Stephen S. Roach – Economy Watch

The Search for America’s Growth Engine: Stephen S. Roach

Stephen S. Roach — Fri, 03 Aug 2012 09:00:37 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

America has typically relied on its domestic market for economic growth, with consumer spending accounting for some 70 percent of annual GDP growth. Given the strong likelihood that US consumers will remain weak for years to come, America’s growth agenda needs to focus on getting more out of the other 30 percent. But can this be done?

NEW HAVEN – The American consumer is but a shadow of its former almighty self. Personal consumption in the United States expanded at only a 1.5% annual rate in real (inflation-adjusted) terms in the second quarter of 2012 – and that was no aberration. Unfortunately, it continues a pattern of weakness that has been evident since early 2008.

Over the last 18 quarters, annualized growth in real consumer demand has averaged a mere 0.7%, compared to a 3.6% growth trend in the decade before the crisis erupted. Never before has the American consumer been this weak for this long.

The cause is no secret. Consumers made huge bets on two bubbles – housing and credit. Reckless monetary and regulatory policies turned the humble abode into an ATM, allowing families to extract dollars from bubbles and live beyond their means.

Both bubbles have long since burst, and US households are now dealing with post-bubble financial devastation – namely, underwater assets, record-high debt, and profound shortages of savings. At the same time, sharply elevated unemployment and subpar income growth have combined to tighten the noose on over-extended consumers.

As a result, American households have hunkered down as never before. Consumers are diverting what little income they earn away from spending toward paying down debt and rebuilding savings. That is both logical and rational – and thus not something that the US Federal Reserve can offset with unconventional monetary easing.

[quote] American consumers’ unprecedented retrenchment has turned the US economy’s growth calculus inside out. Consumption typically accounts for 70% of GDP (71% in the second quarter, to be precise). But the 70% is barely growing, and is unlikely to expand strongly at any point in the foreseeable future. That puts an enormous burden on the other 30% of the US economy to generate any sort of recovery. [/quote]

In fact, the other 30% has not done a bad job, especially considering the severe headwinds coming from consumers’ 70%. The 30% mainly consists of four components – capital spending by firms, net exports (exports less imports), residential construction, and government purchases. (Technically, the pace of inventory investment should be included, but this is a cyclical buffer between production and sales rather than a source of final demand.)

Given the 0.7% trend in real consumption growth over the past four and a half years, the US economy’s anemic 2.2% annualized recovery in the aftermath of the Great Recession is almost miraculous. Credit that mainly to the other 30%, especially to strong exports and a rebound in business capital spending.

By contrast, the government sector has been moving in the opposite direction, as state and local governments retrench and federal purchases top out after post-crisis deficit explosions. The housing sector has started to recover over the past five quarters, but from such a severely depressed level that its growth has had little impact on the overall economy.

Given the strong likelihood that consumers will remain weak for years to come, America’s growth agenda needs to focus on getting more out of the other 30%. Of the four growth components that fall into this category, two have the greatest potential to make a difference – capital spending and exports.

[quote] Prospects for these two sources of growth will not only influence the vigor, or lack thereof, of any recovery; they could well be decisive in bringing about an important shift in the US growth model. The 70/30 split underscores the challenge: the US must face up to a fundamental rebalancing – weaning itself from excessive reliance on internal demand and drawing greater support from external demand. [/quote]

Capital spending and exports, which together account for about 24% of GDP, hold the key to this shift. At just over 10% of GDP, the share of capital spending is well below the peak of nearly 13% in 2000. But capital spending must exceed that peak if US businesses are to be equipped with state-of-the-art capacity, technology, and private infrastructure that will enable them to recapture market share at home and abroad. Only then could export growth, impressive since mid-2009, sustain further increases. And only then could the US stem the rising tide of import penetration by foreign producers.

The other 30% is also emblematic of a deeper strategic issue that America faces – a profound competitive challenge. A shift to external demand is not there for the asking. It must be earned by hard work, sheer determination, and a long overdue competitive revival.

On that front, too, America has been falling behind. According to the World Economic Forum’s Global Competitiveness Index, the US slipped to fifth place in 2011-2012, from fourth place the previous year, continuing a general downward trend evident since 2005.

The erosion is traceable to several factors, including deficiencies in primary and secondary education as well as poor macroeconomic management. But the US also has disturbingly low rankings in the quality of its infrastructure (#24), technology availability and absorption (#18), and the sophistication and breadth of its supply-chain production processes (#14).

Improvement on all counts is vital for America’s competitive revival. But meeting the challenge will require vigorous growth from America’s other 30% – especially private capital spending. With the American consumer likely to remain on ice, the same 30% must also continue to shoulder the burden of a sluggish economic recovery.

None of this can occur in a vacuum. The investment required for competitive revival and sustained recovery cannot be funded without a long-overdue improvement in US saving. In an era of outsize government deficits and subpar household saving, that may be America’s toughest challenge of all.

By Stephen S. Roach

Copyright: Project-Syndicate, 2012

Stephen S. Roach is the Non-Executive Chairman of Morgan Stanley Asia, as well as being a lecturer at Yale University’s School of Management and Jackson Institute for Global Affairs. In 2009, Roach authored “The Next Asia”, which contained key research papers on Asia and how the region fits into the broad global context of the globalization of investing and financial markets around the world.

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

The post The Search for America’s Growth Engine: Stephen S. Roach appeared first on Economy Watch.

America’s False Recovery – Why The US Is Not An Oasis Of Prosperity: Stephen Roach

Stephen S. Roach — Fri, 29 Jun 2012 08:38:14 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

The U.S.’s recovery from the 2008 financial crisis has led to widespread hope that America has the capacity to stay the course and provide a backstop for the rest of the world in the midst of the euro crisis. But a closer analysis of America’s recent economic growth suggests that the economy may be even more vulnerable to foreign crises than before.

NEW HAVEN – In September 1998, during the depths of the Asian financial crisis, Alan Greenspan, the United States Federal Reserve’s chairman at the time, had a simple message: the US is not an oasis of prosperity in an otherwise struggling world. Greenspan’s point is even closer to the mark today than it was back then.

Yes, the US economy has been on a weak recovery trajectory over the past three years. But at least it’s a recovery, claim many – and therefore a source of ongoing resilience in an otherwise struggling developed world. Unlike the Great Recession of 2008-2009, today there is widespread hope that America has the capacity to stay the course and provide a backstop for the rest of the world in the midst of the euro crisis.

Think again. Since the first quarter of 2009, when the US economy was bottoming out after its worst post-war recession, exports have accounted for fully 41 percent of the subsequent rebound.

[quote]That’s right: with the American consumer on ice in the aftermath of the biggest consumption binge in history, the US economy has drawn its sustenance disproportionately from foreign markets. With those markets now in trouble, the US could be quick to follow.[/quote]

America Exposed

Three regions have collectively accounted for 83 percent of America’s export-led growth impetus over the past three years – Asia, Latin America, and Europe. (Since regional and country trade statistics assembled by the US Department of Commerce are not seasonally adjusted, all subsequent comparisons are presented on the basis of a comparable seasonal comparison from the first quarter of 2009 to the first quarter of 2012.)

