goals, the Bush administration has turned to supply-side economics, which advocates removing taxes that are held to discourage people from working and investing their savings in the private sector....

Posted by: jd on March 31, 2003 11:12 AM

"The End of Taxes as We Know Them
By DANIEL ALTMAN - NYTimes"

Yeah, the Administration is attempting to reduce the total tax burden of the federal government from 19% of GDP to maybe 18% of GDP. Big deal. Tell me when they get to 10% of GDP...then I'll be impressed. (And if they get to <5% of GDP...which is what the federal government operated at for most of its first 150 years...I'll send everyone who's posted so far a Silver Eagle U.S. dollar. :-))

Posted by: Mark Bahner on March 31, 2003 02:15 PM

Hmmm. 5% of GDP? I have this theory that Mr. Bahner is actually from some small country to the south of us where the following government expenditures are lacking:

social security
unemployment insurance
health care protection
deposit insurance
financial aid for education
public transportation

e.g., the country of his fondest dreams bears some resemblance to Belize, Haiti, or Jamaica. No doubt he regards such a place as paradise, in spite of its low per capita GDP. Must be all those babes at the beach in bikinis. ;-)

Posted by: andres on March 31, 2003 08:48 PM

Ethan, I think you'll find that the Morgan Stanley Team are now focused on the 'twin deficits', ie the sum of the two.

'when countries with accelerated baby boom effects....

Maybe it would be better to talk about 'countries with accelerated cohort shrinkage effects....' Remember this is not a one-off bloat, but an iterative process set to repeat itself with each generation. I have no real idea what the full macro consequneces of all this will be, since we've never seen it before, but I wouldn't bank on the high interest rates Europe-Japan story, if only because the resulting payments on ballooning government debt would make for crippling taxation levels (and thus little job creation) and in all probability national bankruptcy.

Pedro Solbes (EU Economics Commissioner) recently forecast that 'a clear and unequivocal risk of unsustainable public finances exists in at least half of EU Member States'. I couldn't put it better myself, except to add that the downside risks may be greater than even he imagines.

http://www.edwardhugh.net/demography.html


If there is to be a correction it looks to me more like a RELATIVE reduction in the position of the US/European/Japanese consumer in relation to that of the Indian/Chinese one. I think the relative demographics pretty much guarantee that. But of course the people who brought you Argentina 2001, the Euro, and 'Shock and Awe' will tell you that I've just got an over-rich imagination.

Posted by: Edward Hugh on March 31, 2003 10:40 PM

Trying to put the last point about 'baby boomers' more clearly: the mistake is to think this is a one-off, with eventual homeostasis. This is a profound transformation, and it's the line of the curve you need to look at.

Posted by: Edward Hugh on April 1, 2003 12:12 AM

I dunno that I fully agree with Edward's predictions - but he does imply, correctly, that economists pay far too little attention to demography when talking about capital investment, national savings, current account balances, real interest rates, etc.

Keeping your eye on the longer-run ball is important even if you're just concerned with the shorter run.

Posted by: derrida derider on April 1, 2003 03:08 AM

"Hmmm. 5% of GDP? I have this theory that Mr. Bahner is actually from some small country to the south of us..."

No, I'm from a planet where people understand that when the federal government "provides:"

social security
unemployment insurance
health care protection
deposit insurance
financial aid for education
public transportation

...merely means that The People send their money to a central location, in the hope that they'll get the same amount back.

In other words, on my planet, we recognize that the federal government's actions in virtually all situations you mention, are simply to take people's money, and shuffle it around in a way that the federal government thinks is best.

Now, maybe on your planet, Ted Kennedy and G.W. Bush have a better idea how to spend money on education than your local parents, teachers, and administrators. But on my planet, we've given up on the idea of an omniscient federal government. In fact, on my planet, we don't think the federal government is even *as good as* the local population, in solving local problems.

Posted by: Mark Bahner on April 1, 2003 09:21 AM

Yes, they do, because at the very least they will (on the left) try to ensure some modicum of social well being on all citizens rather than leaving the money in private hands and seeing it be used for conspicuous consumption and outright class warfare.

Posted by: Lorenzo Dei Medici on April 1, 2003 09:39 AM

" how to spend money on education "

While how and who decides are issues, they don't really get to the main point of taxation to provide education which is if the money is really spent at all. Many parents will choose to use the money for other things, and some couldn't afford to educate their kids at all. Not sending millions of kids to get basic schooling is basically a recipe for creating a third world nation. It probably qualifies as child abuse too.

Perhaps you mean that local governments should be the ones taking the money and shuffling it around, but then why wouldn't you say individuals know best since they are always the most local. And I think you forgot to add in defense.

Posted by: snsterling on April 1, 2003 10:23 AM

"In other words, on my planet, we recognize that the federal government's actions in virtually all situations you mention, are simply to take people's money, and shuffle it around in a way that the federal government thinks is best."

Mark, time for you to enroll in the militias. Simple fact is, _you_ are the federal government along with all the other 200 million voting-age americans. _You_ elected the 535 idiots (mostly) sitting in Congress and, through the admittedly imperfect mechanism of the electoral college, you also elected President Bush. By referring to the federal government as an alien entity that is not related to you in any way (would you do so if they spent the right amount of money, and on programs that you want?), your are in effect stating the desire to start your own country. There's nothing wrong with that as long as you start that country somewhere else. But at least be direct about it.

Posted by: andres on April 1, 2003 12:03 PM

"No, I'm from a planet where people understand that when the federal government "provides:"

social security
unemployment insurance
health care protection
deposit insurance
financial aid for education
public transportation

...merely means that The People send their money to a central location, in the hope that they'll get the same amount back."

veterans benefits
national defense
medicaid
national parks

on and on and on - YES! I am truly happy to be on a bit of planet America.

Posted by: dahl on April 1, 2003 12:26 PM

"Mark, time for you to enroll in the militias. Simple fact is, _you_ are the federal government along with all the other 200 million voting-age americans."

Sigh. No, instead, you should take a history/civics class, Andres.

The People are most definitely NOT the federal government. The Founding Fathers understood that very clearly. Look at the 10th amendment to the Constitution, if you're in doubt.

"By referring to the federal government as an alien entity that is not related to you in any way..."

They are not an "alien entity." The SHOULD be servants, but instead they are masters. They are enemies, because the violate The Law (the Constitution).

"...your are in effect stating the desire to start your own country."

No, I'm stating my desire for the elected (and appointed) members of the federal government to follow The Law (the Constitution). But I don't expect them to do so any time in the future, because the overwhelming majority of U.S. citizens don't insist that they follow the Constitution. Instead, the overwhelming majority of U.S. citizens vote for Democrats, Republicans, Greens, and Reforms, rather than Libertarians.

"There's nothing wrong with that as long as you start that country somewhere else."

No, you should be the one who goes elsewhere, if you don't want the federal government to follow The Law.

Posted by: Mark Bahner on April 15, 2003 03:10 PM
Post a comment