Who’s bothered about global imbalances?

Who’s bothered about global imbalances?
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First Published: Tue, Jul 21 2009. 09 38 PM IST

Updated: Tue, Jul 21 2009. 09 38 PM IST
It’s boom time again, folks.
Goldman Sachs, described memorably by Rolling Stone columnist Matt Taibbi as a “great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money,” has forecast that the Standard and Poor’s Index will rise to 1,060 points by the end of the year in the biggest rally in 27 years.
Goldman Sachs doesn’t really have a great track record in forecasting the S&P, or indeed oil prices (remember the $200 [Rs9,660] a barrel prediction?), but there’s little doubt that optimism has returned to the markets.
The question is: optimism about what? Are the markets betting that the broken financial system will be mended to function as before, deleveraging will soon come to a stop, the US consumer will start spending again, global imbalances are not imbalances at all, capital flows to emerging markets (EM) will go back to their heydays and the global economy will grow strongly even after the unprecedented government stimulus has been withdrawn?
These are heroic assumptions.
But there’s another simple explanation—Asia will pick up the slack in the global economy. That is the reason investors are once again betting big on Asia. In a research note titled How big is Asia?, Frederic Neumann, economist with Hongkong and Shanghai Banking Corp. (HSBC), compares Asia with the rest of the world. He points out that China’s consumption is just 15.5% of US consumption, while Asia ex-Japan’s is 40.6% of US household spending.
So, if the US consumer stops splurging, will the global economy collapse? No, says the HSBC economist, arguing that this year “Asia ex-Japan consumption growth more than makes up for the shortfall in the US and the EU (European Union) by a solid $58 billion.”
In other words, while the US continues to be the world’s biggest consumer, the shortfall in its consumption as a result of more saving, loss of jobs and repayment of debts will be more than made up by increased consumption in Asia.
What about investment? Neumann says investment spending is already considerably larger in Asia ex-Japan than in the US. While that may be misleading because much of that investment goes into factories and ports designed for exports to the West, Neumann feels that even so, the region can well sustain its current investment spending, “given ample fiscal and monetary ammunition”.
And he goes on to make another interesting point. “Looking ahead, and assuming a gradual normalization of US consumption growth, US incremental spending will bounce back again, and exceed Asia ex-Japan incremental expenditure in 2011, and possibly in 2012. Thereafter, however, the region is becoming decisively the bigger incremental spender on consumer goods and services.”
That rather rosy outlook assumes that the US consumer will bounce back relatively quickly. It also assumes that Asian nations will be able to switch their export-driven economies to a more domestic-oriented one without much disruption. It assumes a painless solution to the problem of global imbalances.
Not everybody agrees. Take the recent note on the global outlook by Deutsche Bank Global Markets Research, which argues that what we will now see is the reverse of the “Great Moderation,” an unusually benign period of global growth plus low inflation that we saw since the 1990s.
The note argues that the earlier global economic model has failed and as a result we are likely to see a period of lower growth. Here’s the crux of their argument: “The consumer countries of the past will have to save more in the future as the asset market downturns have destroyed household wealth. Other countries that could eventually boost consumption to offset this increased saving are unlikely to fill the new void in global consumption for some time. Improvement of social security systems would go a long way to reduce excessive household savings in EM countries (as it reduces the need to have cash under the mattress for medical emergencies and old age), but the development of such social security systems will take many years.”
The upshot will be a much lower global trend growth of around 2.5% in future, compared with 3% in the 1980s and almost 4% during the 1990s and the last boom.
Stephen Roach, chairman of Morgan Stanley Asia, has pointed out that while the US consumers are pulling back as never before, China is directing a powerful stimulus campaign that is concentrated in fixed investment and exports. Thus, he says, “A pullback in excess demand is being countered by efforts to boost global supply. Sadly, this could set up a still unbalanced global economy up for yet another serious accident at some point in the years ahead.”
Roach is right. It’s very unlikely the global economic system can be reformed so simply. But there are powerful forces that do not want a fundamental change in the system, beyond tinkering around its edges. The US and European elites and countries such as China and India have been big beneficiaries of the system. Hence the hope that throwing money at the problem will make it go away.
That is, incidentally, a perfect setting for the reflation of asset markets. In turn, that also improves the fundamentals —witness the repairing of balance sheets going on among real estate companies. Simply put, the markets are going up because all that excess liquidity, now no longer panicky, is seeking a decent return. Who?cares?about global imbalances?
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at capitalaccount@livemint.com
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First Published: Tue, Jul 21 2009. 09 38 PM IST