Not surprisingly, Asia led the way, accounting for 33 percent of the total US export surge over the past three years. The biggest source of this increase came from the 15-percentage-point contribution of Greater China (the People’s Republic, Taiwan, and Hong Kong). Needless to say, China’s unfolding slowdown – even under the soft-landing scenario that I still believe is most credible – is taking a major toll on the largest source of America’s export revival. The remainder of the Asian-led US export impetus is spread out, led by South Korea, Japan, and Taiwan – all export-led economies themselves and all heavily dependent on a slowing China.

Latin America provided the second-largest source of America’s export resurgence, accounting for another 28 percent of the total gains in US foreign sales over the past three years. Brazil and Mexico collectively accounted for 19 percentage points of that increase. Growth in both economies is now slowing significantly, especially in Brazil. But, given the close linkages between Mexican production and US consumption (which is now sputtering again), any resilience in the Mexican economy could be short-lived.

Finally, there is the sad case of Europe, which has accounted for 21 percent of the cumulative growth in US exports over the past three years. Here, the US Commerce Department statistics are not as helpful in pinpointing the source of the impetus, because only a partial country list is published. What we do know is that the United Kingdom, Germany, and France – the so-called core economies – collectively accounted for just 3.5 percent of total US export growth since early 2009, with the UK grabbing the bulk of that increase. That suggests that most of America’s European export gain was concentrated in the region’s so-called peripheral economies. And that is clearly a serious problem.

Forecasts are always hazardous, but some “what-if” scenarios shed considerable light on what all of this means for the world’s largest economy. Since the second quarter of 2009, US annualized real GDP growth has averaged 2.4 percent. With roughly 40 percent of that increase attributable to exports, that means the remainder of the economy has grown at an anemic 1.4 percent pace.

Under a flat-line export scenario, with no rise in US exports, and if everything else remains the same (always a heroic assumption), overall real GDP growth would converge on that 1.4 percent bogey. That is a weak growth trajectory by any standard – likely to result in rising unemployment and further deterioration in consumer confidence.

Alternatively, in a moderate export-downturn scenario, with real exports falling by 5 percent over a four-quarter period, real GDP growth could slip below the 1 percent “stall speed” threshold – leaving the US economy vulnerable to a recessionary relapse. By way of reference, the assumption of a 5 percent export downturn pales in comparison with the precipitous 13.6 percent decline in real exports that occurred in 2008-2009. As such, this “what if” is a cautiously optimistic assessment of the downside risks stemming from weak external demand.

No Innocent Bystanders In The Global Economy

All of this underscores one of the more obvious, yet overlooked, implications of an increasingly interdependent world: we are all in it together. The euro crisis is a serious shock, and is now producing ripple effects around the world. Europe is export-led China’s largest source of external demand; as China goes, so goes the rest of China-centric Asia; and, from there, the ripples reach the shores of an increasingly export-dependent US economy. As recent weakness in employment and retail sales suggests, that may already be happening.

Greenspan’s warning in 1998 came at a time when US exports accounted for only about 10.5 percent of GDP. Today, that share stands at a record-high 14 percent, as post-crisis America has made a big bet on an export-led revival. The current global slowdown is not on a par with what occurred in the late 1990’s or the more wrenching shocks of 3-4 years ago – at least not yet. But today’s global downturn can hardly be dismissed as unimportant for the US or anyone else.

[quote]In an era of globalization, there are no innocent bystanders. There are certainly no oases of prosperity in the face of yet another major shock in the global economy. America’s growth mirage is an important case in point.[/quote]

By Stephen S. Roach

Copyright: Project-Syndicate, 2012

Stephen S. Roach is the former Chairman of Morgan Stanley Asia and a lecturer at Yale University’s School of Management and Jackson Institute for Global Affairs. In 2009, Roach authored “The Next Asia”, which contained key research papers on Asia and how the region fits into the broad global context of the globalization of investing and financial markets around the world.

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

The post America’s False Recovery – Why The US Is Not An Oasis Of Prosperity: Stephen Roach appeared first on Economy Watch.

Can Asia Overcome Its Vulnerability To The European Crisis? : Stephen Roach

Stephen S. Roach — Wed, 30 May 2012 08:49:04 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

With the exception of Japan, the rest of Asia came through the 2008 financial crisis with relatively little damage. But for the second time in less than four years, the region now faces another major external demand shock, which could turn a mild recession into something far worse.

NEW HAVEN – Asian authorities were understandably smug in the aftermath of the financial crisis of 2008-2009. Growth in the region slowed sharply, as might be expected of export-led economies confronted with the sharpest collapse in global trade since the 1930’s. But, with the notable exception of Japan, which suffered its deepest recession of the modern era, Asia came through an extraordinarily tough period in excellent shape.

That was then. For the second time in less than four years, Asia is being hit with a major external demand shock. This time it is from Europe, where a raging sovereign-debt crisis threatens to turn a mild recession into something far worse: a possible Greek exit from the euro, which could trigger contagion across the eurozone. This is a big deal for Asia.

Financial and trade linkages make Asia highly vulnerable to Europe’s malaise. Owing to the former, the risks to Asia from a European banking crisis cannot be taken lightly. Lacking well-developed capital markets as an alternative source of credit, bank-funding channels are especially vital in Asia.

Indeed, the Asian Development Bank estimates that European banks fund about 9 percent of total domestic credit in developing Asia – three times the share of financing provided by banks based in the United States. The role of European banks is especially significant in Singapore and Hong Kong – the region’s two major financial centres. That means that Asia is far more exposed to an offshore banking crisis today than it was in the aftermath of Lehman Brothers’ collapse in 2008, which led to a near-meltdown of the US banking system.

The transmission effects through trade linkages are just as worrying. Historically, the US was modern Asia’s largest source of external demand. But that appears to have changed over the past decade. Seduced by China’s spectacular growth, the region shifted from US- to China-centric export growth.

That seemed like a good move. Combined shipments to the US and Europe fell to 24 percent of developing Asia’s total exports in 2010 – down sharply from 34 percent in 1998-1999. Meanwhile, over the same period, Asia’s dependence on intraregional exports – trade flows within the region – expanded sharply, from 36 percent of total exports in 1998 to 44 percent in 2010.

These numbers seem to paint a comforting picture of an increasingly autonomous Asia that can better withstand the blows from the West’s recurring crises. But research by the International Monetary Fund shows that, beneath the veneer, 60-65 percent of all trade flows in the region can be classified as “intermediate goods” – components that are made in countries like Korea and Taiwan, assembled in China, and ultimately shipped out as finished goods to the West.

With Europe and the US still accounting for the largest shares of China’s end-market exports, there can be no escaping the tight linkages of Asia’s China-centric supply chain to the ups and downs of demand in the major developed economies. Moreover, there is an important and worrisome twist to those linkages: China itself has tilted increasingly toward Europe as its major source of external demand. In 2007, the European Union surpassed the US as China’s largest export market. By 2010, the EU accounted for 20 percent of total Chinese exports, while the US share was just 18 percent.

