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'World economy may disappoint next year'
November 15, 2006
Economist at Morgan Stanley, Stephen Roach says,"I think we are coming to a critical point in the global business cycle, where an unbalanced world needs to get rebalanced and I think the key mechanism of that rebalancing will be slower rate of consumption by the US consumer. I think that's been triggered as we speak by the bursting of the US housing bubble. I think it has global consequences for those economies that are heavily dependent on the US consumers."
Excerpts from an inerview given to CNBC-TV18
Are you feeling bullish or bearish?
Both - I hate labels. The global business cycle is turning to a downside and that will certainly leave me bearish on prospects for world economic growth for 2007. The constructive comments that I have added to the debate in the last few months, have more to do with structural underpinnings of the global economy.
And the fact that the so-called stewards of globalisation - the G7 finance minister and the International Monetary Fund are now mindful of the serious risks that could be caused by mounting global imbalances and are beginning a long process to do something about it. So, I have to take those legitimate concerns and efforts on board, in accessing my overall outlook for the global economy.
I read in one of your recent reports that you are structurally positive but cyclically slightly pessimistic, what does that mean?
Again that is very much what I try to say. Cyclically, the world economy looks like it will disappoint next year, in terms of economic growth as the US housing bubble bursts, the US consumer and the construction industry feels the heat - it has global implications.
Structurally, if the G7 and the IMF can get the architecture right in dealing with global imbalances, that could temper the downside and that will leave me a little less pessimistic than I might otherwise be.
Are you convinced that structurally we have a lot to be positive about?
This is a glimmer that things may be getting better in terms of the global policy architecture, that is required to deal with mounting imbalances. We have an IMF meeting coming up very shortly, which will give us a further read, whether or not these global policymakers are truly up to the task.
Do the cyclical factors really worry you?
It certainly was a possibility six years ago, plus an equity bubble popped and the world went into a mild recession at the end of 2000 and early 2001. We are now seeing the bursting of a major asset bubble in the US property market. It could well have equally profound implications on the US and what is still a US-centric global economy.
We have to take these developments seriously and if an asset bubble six years ago gave us a recession - the question obviously is why can't it do it again this time as well?
You have seen the first signs of trouble in the housing market already - can we get away with or do you think it will be a really big problem?
There are two dimensions of the housing bubble response - there is the construction activity that is associated with building new homes and renovation of old homes and there is the price effect that has to deal with the value of the asset class.
In the construction area, we are moving under recession right now, we are not going to get away with a mild slowing of growth rate. There is a huge backup of inventory of unsold homes - both new and existing sales are falling precipitously.
Ironically, construction activity is still being maintained at a high level in the residential construction sector because a lot of projects underway need to be completed but the pipeline is drying up and there will be a recession.
In terms of house prices, the adjustments will hopefully be more moderate. We are hoping that there won't be a widespread price destruction and major declines in home prices. If that occurs, then the impact on wealth dependant, asset dependant American consumers will be particularly acute.
How important is the US consumer as an engine of global economic growth?
I don't want to sound too US-centric but the American consumer is by far the dominant consumer in the global economy. Last year, the US consumer spent close to $9 trillion that is 20 per cent more than all consumers in Europe. It is more than three times the consumption levels in Japan. It's about 10 times consumption levels in China and it is 17 times consumption spending in India. So, the American consumer is clearly the most powerful consumer in the world. US consumption is a record 70 per cent of US GDP and the consumption is not supported by income as I just eluded to.
It has been associated with record debt service ratios and negative saving rates for the first time since 1933. So, I think the case for consumption adjustment is compelling and unless some other brave consumer steps up somewhere else in the world and I am dubious of that, then I think there will be global consequences of the coming consolidation of the American consumer.
If the US consumer does slow down, can the US get away with a non-recession like situation, a mild kind of growth which some of the economists tend to be veering towards?
I think in a post-housing boom climate, the US growth rate will be about 2 per cent weaker than otherwise might have been the case. They will have their 1 per cent point reduction coming from their construction impacts in the building area, and the other one per cent point reduction coming from consumption. We have been growing about 3.25-3.50 per cent over the last few years, so if we take a couple of points off of that, then that will still leave you with a positive growth rate of say 1.25-1.50 per cent zone.
If the US and China were to slow down at the same time, what happens to global commodities like crude, hard commodities, precious metals etc?
Commodity professionals have concluded that this sector is now in the early stages of a secular boom and everybody is talking about a super-cycle in commodities, and ignoring the possibility of downside pressures that would be evident, if China and the American consumer slows down.
China last year, accounted for a bulk of incremental demand in most of the major commodity prices. Here is a country that accounted for 5 per cent of world GDP but consumed about 25 per cent of all the aluminum in the world. Around 35-40 per cent of steel, iron, coal and nearly 50 per cent of the cement in the world last year was poured into China.
So, if China slows or if it tries to move to a more commodity efficient growth model, (which it has to do in order to deal with high cost of commodity prices) there could be a significant downside to global commodity prices.
Will you be surprised if the Fed raises rates in the next quarter or so?
I wouldn't be shocked at anything. The Fed has indicated that it does have concerns over the residue of inflationary pressure in the pipeline, but they are also mindful of the fact that their policy action impacts the economy. So, they do not want a tightening policy at a time when they are fearful that the business cycle maybe slipping. If the economy looks like it is coming back smartly, there is still a residue of inflationary pressure - then you could see some additional tightening by the US central bank. I don't suspect that would be the case but I could be wrong.
What's your best guess - will they cut interest rate down to 2.5-3 per cent or could it go lower than that?
Given the adjustments that I envision, I would find it very difficult to see them cutting the federal funds rate below 4 per cent at any point in the next year or so.
Where does it leave emerging markets though, what's bad for the US, is it good for the emerging markets?
Emerging markets are very vulnerable in that regard. Our emerging market experts at Morgan Stanley, don't agree with me for a second. They stress that their new fundamentals justify these narrow spreads. And I think to some extend their points are well taken because emerging markets have come a long way since the financial crises of 1997-98, in correcting many of the flaws that were evident back then.
But the next crisis is never like the last crisis and the next crisis could well be the loss of momentum by the American consumer, which is still the driver of the end market demand that supports most emerging market economies in the world. So I suspect, emerging markets could get hit on the shortfall of their major source of end market demand.
Just to sum up you are saying that we have a tough couple of years ahead for the financial and commodity markets across the world?
I think we are coming to a critical point in the global business cycle, where an unbalanced world needs to get rebalanced and I think the key mechanism of that rebalancing will be slower rate of consumption by the US consumer. I think that's been triggered as we speak by the bursting of the US housing bubble. I think it has global consequences for those economies that are heavily dependent on the US consumers.
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