"The global economy has experienced a positive capacity shock through globalization. The need to find an equilibrium should have caused a downward price level adjustment in the developed economies. Instead, monetary authorities, mainly the Fed, are using cheap money to fight this adjustment, causing a massive property bubble that creates superficial demand and stops prices from declining. However, as soon as the bubble bursts, the world will need a bigger downward adjustment because of the extra capacity formed during the bubble.
Most importantly, so much debt has been created that it may lead to debt deflation. Globalization would have caused benign deflation that benefits consumers and causes some industries to relocate to lower-cost locations. But fighting against this sort of deflation with bubbles and debts must lead to deflation. In my view, this is what happened in the 1920s after World War I.
When the global property bubble bursts, debt deflation could ensue. It is always possible that the Fed could create another bubble to postpone the inevitable. For example, direct purchase of US Treasuries to push the 10-year yield down to 2% could create another property bubble. However, the Fed may repent and Mr. Greenspan could retire. It may not be profitable to bet on the next bubble."
Looking back from 2007, Andy Xie seems to have been a economic prophet. Particularly fascinating was his call that by avoiding benign deflationary pressures monetary authorities were setting themselves up for malign deflationary pressures in the future. Too bad his views did not get more of hearing back in 2003-2005. Sadly, the Morgan Stanley Global Economic Forum no longer has its archives open to his article. So this is my attempt to preserve his words for posterity's sake.
I found another Andy Xie gem at the Morgan Stanley Global Economic Forum titled "Three Horsemen and the Ghostbusters" dated January 26, 2006. In this piece Andy notes the following:
"From a longer-term perspective, the central banks may have won a pyrrhic victory. They have used liquidity to inflate asset prices to offset deflationary pressure – mostly benign deflation from productivity growth due to technological progress and globalisation. Instead of tolerating price declines in line with productivity growth, the central banks have engaged in credit inflation, creating a massive asset inflation party that would cause inflation in the absence of deflationary pressure.
The asset inflation party is not costless, I believe, and will be followed by a burst or an extended period of slow growth. Inflation due to commodity inflation, deflation due to overcapacity, or a shock should mark the turning point. I see the cycle turning down in 2006"
Right message once again, just off on his timing by a year or so. Hey, even great ones miss a few calls (e.g. Nouriel Roubini).
Post a Comment