Catching Up with Steve and Andy

An excellent Rose Bowl Game last night provided sufficient distraction that today's post will be rather brief (watching Vince Young and Reggie Bush makes you wonder what the game of football is going to look like twenty years from now - comparing the speed and size of today's players with those of a generation ago, it's hard to imagine what the future holds).

Today, just a few excerpts from some recent commentary over at Morgan Stanley. Fan favorites Stephen Roach and Any Xie, along with the rest of the Morgan Stanley Global Economics Team checked out on December 16th, leaving behind a treasure trove of commentary to work through over the holidays.

In The Symbiosis Trap, Mr. Roach once again laments the still unbalanced global economy and once again predicts that this could be the year that the imabalances start to matter - one of these years he's going to be right.

To the extent that foreign purchases of dollar-denominated assets represent the functional equivalent of a subsidy to US interest rates, asset markets enjoy artificial valuation support. The result is a surge in housing values that many Americans now perceive to be a new and permanent source of saving. This, in turn, has had a profound impact in reshaping saving and spending strategies of US consumers. In essence, the income-based consumption models of yesteryear have been replaced by asset-driven frameworks. The repercussions of this transformation are profound: The income-based personal saving rate has plunged deeper into negative territory than at any point since 1933.
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“So what!” retorts the symbiosis crowd. After all, these are precisely the excesses — both for China and the US — that we in the rebalancing crowd have been bemoaning for years. Fair point. Moreover, a year ago, when there were widespread concerns over global imbalances, the dollar rose instead of fell — and those concerns lost credibility. As long as the world is willing to finance America’s saving shortfall, goes the argument, there is no reason to worry about sustainability. This, in my view, is the essence of the “symbiosis trap.” The consensus has been lulled into a false sense of security — believing that imbalances will remain a non-issue for the global economy and world financial markets.
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In fact, our latest estimates suggest that the US current account deficit, which stood at a record 6.4% of GDP in the first half of 2005, could well increase toward 7.5% over the next year. In short, America will be upping the ante in terms of what it expects from China and the rest of the world in order to sustain the symbiosis trade.

In Five Risks, the first four risks sound a lot like last year's risks, and the year before that. The only new risk is a little thing called central bank credibility. Hmmm...

Global Rebalancing. Global imbalances have been building for years, and the longer they fester without major financial market consequences, the greater the conviction this state of disequilibrium is sustainable.
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China slowdown. After years of skepticism, the world now treats China as a perma-growth story, capable of 9%-plus GDP growth in perpetuity.We were wrong on the China slowdown in 2005 and we have raised our growth forecast for 2006. However, based on intelligence gathered on a recent trip to Beijing, I now believe that Chinese bank lending will slow sharply in 2006.
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American consumer. The consumer has been the mainstay of a decade of US-centric global growth, and the consensus now believes that US consumption is impervious to external shocks. I think that perception will be challenged in 2006.
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The dollar. A year ago, the dollar bears were strutting; now it’s the new-paradigm dollar bulls. However, with the end of the Federal Reserve’s tightening cycle now in sight, I expect the interest rate differential theme to fade in importance as a driver of currencies.
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Central bank credibility. Ben Bernanke will lack support from the confidence factor that Alan Greenspan has long enjoyed, potentially a serious problem in a US current account adjustment. Inasmuch as transitions to new Fed chairmen have not gone well in the past, this risk cannot be taken lightly.

In 2006 Outlook — Déjà Vu, Any Xie predicts more of the same in Asia for 2006, unless of course, something really bad happens.

The outlook for next year appears similar to that one year ago. We expect muddling through again. While the current business cycle is overextended and full of imbalances and fragilities, low inflation has allowed central banks around the world to maintain stimulus.
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The hedge fund boom has fundamentally altered how risks are priced. Hedge funds help central banks by keeping risk premiums low everywhere, which has made borrowing easier. Easier financing has led to a global property boom, which is at the heart of demand creation in this business cycle.
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We estimate that the global asset bubble, mainly in property, may amount to US$15 trillion, which would make it the biggest bubble in history. However, players in the global financial markets are not scared, as there is a belief that the central banks will not burst the bubble. Hence risk premiums are kept low, sustaining the bubble. There is a self-reinforcing relationship between the central banks and hedge funds, which is sustaining global GDP growth despite the existence of imbalances and structural fragilities.
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Bubbles burst when they are least expected to. In 1990, the bookstores in the US were full of books on Japan’s different but more effective economic model. In 1996, the World Bank had just come out with a study on the ‘East Asian Miracle’. In 2000, several large funds threw away their long-held skepticism on the tech story and bought NASDAQ. History is full of examples of those who thought bubbles would last forever.

The current bubble, just as previous ones, will burst unexpectedly, in our view. As long as inflation remains low, the central banks are unlikely to burst it by tightening. Considering the extent of overcapacity in China, it is difficult to imagine that inflation will get out hand. Hence, we would expect the burst to be triggered by a shock, probably due to internal fragilities in emerging economies.

And finally, calling him the midwife of the current era of globalization, Andy Xie says, Goodbye, Mr. Greenspan, and good luck Mr. Bernanke - you'll need it.

The era of stimulus is ending: The large US trade deficit and the low US bond yield are signaling the end of the stimulus era. Alan Greenspan has essentially run a Keynesian stimulus program for the global economy in the past decade. A flat yield curve at a low level of bond yield makes further monetary stimulus hard to achieve, in our view.
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The quadrupling of US imports during Alan Greenspan’s 18-year reign summarizes his global impact. This increase in US import demand has underwritten globalization, led by the integration of developing economies with the US. In that regard, his policy has affected manufacturing-led Asia most.
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Why does the US trade deficit keep rising, and why is it so well funded? The sustainability of globalization depends on the answers to these questions, in my view.

Mr. Greenspan’s ability to sustain investor confidence and his accommodative monetary policy towards asset demand are the answers to the above questions, I believe.
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Mr. Greenspan was instrumental in propping up optimism, which led to rising risk appetite and demand for risk assets. He accommodated such demand by tolerating a rapidly rising demand for money from asset markets. Rising asset prices in the US led to unusually strong consumption. This inflationary force has offset the deflationary force from globalization.

The high level of wealth and institutional credibility of the US have allowed it to play such a critical role in giving birth to globalization. The credibility of the US Treasury as the modern equivalent of gold for wealth hoarding is the instrument for sustaining the funding of the US trade deficit.

Mr. Greenspan has been the right person at the right time in right place to play such an important role. If there were a midwife to the current era of globalization, it would be him.

The epidural for suppressing the birth pain of globalization is the vast global property bubble, thanks to financial globalization. Mr. Bernanke, successor to Mr. Greenspan, will have to handle its aftermath carefully to prevent a backlash against globalization when the bubble bursts, as I believe it will.