[quote]In other words, a China-centric Asian supply chain has made a big bet on the grand European experiment – a bet that now appears to be backfiring. Indeed, in China, a now-familiar pattern is playing out yet again – another slowdown in domestic growth stemming from a crisis in the advanced economies of the West. And, as goes China, so will go the rest of an increasingly integrated Asia.[/quote]

The good news is that, so far, the downside has been much better contained than was the case in late 2008 and early 2009. Back then, Chinese exports went from boom to bust in just seven months – from 26 percent annual growth in July 2008 to a 27 percent decline in February 2009. This time, the annual export gain has slowed from 20 percent in 2011 to 5 percent in April 2012 – a significant deceleration, to be sure, but one that stops well short of the previous outright collapse. That could change in the event of a disorderly euro breakup, but, barring that outcome, there is reason to be more sanguine this time around.

[quote]The bad news is that Asia seems to be learning little from repeated external demand shocks. In the end, internal demand is the only effective defense against external vulnerability. Yet the region has failed to construct that firewall.[/quote]

On the contrary, private consumption fell to a record-low 45 percent of developing Asia’s GDP in 2010 – down ten percentage points from 2002. In these circumstances, immunity from external shocks – or “decoupling,” as it is often called – seems fanciful.

As with most things in Asia nowadays, China holds the key to supplying Asia’s missing consumer demand. The recently enacted 12th Five-Year Plan (2011-15) has all the right ingredients to produce the ultimate buffer between the dynamism of the East and the perils of a crisis-battered West. But, as the euro crisis causes China’s economy to slow for the second time in three and a half years, there can be little doubt that implementation of the Plan’s pro-consumption rebalancing is lagging.

There are no oases of prosperity in a crisis-prone globalized world. That is equally true for Asia, the world’s fastest-growing region. As Europe’s crisis deepens, the twin channels of financial and trade linkages have placed Asia’s economies in a vice. Rebalancing is the only way out for China and its partners in the Asian supply chain. Until that occurs, the vice now gripping Asia will only continue to tighten.

By Stephen S. Roach

Copyright: Project-Syndicate, 2012

Stephen S. Roach is the Non-Executive Chairman of Morgan Stanley Asia, as well as being a lecturer at Yale University’s School of Management and Jackson Institute for Global Affairs. In 2009, Roach authored “The Next Asia”, which contained key research papers on Asia and how the region fits into the broad global context of the globalization of investing and financial markets around the world.

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

The post Can Asia Overcome Its Vulnerability To The European Crisis? : Stephen Roach appeared first on Economy Watch.

America Needs To Rethink Its Priorities With China: Stephen Roach

Stephen S. Roach — Tue, 01 May 2012 01:53:25 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

The United States fixation with the Renminbi has distracted the government from far more important economic issues in its relationship with China. Rather than vilifying China as the principal economic threat to America, this relationship should be recast as an opportunity – especially when the opportunities of market access far outweigh the currency threat.

NEW YORK – For seven years, the United States has allowed its fixation on the renminbi’s exchange rate to deflect attention from far more important issues in its economic relationship with China. The upcoming Strategic and Economic Dialogue between the US and China is an excellent opportunity to examine – and rethink – America’s priorities.

Since 2005, the US Congress has repeatedly flirted with legislation aimed at defending hard-pressed American workers from the presumed threat of a cheap Chinese currency. Bipartisan support for such a measure surfaced when Senators Charles Schumer (a liberal Democrat from New York) and Lindsey Graham (a conservative Republican from South Carolina) introduced the first Chinese currency bill.

[quote]The argument for legislative action is tantalizingly simple: the US merchandise trade deficit has averaged a record 4.4 percent of GDP since 2005, with China accounting for fully 35 percent of the shortfall, supposedly owing to its currency manipulation. The Chinese, insists a broad coalition of politicians, business leaders, and academic economists, must revalue or face sanctions.[/quote]

This reasoning resonates with the US public. Opinion polls conducted in 2011 found that fully 61 percent of Americans believes that China represents a serious economic threat. As such, the currency debate looms as a major issue in the upcoming US presidential campaign. “Enough is enough,” President Barack Obama replied, when queried on the renminbi in the aftermath of his last meeting with Chinese President Hu Jintao. Obama’s presumptive Republican challenger, Mitt Romney, has promised to declare China guilty of currency manipulation the day he takes office.

But, however appealing this logic may be, it is wrong. First, America’s trade deficit is multilateral: the US ran deficits with 88 nations in 2010. A multilateral imbalance – especially one that it is traceable to a saving shortfall – cannot be fixed by putting pressure on a bilateral exchange rate. Indeed, America’s major threat is from within. Blaming China merely impedes the heavy lifting that must be done at home – namely, boosting saving by cutting budget deficits and encouraging households to save income rather than rely on asset bubbles.

Second, the renminbi has now appreciated 31.4 percent against the dollar since mid-2005, well in excess of the 27.5 percent increase called for by the original Schumer-Graham bill. Mindful of the lessons of Japan – especially its disastrous concession on sharp yen appreciation in the Plaza Accord of 1985 – the Chinese have opted, instead, for a gradual revaluation. Recent moves toward renminbi internationalization, a more open capital account, and wider currency trading bands leave little doubt that the endgame is a market-based, fully convertible renminbi.

Third, there has been significant improvement in China’s external imbalance. The International Monetary Fund estimates that China’s current-account surplus will narrow to just 2.3 percent of GDP in 2012, after peaking at 10.1 percent in 2007. American officials have long bemoaned China’s saving glut as a major source of global instability. But they should look in the mirror: America’s current-account deficit this year, at an estimated $510 billion, is likely to be 2.8 times higher than China’s surplus.

Finally, China has evolved from the world’s factory to its assembly line. Research shows that no more than 20 to 30 percent of Chinese exports to the US reflect value added inside China. Roughly 60 percent of Chinese exports represent shipments of “foreign invested enterprises” – in effect, Chinese subsidiaries of global multinationals. Think Apple. Globalized production platforms distort bilateral trade data between the US and China, and have little to do with the exchange rate.

Rather than vilifying China as the principal economic threat to America, the relationship should be recast as an opportunity. The largest component of US aggregate demand – the consumer – is on ice. With households focused on repairing severely damaged balance sheets, inflation-adjusted private consumption has expanded at an anemic 0.5 percentaverage annual rate over the past four years. Consumer deleveraging is likely to persist for years to come, leaving the US increasingly desperate for new sources of growth.

[quote]Exports top the list of possibilities. China is now America’s third largest and most rapidly growing export market. There can be no mistaking its potential to fill some of the void left by US consumers.[/quote]

The key to realizing that opportunity lies in access to Chinese markets – all the more significant in light of China’s upcoming pro-consumption rebalancing. Historically, China has had an open development model, with imports running at 28 percent of GDP since 2002 – nearly three times Japan’s 10 percent import ratio during its high-growth era (1960-1989). As a result, for a given increment of domestic demand, China is far more predisposed toward foreign sourcing.

As the Chinese consumer emerges, demand for a wide variety of US-made goods – ranging from new-generation information technology and biotech to automotive components and aircraft – could surge. The same is true of services. At just 43 percent of GDP, China’s services sector is relatively tiny. There is enormous scope for America’s global services companies to expand in China, especially in transactions-intensive distribution sectors – wholesale and retail trade, domestic transportation, and supply-chain logistics – as well as in the processing segments of finance, health care, and data warehousing.

