Zeev's Turnips Patch-No Politics (ZEEV)

[Frank Pembleton]

Global: Sinking
Stephen Roach (New York)

Suddenly, there’s a sinking feeling again. And it’s truly global in scope. From Asia, to Europe, to the United States, and to Latin America, the world economy seems to have lost any semblance of upward momentum. The case for a year-end acceleration appears to be in tatters. An engineless global economy is simply lacking in any real source of growth. It’s starting to feel like a global double dip.

America, of course, is to blame for all this. In a US-centric world, global economic growth draws its sustenance from the ups and downs of the US economy. At market exchange rates, the US has accounted for 64% of world GDP growth since 1995; on a purchasing power parity basis, that contribution is closer to 40%. No matter how you cut it, since 1995, the United States has accounted for twice as much world GDP growth as its share in the world economy might otherwise suggest. When America booms, the rest of the world goes along for the ride. When America sags, the rest of the world sinks like a stone. And that’s precisely what’s going on at this key juncture in the global business cycle. But the rest of the world certainly deserves its fair share of the blame. Lacking in autonomous domestic demand, the non-US world is beholden to the whims of the global trade cycle. And with the US the engine of global trade, America’s latest spate of growth problems has been magnified in the world at large.

Nor can there be any mistaking the recent deterioration in the near-term US growth outlook. While real GDP growth appears to have surged by around 4% in 3Q02, Dick Berner tells me that the economy is on a trajectory that may even fall short of the 1% growth threshold in the current period. If that’s the case, it would essentially replicate the saw-tooth results of the first two quarters of this year -- a 5% growth spurt in 1Q02 followed by an anemic 1.3% increase in the second period. The weakness in the current period is shaping up to be broadly based. What’s particularly intriguing this time is the likelihood of a marked deceleration in consumer demand. September’s weakness in vehicle sales, in conjunction with disappointing department and chain store purchases, puts consumption on a very weak trajectory entering the fourth quarter. Contrary to widespread expectations, the so-called refi cycle -- a record surge of home mortgage refinancing activity -- now seems to be having a limited impact on discretionary consumer buying. Maybe the profligate American consumer finally has all the cars, DVD players, and kitchen appliances that he or she will need for a long time. If that’s the case, a "saturation effect" could well crimp the refi impact on personal consumption. Who knows, maybe over-extended American consumers will use the windfall of reduced debt service to rebuild saving or even pay down debt. Stranger things have happened.

Not surprisingly, America’s travails have been magnified elsewhere in a US-centric world. That’s especially the case in Asia ex-Japan, a region that I have long felt was a levered play on US growth. The latest data confirm that the region’s export-led growth dynamic has taken a discernible turn for the worse. That’s particularly true in Korea, Malaysia, and Indonesia. Significantly, this compression in external demand growth first showed up in the July/August data, well ahead of the current strike-related disruption to America’s west-coast shipping ports. With the benefit of hindsight, it may well be that some pre-strike stocking of Asian-made products artificially boosted US and world GDP growth in the first three quarters of this year. To the extent that now gets unwound, the payback could well exacerbate the downside of Asian growth risks. The case of Korea is especially noteworthy. Of all the countries in Asia, Korea was the poster child for post-crisis reform. Yet, as Andy Xie has recently noted, chances are rising of yet another hard landing in Korea (see his dispatch, "Korea: Rising Risk of Hard Landing," corrected in today's Forum). At work are the excesses of the household debt cycle, a property bubble in Seoul, and a rapidly emerging export compression -- with Korean export growth just reported to have slowed from 18.9% in August to just 12.6% in September. With US-led external demand slowing, a bursting of the Korean credit bubble -- either spontaneous or policy-assisted -- can only raise the odds of a hard landing for one of Asia’s heretofore best-performing post-crisis economies.

US-induced aftershocks are also evident in most other regions of the world. Europe has, perhaps, felt the impacts most acutely. Almost entirely lacking in domestic demand support, slippage in external demand has already triggered near-double-dip conditions in the Euroland manufacturing sector. That’s the verdict that can be taken from the latest euro-zone Purchasing Managers’ Index, which fell back below the key "50" threshold in August. Japan’s recent shortfall in industrial production is also troublesome in that regard -- a 1.6% increase (the monthly rate) versus the 4.5% government forecast. With limited growth in domestic demand, it seems reasonable to conclude that Japan’s latest production shortfall was very much a by-product of US-led impairment of its export growth. Nor is Latin America in any shape to weather a global storm. Crises in Argentina and Brazil have spilled over to the Andean economies, and it’s only a matter of time before NAFTA linkages threaten much weaker economic growth in Mexico, in my view.

Maybe all this is just another one of those periodic bumps on the road to global recovery. But, then again, maybe not. Needless to say, I come down on the side that says this glass is half empty. The world economy is lacking a new growth dynamic and, as I see it, stands to have an exceedingly difficult time in getting restarted. Policy traction is more elusive than ever, especially for the once-proud US growth engine -- where pent-up demand for autos and housing has been spent and where deflationary risks are mounting. The numbers have turned nasty for a reason -- a US-centric global economy can only magnify a growth shortfall in the US. In that vein, I continue to fear that America’s double dip could well be the world’s double dip.

The main problem with this view is that it has now taken investors around the world by storm. As the resident bear, my telephone has been ringing off the hook. Clients are showing up without appointments. And incoming congratulatory emails have hit a new personal high. All this is what the indomitable Barton Biggs describes as an emotional capitulation (see his 30 September essay, "Markets, Mobs, and Mayhem"). Yet this shouldn’t be so surprising. After all, the dreams of recovery are now in the process of being shattered, and the angst of that realization is finally hitting home.

I do not doubt the intensity of the emotional reaction to this painful realization. The risk is that we confuse the emotional rhetoric with what the markets are actually discounting. And from where I sit, the so-called emotional capitulation is not in the price. For example, Steve Galbraith, our US equity strategist, points to quantitative work that suggests stocks are still discounting 2.6% y-o-y real GDP growth in 1Q03; while that’s well below the Blue Chip forecasting consensus (3.4%), it stops far short of factoring in a double dip. Similarly, while deflationary fears are rising, they are not in the price of the bond market. By my reckoning, the long end of the Treasury yield curve is still discounting 10 years of 1.5% inflation. While that’s certainly a subdued picture, it stops well short of the outright deflation I still fear (see my 2 October dispatch, "Don’t Give Up on Treasuries"). Consequently, while there has been undeniable capitulation in the marketplace for ideas, there has yet to be full-blown capitulation in the marketplace for assets. Until the latter occurs, it’s hard for me to believe that the worst is over in the markets.
http://www.morganstanley.com/GEFdata/digests/20021004-fri.html