Monday, March 27, 2006

The end is near

Stephen Roach, Chief Economist at Morgan Stanley, speech at the China Development Forum in Beijing on March 19.

“There is a very simple and extremely powerful macro point that is being overlooked in this debate: America no longer has the internal wherewithal to fund the rapid growth of its economy. Suffering from the greatest domestic saving shortfall in modern history, the United States is increasingly dependent on surplus foreign saving to fill the void. The net national saving rate the combined saving of individuals, businesses, and the government sector after adjusting for depreciation fell into negative territory to the tune of -1.2 per cent of national income in late 2005. That means America doesn't save enough even to cover the replacement of its worn-out capital stock. This is a first for the United States in the modern post-World War II era, and I believe a first for any great power over a much longer sweep of world history.

...America, in general, and its consumers, in particular, treat rapid economic growth as an entitlement. That leaves the United States with little choice other than to pursue the second option - drawing heavily on the global saving pool in order to fund economic growth. Once the United States started down the slippery path of consuming beyond its internal means, it got harder and harder to break the habit. Ironically, it has become exceedingly difficult for Washington to accept the consequences of that habit - a nation that has become beholden both to external funding and production. And yet that's exactly how China fits into America's macro equation.

That underscores a key attribute of the savings-short, deficit nation: It is forced to run current account deficits in order to attract the requisite foreign capital. And in the case of the United States, where external funding needs are so massive - now closing in on US$800 billion per year, or about US$3 billion per business day - most of the current account imbalance shows up in the form of a huge trade deficit. In 2005, the trade deficit in goods and services accounted for fully 93 per cent of the total current-account gap.


Carson C. Chow said...

So are we headed for a full blown depression?

Steve Hsu said...

If foreign creditors stop buying treasuries (or demand a much higher return on their investment, in light of likely future dollar devaluations) we will see the mother of all financial meltdowns.

When will this happen? Who knows. A lot of people were burned in 2004-05 betting against the dollar. However, I think the dollar will decline this year by 5-10% on a trade weighted basis.

Seth said...

Ok, Steve, you said 40% a month or two ago based on the Plaza Accord analogy. That made some sense. Are you arguing now that it has to happen gradually and 5-10% is the allotted decline for 06?

Seems to me it's more likely to be abrupt and we just don't know when.

I don't know that the fallout from a decline would be so catastrophic. Where else can that money really hide? Europe? Japan? Qatar?

A weaker dollar would start rebalancing the US economy towards tradeables again and perhaps get China focused on building a broader middle-class by investing for domestic consumption. They aren't doing so right now because they're so scared of unleashing the associated political forces.

High-minded American CEOs and philanthropists are fond of bemoaning our collective lack of interest in engineering, etc. A cheap dollar might make it economically rational for more high schoolers to think about an engineering career. As things stand, the game seems to be: 2 and 20 as a hedgie or work at walmart.

Steve Hsu said...

40% is a longer term figure. I really don't know what will happen this year -- if I did, I would be earning my 2 and 20! But, I have a feeling that the long term prospects for the dollar are starting to work their way into the consciousness of international investors and central bankers, so we may see a negative move this year.

BTW, this "where would they put their money if not in dollars" question is the main point. Once they've lost confidence in the dollar they'll put it in euros or Swiss francs or yen or whatever.

I agree with you that people like Friedman bemoaning the lack of engineering students here is a bit hypocritical -- if his kids had any scientific talent he would probably make sure they get on the VC or executive or hedge fund track!

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