The US needs to refocus the US-China trade agenda toward expanded market access in these and other areas – pushing back against Chinese policies and government procurement practices that favour domestic production and indigenous innovation. Some progress has been made, but more is needed – for example, getting China to join the World Trade Organization’s Government Procurement Agreement. At the same time, the US should reconsider antiquated Cold War restrictions on Chinese purchases of technology-intensive items.

For a growth-starved US, the opportunities of market access far outweigh the currency threat. The long-dormant Chinese consumer is about to be unleashed. This plays to one of America’s greatest strengths – its zeal to compete in new markets. Shame on the US if it squanders this extraordinary chance by digging in its heels at the upcoming Strategic and Economic dialogue.

By Stephen S. Roach

Copyright: Project-Syndicate, 2012

Stephen S. Roach is the Non-Executive Chairman of Morgan Stanley Asia, as well as being a lecturer at Yale University’s School of Management and Jackson Institute for Global Affairs. In 2009, Roach authored “The Next Asia”, which contained key research papers on Asia and how the region fits into the broad global context of the globalization of investing and financial markets around the world.

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

The post America Needs To Rethink Its Priorities With China: Stephen Roach appeared first on Economy Watch.

China’s Obsession With Stability: Stephen Roach

Stephen S. Roach — Thu, 29 Mar 2012 08:55:13 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

Given centuries of turmoil in China, today’s leaders will do everything in their power to preserve political, social, and economic stability. That is why they removed Bo Xilai, the powerful Party Secretary of Chongqing, just before a major conference that attacked the economic model that he personified.

BEIJING – The first principle that I learned when I started focusing on China in the late 1990’s is that nothing is more important to the Chinese than stability – whether economic, social, or political.

Given centuries of turmoil in China, today’s leaders will do everything in their power to preserve stability. Whenever I have doubts about a potential Chinese policy shift, I examine the options through the stability lens. It has worked like a charm.

Stability was on everyone’s mind at the annual China Development Forum (CDF) held March 17-20 in Beijing. Hosted by Premier Wen Jiabao, with many ministers of the State Council in attendance, the CDF is China’s most important international conference. Yet, literally two days before this year’s CDF began, the controversial Bo Xilai was removed as Party Secretary of Chongqing. As a strong candidate to join the Standing Committee of the Politburo, China’s inner circle of leadership, Bo’s sudden demise was stunning. There was a palpable buzz in the air as we convened in the Diaoyutai State Guesthouse.

The formal sessions played out predictably, placing great emphasis on the coming structural transformation of China’s growth model – a colossal shift from the all-powerful export- and investment-led growth of the past 32 years to a more consumer-led dynamic. There is now broad consensus among China’s senior leadership in favour of such a rebalancing. As one participant put it, “The debate has shifted from what to do to how and when to do it.”

Related: The Chinese Economy

Related: China Economic Forecast

Many of the other themes flowed from this general conclusion. A shift to services-led growth and an innovations-based development strategy were highlighted. At the same time, there was considerable concern about the recent resurgence of state-owned enterprises, which has tilted the distribution of national income from labour to capital – a major impediment to China’s pro-consumption rebalancing. The World Bank and the China Development Research Center (the CDF’s host) had just released a comprehensive report that addressed many aspects of this critical issue.

But the CDF’s formal proceedings never even hinted at the elephant in the chambers of Diaoyutai. There was no mention of Bo Xilai and what his dismissal meant for China’s domestic politics in this critical year of leadership transition. While it is easy to get caught up in the swirling tales of palace intrigue that have followed, I suspect that Bo’s removal holds a far deeper meaning.

[quote]Chinese officials faced the risk of a dangerous interplay of political and economic instability. Hit by a second external demand shock in three years – first, America’s subprime crisis, and now Europe’s sovereign-debt crisis – any outbreak of internal political instability would pose a far greater threat than might otherwise be the case.[/quote]

Bo personified that risk. He embodied the so-called “Chongqing model” of state capitalism that has been ascendant in China in recent years – government-directed urbanization and economic development that concentrates power in the hands of regional leaders and state-owned enterprises.

I spent some time in Chongqing – a vast metropolitan area of more than 34 million people – last summer. I left astonished at the scope of the city’s plans. Orchestrated by Chongqing Mayor Huang Qifan, the principal architect of the spectacular Pudong development project in Shanghai, the goal is to transform the Liangjiang area of Chongqing into China’s first inland urban development zone. That would put Liangjiang on a par with coastal China’s two earlier showcase projects – Pudong and the Binhai area of Tianjin.

Yet this is the same state-dominated development model that came under heavy criticism at this year’s CDF – and that stands in sharp contrast to the more market-driven alternative that has gained broad consensus among senior Chinese leaders. In other words, Bo was perceived not only as a threat to political stability, but also as the leading representative of a model of economic instability. By dismissing Bo so abruptly, the central government has, in effect, underscored its unwavering commitment to stability.

This fits with yet another curious piece of the Chinese puzzle. Five years ago, Wen famously warned of a Chinese economy that was in danger of becoming “unstable, unbalanced, uncoordinated, and unsustainable.” I have repeatedly stressed the critical role that Wen’s “Four Uns” have played in shaping the pro-consumption strategy of the “Next China.” Wen’s critique paved the way for China to face its rebalancing imperatives head on.

But, in their formal remarks to the CDF this year, China’s senior leadership – including Premier-designate Li Keqiang – dropped all explicit references to the risks of an “unstable” Chinese economy. In short, the Four Uns have now become three.

[quote]In China, such changes in language are no accident. The most likely interpretation is that those at the top no longer want to concede anything when it comes to stability. By addressing economic instability through pro-consumption rebalancing, and political instability by removing Bo, stability has gone from a risk factor to an ironclad commitment.[/quote]

There can be no mistaking the Chinese leadership’s core message nowadays. They are the first to concede that their growth and development strategy is at a critical juncture. They worry that the “reforms and opening up” of Deng Xiaoping are in danger of losing momentum. By addressing the interplay between economic and political risks to stability, the government is clearing the way for the next phase of China’s extraordinary development. I would not advise betting against their commitment to achieving that goal.

By Stephen S. Roach

Copyright: Project-Syndicate, 2012

Stephen S. Roach is the Non-Executive Chairman of Morgan Stanley Asia, as well as being a lecturer at Yale University’s School of Management and Jackson Institute for Global Affairs. In 2009, Roach authored “The Next Asia”, which contained key research papers on Asia and how the region fits into the broad global context of the globalization of investing and financial markets around the world.

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

The post China’s Obsession With Stability: Stephen Roach appeared first on Economy Watch.

The Asian Argument For Austerity: Stephen Roach

Stephen S. Roach — Tue, 06 Mar 2012 08:56:07 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

With Europe on the brink of recession and recovery in the US finally getting some traction, the case for fiscal consolidation appears increasingly weak. But the case becomes stronger when one considers Asian countries’ path from crisis in the late 1990’s to astounding growth and prosperity today.

