I used to look forward to reading Stephen Roach's commentaries every Monday and Friday at the Morgan Stanley Global Economic Forum. He had much to say about global economic imbalances and was one of the few thoughtful observes who took the 'liquidity glut' view seriously. (See his critique of the 'saving glut' view here.) Some of his classics form the Global Economic Forum include "Original Sin" and "The Great Unraveling." Unfortunately, he stopped writing for this outlet when he took on new responsibilities with Morgan Stanley. His commentaries have been missed. I was delighted, therefore, to run across this Op-Ed of his in the Financial Times yesterday.
America’s inflated asset prices must fall
By Stephen Roach
The US has been the main culprit behind the destabilising global imbalances of recent years. 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. 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. With America’s net national saving averaging a mere 1.4 per cent of national income over the past five years, the US has had to import surplus saving from abroad to keep growing. That means it must run massive current account and trade deficits to attract the foreign capital.
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. Despite generally subpar income generation, private consumption soared to a record 72 per cent of real gross domestic product in 2007. Household debt hit a record 133 per cent of disposable personal income. And income-based measures of personal saving moved back into negative territory in late 2007.
None of these trends is sustainable. It is only a question of when they give way and what it takes to spark a long overdue rebalancing. A sharp decline in asset prices is necessary to rebalance the US economy. 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.