Forget central bank intervention, fiscal stimulus and China-bashing - what America needs is a sharp decline in asset prices, and to stand back and let markets do their work, says Stephen Roach, chairman of Morgan Stanley Asia, writing in Tuesday’s FT.
The US has been the main culprit behind the destabilising global imbalances of recent years, he argues. America’s massive current account deficit absorbs about 75 per cent of the world’s surplus saving. Most believe that a weaker US dollar is the best cure for these imbalances. Yet a broad measure of the US dollar has dropped 23 per cent since February 2002 in real terms, with only minimal impact on America’s gaping external imbalance.
Dollar bears argue that more currency depreciation is needed. Protectionists insist that China – which has the largest bilateral trade imbalance with the US – should bear a disproportionate share of the next downleg in the US dollar.
There is good reason to doubt this view, says Roach.
America’s current account deficit is due more to bubbles in asset prices than to a misaligned dollar. A resolution will require more of a correction in asset prices than a further depreciation of the dollar. At the core of the problem is one of the most insidious characteristics of an asset-dependent economy – a chronic shortfall in domestic saving.
America’s aversion toward saving did not appear out of thin air. Waves of asset appreciation – first equities and, more recently, residential property – convinced citizens that “a new era was at hand”. Reinforced by a monstrous bubble of cheap credit, there was little perceived need to save the old-fashioned way – out of income. Assets became the preferred vehicle of choice.
With one bubble begetting another, America’s imbalances rose to epic proportions.
Now, a sharp fall in asset prices is necessary to rebalance the US economy, reasons Roach.
It is the only realistic hope to shift the mix of saving away from asset appreciation back to that supported by income generation. That could entail as much as a 20-30 per cent decline in overall US housing prices and a related deflating of the bubble of cheap and easy credit.
Those trends now appear to be underway, he notes.
Reflecting an outsize imbalance between supply and demand for new homes, residential property prices fell 6 per cent in the year to October 2007 for 20 major metropolitan areas in the US, according to the S&P Case-Shiller Index. Most likely, this foretells a broader downturn in nationwide home prices in 2008 that could continue into 2009. Meanwhile, courtesy of the subprime crisis, the credit bubble has popped – ending the cut-rate funding that fuelled the housing bubble.
As home prices move into a protracted period of decline, “consumers will finally recognise the perils of bubble-distorted saving strategies”, he adds.
America’s shift back to income-supported saving will be a “pivotal development for the rest of the world.” As consumption slows and household saving rises in the US, the need to import surplus saving from abroad will diminish. Demand for foreign capital will recede – leading to a reduction of both the US current-account and trade deficits. The global economy will emerge bruised, but much better balanced.
But first, Washington policymakers and politicians need to stand back and let this adjustment play out.
Yet, notes Roach, the US body politic is “panicking in response” – underwriting massive liquidity injections that produce another asset bubble and proposing fiscal pump-priming that would depress domestic saving even further. Such actions can only compound the problems that got America into this mess in the first place.
China-bashers in the US Congress also need to stand down. America does not have a China problem – it has a multilateral trade deficit with over 40 countries.
By focusing incorrectly on the dollar and putting pressure on the Chinese currency, Congress would only shift China’s portion of the US trade deficit elsewhere – most likely to a higher-cost producer. That would be the same as a tax hike on American workers. If the US returns to income-based saving in the aftermath of the bursting of housing and credit bubbles, its multilateral trade deficit will narrow and the Chinese bilateral imbalance will shrink.
It is going to be a very painful process to break the addiction to asset-led behaviour, concludes Roach. But this has always been the potential endgame of a bubble-prone US economy. The longer America puts off this reckoning, the steeper the ultimate price of adjustment.