NEW HAVEN – The austerity debate was the topic du jour at this year’s World Economic Forum in Davos. With good reason. Europe is slipping back into recession just when recovery in the United States is finally getting some traction. That has undermined the case for fiscal consolidation, which is so heavily favoured in Europe.

Yet I took away a different conclusion from Davos. I moderated a session on “The New Context in East Asia,” addressed by a panel of senior representatives from Thailand, South Korea, Malaysia, Singapore, and Japan. With the exception of the Japanese participant, all had first-hand experience with the devastating Asian financial crisis of the late 1990’s.

I couldn’t resist the temptation to draw Asia into the debate between Europe and the US. Rather than ask the Asian panelists to theorize about the impact of austerity in the overly indebted developed West, I asked them to assess their own experiences during and after the crisis of the late 1990’s.

Frankly, I was surprised by what I heard. The panelists agreed on two points: first, they initially detested the wrenching adjustment programs dictated by the terms of the International Monetary Fund’s so-called conditional bailouts (the South Koreans still refer scornfully to the “IMF crisis” of the late 1990’s).

[quote]Second – and here’s where the surprise came – they all agreed that, with the benefit of hindsight, these excruciating adjustments were worth it, because their crisis-torn economies were forced to embrace structural reforms that paved the way for their spectacular economic performance today.[/quote]

On the surface, the numbers speak for themselves. In 1998, during the depths of the Asian crisis, aggregate output in the so-called ASEAN-5 – Indonesia, Malaysia, the Philippines, Thailand, and Vietnam – plunged by 8.3 percent. Real GDP in South Korea – long considered the darling of Asia’s newly industrialized economies – contracted by 5.7 percent that year. But then the tough conditionality of IMF bailouts and adjustment programs – Asia’s own dose of austerity – kicked in.

In response, current-account balances – the Achilles’ heel of the so-called East Asian growth miracle – went from deficit to surplus. For the ASEAN-5, current-account deficits averaging 4 percent of GDP in 1996-97 swung dramatically into average surpluses of 6.8 percent of GDP in 1998-99. A similar transformation occurred in South Korea, where a 2.8 percent current-account deficit in 1996-1997 became an 8.6 percent surplus in 1998-1999.

Since then, the region has never looked back. Within two years, most of Asia’s crisis-ridden economies had regained their pre-crisis peaks. Nor was this a temporary rebound. Beginning in 1999, the ASEAN-5 began a ten-year spurt of 5 percent average annual GDP growth (5.5 percent in South Korea over the same period). In short, there were no lasting negative effects from the short-term dose of austerity, and, to the extent that austerity was essential to post-crisis healing, the long-term benefits have proven to be both enduring and astounding.

Three lessons for the rest of us come to mind. First, there is no gain without pain. Few of us in the developed world can fathom aggregate-output contractions on the scale that crisis-torn Asia suffered in 1998, let alone muster the political will to impose them on our economies. The economic dislocations and the humiliation of proud nations were, indeed, devastating (as Greeks today can attest). But, once the excesses were purged, Asia’s post-crisis rebounds were both strong and sustainable.

Second, currencies played an important role as an escape valve in the early days of Asia’s post-crisis adjustment process. As the region moved from hard exchange-rate pegs to floating rates, Asian currencies plunged – with drops against the dollar ranging from 28 percent in South Korea and roughly 37 percent in Thailand, Malaysia, and the Philippines to almost 80 percent in Indonesia.

Finally, there is no substitute for restructuring. In Asia in the late 1990’s, measures aimed at the financial sector dominated IMF-imposed structural adjustment programs, but there were also programs that focused on tax and expenditure reforms, corporate governance, privatization, and business-debt restructuring. While not all of these programs were implemented in strict compliance with IMF conditionality, they played a key role in promoting significant improvements in Asian competiveness.

None of these lessons should be lost on either Europe or the US. While individual countries obviously lack currency flexibility in a monetary union – one of Europe’s most obvious and important differences from Asia in the late 1990’s – there is nothing to prevent a depreciation of the euro from boosting pan-regional competitiveness. The same, of course, is true of the US dollar.

[quote]But no country – or group of countries, in Europe’s case – has ever devalued its way back to prosperity. So Asia’s structural lessons are equally important to the developed world. Indeed, Germany’s economy is out-competing and out-growing the rest of Europe, largely owing to labour-market reforms and deregulation. The same medicine might prove equally beneficial to the rest of Europe – to say nothing of the US, which faces a major competitiveness challenge of its own.[/quote]

In the end, Asia’s developing economies had no choice but to accept draconian measures as the price of bailouts in the late 1990’s. It remains to be seen if rich developed countries are willing to take the same route. Two decades ago, in their book Changing Fortunes, Paul Volcker and Toyo Gyohten underscored the glaring double standard of crisis resolution: “When the [International Monetary] Fund consults with a poor and weak country, the country gets in line. When it consults with a strong country, the Fund gets in line.”

Perhaps that is the key lesson from the Asian crisis of the late 1990’s: austerity can work. But its success or failure ultimately boils down to power politics – namely, a resolution of the tension between short-term palliatives and the commitment to a long-term strategy. That’s where the battle still rages in the West.

By Stephen S. Roach

Copyright: Project-Syndicate, 2012

Stephen S. Roach is the Non-Executive Chairman of Morgan Stanley Asia, as well as being a lecturer at Yale University’s School of Management and Jackson Institute for Global Affairs. In 2009, Roach authored “The Next Asia”, which contained key research papers on Asia and how the region fits into the broad global context of the globalization of investing and financial markets around the world.

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

The post The Asian Argument For Austerity: Stephen Roach appeared first on Economy Watch.

How Will China’s Connectivity Revolution Transform The Nation? : Stephen Roach

Stephen S. Roach — Mon, 06 Feb 2012 09:21:09 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

The pace of China’s Internet revolution has been breathtaking. Since 2006, the number of Internet users in China has more than tripled to 485 million, while the cost of connectivity is also expected to fall sharply as China’s Internet penetration rate continues to grow. But while it is always easy to get carried away with the numbers, the real change in China concerns the implications of connectivity, and not just its scale.

NEW HAVEN – Long the most fragmented nation on earth, China is being brought together like never before by a new connectivity. Its Internet community is expanding at hyper speed, with profound implications for the Chinese economy, to say nothing of the country’s social norms and political system. This genie cannot be stuffed back in the bottle. Once connected, there is no turning back.

The pace of transformation is breathtaking. According to Internet World Stats, the number of Internet users in China has more than tripled since 2006, soaring to 485 million in mid-2011 – more than three times that in 2006. Moreover, China’s rush to connectivity is far from over. As of mid-2011, only 36 percent of its 1.3 billion people were connected – far short of the nearly 80 percent penetration rates seen in South Korea, Japan, and the United States.

Indeed, with the cost of connectivity falling sharply – China’s mobile users are expected to surpass PC users by 2013 – and, with urbanization and per capita incomes also rising sharply, it is not unreasonable to expect China’s Internet penetration rate to cross the 50 percent threshold by 2015. That would be the functional equivalent of adding about three-fourths of all existing Internet users in the US.

Related: Does the Internet Grow GDP?

Nor are the Chinese casual and infrequent Internet users. Consistent with what the social-network theorist Clay Shirky has dubbed a society’s penchant for unlocking the “cognitive surplus” embedded in net-based activities, survey data from the China Internet Network Information Centre suggest that Chinese netizens log an average of 2.6 hours per day online – a full hour longer than the average 15-49-year-old Chinese citizen spends watching television.

China’s microblogs, or social networks, where usage tends be most intense, were estimated to have approximately 270 million users as of late 2011. And there is plenty of upside. Worldwide, about 70 percent of all Internet users currently engage in some form of microblogging, which is the fastest-growing segment of the Internet. In China, this share is just 55 percent.

[quote]When it comes to analyzing China, it is always easy to get carried away with numbers – especially those driven by the country’s sheer size. But the real message here concerns the implications of connectivity, not just its scale. [/quote]

A key implication is the Internet’s potential to play a significant role in the emergence of China’s consumer society – a critical structural imperative for a long-unbalanced Chinese economy. With connectivity comes a national awareness of spending habits, tastes, and brands – essential characteristics of any consumer culture.

The consumption share of China’s economy, at less than 35 percent of GDP, is the lowest of any major country. Surging Chinese Internet usage could well facilitate the pro-consumption initiatives of the recently enacted 12th Five-Year Plan.

The Internet could also enable freer and more open communications, upward mobility, transparent and rapid dissemination of information, and, yes, individuality. China’s leadership has been increasingly vocal in raising concerns about growing inequalities that might otherwise hinder the development of what they call a more “harmonious society.” Online connectivity could be a powerful means to help China come together and achieve this goal.

Finally, there is the Internet’s potential as an instrument of political change. That is hardly an inconsequential consideration for any country in the aftermath of last year’s Arab Spring, which was facilitated in many countries (especially Tunisia and Egypt) by network-enabled mobilization.

[quote]While reform of China’s single-party state has always been viewed as an important objective in modern China – from the so-called Fifth Modernization of Wei Jinsheng in the late 1970’s to recent speeches by Premier Wen Jiabao – meaningful progress has been limited. Is this likely to change as China embraces the Internet?[/quote]

China is no exception in requiring leadership, accountability, and responsiveness as conditions of political stability. Its rapidly expanding Internet community has repeatedly raised national awareness of tough local issues. This was especially evident in the aftermath of the Sichuan earthquake of 2008, ethnic violence in Xinjiang in 2009, and the high-speed rail crash in Wenzhou in 2011.

As the Arab Spring demonstrated, the Internet can quickly transform local incidents into national flashpoints – turning the new connectivity into a potential source of political instability and turmoil. But that has been the case only in countries ruled by highly unpopular autocratic regimes.

By contrast, China’s leadership is viewed with a much greater degree of public sympathy. Their quick and direct response to the recent incidents in Sichuan, Xinjiang, and Wenzhou are important cases in point. Senior Party leaders – especially Premier Wen – were quick to lead an empathetic national response that was largely effective in countering the outpouring of concern expressed on the Internet.

None of this is to deny the dark side of the Chinese Internet explosion – namely, widespread censorship and constraints on individual freedom of expression. China’s “SkyNet” team (rumored to be greater than 30,000) is the largest cyber police force in the world.

Moreover, while China is not alone in censoring the Internet, self-policing by many of the nation’s largest portals amplifies official oversight and surveillance. Recent restrictions on microbloggers – especially denial of access to those who use untraceable aliases – have heightened concerns over Chinese Internet freedom. Such restrictions, of course, cut both ways – potentially limiting personal expression, but also constraining disguised and reckless vigilante attacks.

Filtered or not, a long-fragmented China now has a viable and rapidly expanding network. The power of that network – especially insofar as economic, social, and political change is concerned – is hard to predict. But connectivity adds a new dimension of cohesion to modern China. That can only accelerate the speed of its extraordinary development journey.

By Stephen S. Roach

Copyright: Project-Syndicate, 2012

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

The post How Will China’s Connectivity Revolution Transform The Nation? : Stephen Roach appeared first on Economy Watch.

China vs. India – Is Either Economy At Risk? : Stephen Roach

Stephen S. Roach — Wed, 04 Jan 2012 08:01:55 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

Both China and India depend heavily on the broader economic global climate. The fear is that if China and India fall, Asia would be at risk, and it would be hard to avoid a global recession. Yet fears of hard landings for both economies are overblown, especially regarding China.

NEW HAVEN – Today, fears are growing that China and India are about to be the next victims of the ongoing global economic carnage. This would have enormous consequences. Asia’s developing and newly industrialized economies grew at an 8.5 percent average annual rate over 2010-11 – nearly triple the 3 percent growth elsewhere in the world. If China and India are next to fall, Asia would be at risk, and it would be hard to avoid a global recession.

In one important sense, these concerns are understandable: both economies depend heavily on the broader global climate. China is sensitive to downside risks to external demand – more relevant than ever since crisis-torn Europe and the United States collectively accounted for 38 percent of total exports in 2010. But India, with its large current-account deficit and external funding needs, is more exposed to tough conditions in global financial markets.

Yet fears of hard landings for both economies are overblown, especially regarding China. Yes, China is paying a price for aggressive economic stimulus undertaken in the depths of the subprime crisis. The banking system funded the bulk of the additional spending, and thus is exposed to any deterioration in credit quality that may have arisen from such efforts. There are also concerns about frothy property markets and mounting inflation.

[quote]While none of these problems should be minimized, they are unlikely to trigger a hard landing. Long fixated on stability, Chinese policymakers have been quick to take pre-emptive action.[/quote]

That is particularly evident in Chinese officials’ successful campaign against inflation. Administrative measures in the agricultural sector, aimed at alleviating supply bottlenecks for pork, cooking oil, fresh vegetables, and fertilizer, have pushed food-price inflation lower. This is the main reason why the headline consumer inflation rate receded from 6.5 percent in July 2011 to 4.2 percent in November.

Meanwhile, the People’s Bank of China, which hiked benchmark one-year lending rates five times in the 12 months ending this October, to 6.5 percent, now has plenty of scope for monetary easing should economic conditions deteriorate. The same is true with mandatory reserves in the banking sector, where the government has already pruned 50 basis points off the record 21.5 percent required-reserve ratio. Relatively small fiscal deficits – only around 2 percent of GDP in 2010 – leave China with an added dimension of policy flexibility should circumstance dictate.

Nor has China been passive with respect to mounting speculative excesses in residential property. In April 2010, it implemented tough new regulations, raising down-payments from 20 percent to 30 percent for a first home, to 50 percent for a second residence, and to 100 percent for purchases of three or more units. This strategy appears to be working. In November, house prices declined in 49 of the 70 cities that China monitors monthly.

Moreover, it is a serious exaggeration to claim, as many do today, that the Chinese economy is one massive real-estate bubble. Yes, total fixed investment is approaching an unprecedented 50 percent of GDP, but residential and nonresidential real estate, combined, accounts for only 15-20 percent of that – no more than 10 percent of the overall economy. In terms of floor space, residential construction accounts for half of China’s real-estate investment. Identifying the share of residential real estate that goes to private developers in the dozen or so first-tier cities (which account for most of the Chinese property market’s fizz) suggests that less than 1 percent of GDP would be at risk in the event of a housing-market collapse – not exactly a recipe for a hard landing.

As for Chinese banks, the main problem appears to be exposure to ballooning local-government debt, which, according to the government, totaled $1.7 trillion (roughly 30 percent of GDP) at the end of 2010. Approximately half of this debt was on their books prior to the crisis.

Some of the new debt that resulted from the stimulus could well end up being impaired, but ongoing urbanization – around 15-20 million people per year move to cities – provides enormous support on the demand side for investment in infrastructure development and residential and commercial construction. That tempers the risks to credit quality and, along with relatively low loan-to-deposit ratios of around 65 percent, should cushion the Chinese banking system.

India is more problematic. As the only economy in Asia with a current-account deficit, its external funding problems can hardly be taken lightly. Like China, India’s economic-growth momentum is ebbing. But unlike China, the downshift is more pronounced – GDP growth fell through the 7 percent threshold in the third calendar-year quarter of 2011, and annual industrial output actually fell by 5.1 percent in October.

But the real problem is that, in contrast to China, Indian authorities have far less policy leeway. For starters, the rupee is in near free-fall. That means that the Reserve Bank of India – which has hiked its benchmark policy rate 13 times since the start of 2010 to deal with a still-serious inflation problem – can ill afford to ease monetary policy. Moreover, an outsize consolidated government budget deficit of around 9 percent of GDP limits India’s fiscal-policy discretion.

Related: Comparing India to The World

[quote]While China is in better shape than India, neither economy is likely to implode on its own. It would take another shock to trigger a hard landing in Asia.[/quote]

One obvious possibility today would be a disruptive breakup of the European Monetary Union. In that case, both China and India, like most of the world’s economies, could find themselves in serious difficulty – with an outright contraction of Chinese exports, as in late 2008 and early 2009, and heightened external funding pressures for India.

While I remain a euro-skeptic, I believe that the political will to advance European integration will prevail. Consequently, I attach a low probability to the currency union’s disintegration. Barring such a worst-case outcome for Europe, the odds of a hard landing in either India or China should remain low.

Seduced by the political economy of false prosperity, the West has squandered its might. Driven by strategy and stability, Asia has built on its newfound strength. But now it must reinvent itself. Japanese-like stagnation in the developed world is challenging externally dependent Asia to shift its focus to internal demand. Downside pressures currently squeezing China and India underscore that challenge. Asia’s defining moment could be hand.

By Stephen S. Roach

Stephen S. Roach is the Non-Executive Chairman of Morgan Stanley Asia, as well as being a lecturer at Yale University’s School of Management and Jackson Institute for Global Affairs. In 2009, Roach authored “The Next Asia”, which contained key research papers on Asia and how the region fits into the broad global context of the globalization of investing and financial markets around the world.

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

The post China vs. India – Is Either Economy At Risk? : Stephen Roach appeared first on Economy Watch.

Asia’s Wake-Up Call – Is The Export-Oriented Model Dead? : Stephen S. Roach

Stephen S. Roach — Wed, 30 Nov 2011 08:14:22 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

The US’s and Europe’s woes should be ringing alarm bells across Asia. Although many believe that the region can shrug off almost anything that the rest of the world dishes out, the crises in both regions have intensified Asia’s vulnerability to external shocks. This is Asia’s second wake-up call in three years, and this time the region needs to take the warning seriously.

NEW HAVEN – For the second time in three years, global economic recovery is at risk. In 2008, it was all about the subprime crisis made in America. Today, it is the sovereign-debt crisis made in Europe. The alarm bells should be ringing loud and clear across Asia – an export-led region that cannot afford to ignore repeated shocks to its two largest sources of external demand.

Indeed, both of these shocks will have long-lasting repercussions. In the United States, the American consumer (who still accounts for 71 percent of US GDP) remains in the wrenching throes of a Japanese-like balance-sheet recession. In the 15 quarters since the beginning of 2008, real consumer spending has increased at an anemic 0.4 percent average annual rate.

Never before has America, the world’s biggest consumer, been so weak for so long. Until US households make greater progress in reducing excessive debt loads and rebuilding personal savings – a process that could take many more years if it continues at its recent snail-like pace – a balance-sheet-constrained US economy will remain hobbled by exceedingly slow growth.

A comparable outcome is likely in Europe. Even under the now seemingly heroic assumption that the eurozone will survive, the outlook for the European economy is bleak. The crisis-torn peripheral economies – Greece, Ireland, Portugal, Italy, and even Spain – are already in recession. And economic growth is threatened in the once-solid core of Germany and France, with leading indicators – especially sharply declining German orders data – flashing ominous signs of incipient weakness.

Moreover, with fiscal austerity likely to restrain aggregate demand in the years ahead, and with capital-short banks likely to curtail lending – a serious problem for Europe’s bank-centric system of credit intermediation – a pan-European recession seems inevitable. The European Commission recently slashed its 2012 GDP growth forecast to 0.5 percent – teetering on the brink of outright recession. The risks of further cuts to the official outlook are high and rising.

[quote]It is difficult to see how Asia can remain an oasis of prosperity in such a tough global climate. Yet denial is deep, and momentum is seductive. After all, Asia has been on such a roll in recent years that far too many believe that the region can shrug off almost anything that the rest of the world dishes out.[/quote]

If only it were that easy. If anything, Asia’s vulnerability to external shocks has intensified. On the eve of the Great Recession of 2008-2009, exports had soared to a record 44 percent of combined GDP for Asia’s emerging markets – fully ten percentage points higher than the export share prevailing during Asia’s own crisis in 1997-1998. So, while post-crisis Asia focused in the 2000’s on repairing the financial vulnerabilities that had wreaked such havoc – namely, by amassing huge foreign-exchange reserves, turning current-account deficits into surpluses, and reducing its outsize exposure to short-term capital inflows – it failed to rebalance its economy’s macro structure. In fact, Asia became more reliant on exports and external demand for economic growth.

[break]

The Need For A Consumer-Led Asian Rebalancing Has Never Been Greater

As a result, when the shock of 2008-2009 hit, every economy in the region either experienced a sharp slowdown or fell into outright recession. A similar outcome cannot be ruled out in the months ahead. After tumbling sharply in 2008-2009, the export share of emerging Asia is back up to its earlier high of around 44 percent of GDP – leaving the region just as exposed to an external-demand shock today as it was heading into the subprime crisis three years ago.

China – long the engine of the all-powerful Asian growth machine – typifies Asia’s potential vulnerability to such shocks from the developed economies. Indeed, Europe and the US, combined, accounted for fully 38 percent of total Chinese exports in 2010 – easily its two largest foreign markets.

The recent data leave little doubt that Asia is now starting to feel the impact of the latest global shock. As was the case three years ago, China is leading the way, with annual export growth plummeting in October 2011, to 16 percent, from 31 percent in October 2010 – and likely to slow further in coming months.

In Hong Kong, exports actually contracted by 3 percent in September – the first year-on-year decline in 23 months. Similar trends are evident in sharply decelerating exports in Korea and Taiwan. Even in India – long thought to be among Asia’s most shock-resistant economies – annual export growth plunged from 44 percent in August 2011 to just 11 percent in October.

As was true three years ago, many hope for an Asian “decoupling” – that this high-flying region will be immune to global shocks. But, with GDP growth now slowing across Asia, that hope appears to be wishful thinking.

[quote]The good news is that a powerful investment-led impetus should partly offset declining export growth and allow Asia’s landing to be soft rather than hard. All bets would be off, however, in the event of a eurozone breakup and a full-blown European implosion. [/quote]

This is Asia’s second wake-up call in three years, and this time the region needs to take the warning seriously. With the US, and now Europe, facing long roads to recovery, Asia’s emerging economies can no longer afford to count on solid growth in external demand from the advanced countries to sustain economic development. Unless they want to settle for slower growth, lagging labor absorption, and heightened risk of social instability, they must move aggressively to shift focus to the region’s own 3.5 billion consumers. The need for a consumer-led Asian rebalancing has never been greater.

By Stephen S. Roach

Stephen S. Roach is the Non-Executive Chairman of Morgan Stanley Asia, as well as being a lecturer at Yale University’s School of Management and Jackson Institute for Global Affairs. In 2009, Roach authored “The Next Asia”, which contained key research papers on Asia and how the region fits into the broad global context of the globalization of investing and financial markets around the world.

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

The post Asia’s Wake-Up Call – Is The Export-Oriented Model Dead? : Stephen S. Roach appeared first on Economy Watch.

America’s China-Centric Blame Game Is Absurd: Stephen S. Roach

Stephen S. Roach — Tue, 01 Nov 2011 07:14:03 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

China-bashing in the US has now reached unprecedented levels. While China does account for 42 percent of America’s trade deficit, few realise that the US actually also runs deficits with 87 other countries. At the same time, most of the US problems stem from within the country. Blaming China for all of the US problems will only serve to deflect attention away from those truly responsible for perpetuating the greatest saving shortfall in history.

NEW HAVEN – The United States has a classic multilateral trade imbalance. While it runs a large trade deficit with China, it also runs deficits with 87 other countries. A multilateral deficit cannot be fixed by putting pressure on one of its bilateral components. But try telling that to America’s growing chorus of China bashers.

America’s massive trade deficit is a direct consequence of an unprecedented shortfall of domestic saving. The broadest and most meaningful measure of a country’s saving capacity is what economists call the “net national saving rate” – the combined saving of individuals, businesses, and the government. It is measured in “net” terms to strip out the depreciation associated with aging or obsolescent capacity. It provides a measure of the saving that is available to fund expansion of a country’s capital stock, and thus to sustain its economic growth.

In the US, there simply is no net saving any more. Since the fourth quarter of 2008, America’s net national saving rate has been negative – in sharp contrast to the 6.4 percent-of-GDP averaged over the last three decades of the twentieth century. Never before in modern history has the world’s leading economic power experienced a saving shortfall of such epic proportions.

[quote]Yet the US found a way to finesse this problem. Exploiting what Valéry Giscard d’Estaing called the “exorbitant privilege” of the world’s reserve currency, the US borrowed surplus savings from abroad on very attractive terms, running massive balance-of-payments, or current-account, deficits to attract foreign capital.[/quote]

The US current account, which was last in balance in 1991, hit a record deficit of $801 billion (6 percent of GDP) in 2006. This gap has narrowed in the past couple of years, but much of the improvement probably reflects little more than the temporary impact of an unusually tough business cycle.

This is where America’s multilateral trade deficit enters the equation, for it has long accounted for the bulk of America’s balance-of-payments gap. Since 2000, it has made up fully 96 percent of the cumulative current-account shortfall.

[quote]And that is what ultimately makes the China-centric blame game so absurd. Without addressing the root of the problem – America’s chronic saving shortfall – it is ludicrous to believe that there can be a bilateral solution for a multilateral problem. [/quote]

Yet that is exactly what US officials, together with many prominent economists, believe America needs. Since the trade deficit is widely thought to put pressure on US jobs and real wages, the US-China trade imbalance has come under special scrutiny in these days of great angst. Yes, China does account for the largest component of America’s multilateral trade deficit – making up 42 percent of the total trade gap in 2010. Conscious outsourcing and supply-chain management decisions by US multinationals play an important role in exaggerating China’s share. But that does little to let China off the hook in the eyes of Washington.

[break]

China-Bashing Represents A Corrosive Shift In The American Psyche

Long-standing charges of currency manipulation provide the proverbial smoking gun that US politicians – of both parties – believe justifies the imposition of steep tariffs on China’s exports to the US (which totalled $365 billion in 2010). That was precisely the argument behind the US Senate’s recent overwhelming approval of a “currency bill” that took dead aim on China.

[quote]While it may be expedient to hold others accountable for America’s problems, this is bad economics driving bad politics. In an era of open-ended US government budget deficits and chronic shortfalls in personal saving, America is doomed to suffer subpar savings and massive multilateral trade deficits for as far as the eye can see.[/quote]

Closing down trade with China, while failing to address the saving shortfall, is like putting pressure on one end of a water balloon. The Chinese component of America’s multilateral trade deficit will simply migrate somewhere else – most likely to a higher-cost producer. That would be the functional equivalent of a tax hike on beleaguered American families – hardly the solution that US politicians are promising.

This is not to ignore important US-China trade issues that need to be addressed. Market access should be high on the agenda – especially for a sluggish US economy that needs new sources of growth, like exports. With China now America’s third largest – and by far its most rapidly growing – export market, the US should push hard to expand business opportunities in China, especially as the Chinese economy tilts increasingly toward internal demand. China should be viewed as an opportunity, not a threat.

At the same time, the US government should come clean with the American public about charges of Chinese currency manipulation and unfair trade practices. The renminbi has, in fact, appreciated by 30 percent relative to the US dollar since mid-2005. In broad multilateral terms – a far more meaningful gauge because it measures a currency’s value against a broad cross-section of a country’s trading partners – the “real effective” renminbi currently stands about 8 percent above its most recent 12-year average (1998-2010).

Yes, China continues to accumulate vast foreign-exchange reserves. But this is as much the result of speculators’ “hot money” plays as it is a conscious and perfectly reasonable effort by Chinese policymakers to remain focused on financial stability and manage currency appreciation in a gradual and orderly fashion.

[quote]China-bashing in the US speaks to a corrosive shift in the American psyche. It deflects attention away from those truly responsible for perpetuating the greatest saving shortfall in history. The US has been seduced by the political economy of false prosperity. That seduction has allowed America to live beyond its means for nearly two decades. Now the game is up.[/quote]

The ultimate test of any nation’s character is to look inside itself at moments of great challenge. Swept up in the blame game, the US is doing the opposite. And that could well be the greatest tragedy of all. After all, America’s 88 deficits did not arise of thin air.

By Stephen S. Roach

Stephen S. Roach is the Non-Executive Chairman of Morgan Stanley Asia, as well as being a lecturer at Yale University’s School of Management and Jackson Institute for Global Affairs. In 2009, Roach authored “The Next Asia”, which contained key research papers on Asia and how the region fits into the broad global context of the globalization of investing and financial markets around the world.

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

The post America’s China-Centric Blame Game Is Absurd: Stephen S. Roach appeared first on Economy Watch.