Monday, April 04, 2005

Bubble Trouble
Morgan Stanley's Andy Xie sees a three-pillared bubble.
Three Pillars of the Global Bubble

American optimism, Japanese pessimism, and the Chinese labor surplus are the three pillars of the global bubble economy, ... American optimism turns liquidity into rising asset markets and, through the wealth effect, consumption. Japanese pessimism has channeled the liquidity from BoJ’s easy monetary policy into demand for the US Treasuries, capping the US bond yield despite the strong US economy. The Chinese labor surplus allows global companies to decrease production costs and keeps inflation down despite strong demand.

The above factors form the conditions for but do not automatically lead to a global bubble economy. An accommodative Fed allows the bubble to happen. The Fed sees CPI inflation as the only warning signal for slowing economic growth. In today’s global economy, CPI inflation is the second-to-last price to move up after wages. When CPI inflation is significant, the bubble is already gigantic. The Fed’s easy attitude towards asset inflation has ... led the global economy to where it is today.

In addition to the Fed’s accommodative attitude, the behavior of the Asian central banks is also a factor in maintaining the global bubble. The large US trade deficits that result from asset-based consumption flood the world with dollar supply. The oversupply depresses the dollar’s value, which should cause inflation in the US that forces the Fed to tighten. Instead, the Asian central banks have been mopping up the unwanted dollars in the world to buy Treasuries. From the perspective of Asian central banks, they see a higher US interest rate, not a weak dollar, as the key to a stable equilibrium. So they are propping up the dollar and hope that the Fed will step up its pace of raising interest rates. Instead, the Fed sees that the Asian central banks are holding its bag and that, therefore, it can afford to take things slow and keep the ‘measured pace’ policy in raising interest rates.
Stephen Roach sees the bubble popping.
America’s income-short, consumer-led recovery is the aberration -- not the norm .... It is all about ever-declining personal saving rates, ever-widening current account deficits, mounting debt burdens, and increasingly wealth-dependent consumers. It ... is one of the most precarious macro models that has ever existed for a major economic power ... that not only puts pressure on future prospects in the US but also underscores the tensions bearing down on the rest of the world. In my view, income-short growth models are not sustainable -- the only question pertains to the circumstances of their demise.
Coping with the global labor arbitrage could well test an unbalanced world’s commitment to globalization. The temptation of politicians in the developed world is to react to pressures on voters by indulging in scapegoating -- in effect, pinning the blame on the China and Indias of the world. Consequently, to the extent that developed nations fail to address the excesses of deficit-financed lifestyles, the risks of trade tensions and protectionism may only mount. Courtesy of the unrelenting pressures on labor income that arise from this cross-border labor arbitrage, high-wage workers have found it exceedingly difficult to sustain life-styles. Asset-dependent US consumers ... have consciously elected to draw down saving and go deeply into debt in order to defend the most cherished of American values -- excess consumption. Liquidity-prone central banks have been the great enabler of this process. The Federal Reserve has led the charge with its post-bubble zero real interest rate policy. And by freely funding the US current-account deficit, foreign central banks -- especially those in Asia -- have done more than their fair share in subsidizing US interest rates. That not only keeps the asset party going but also provides the cut-rate refinancing rates that have allowed American consumers to keep on extracting purchasing power from increasingly over-valued assets such as homes.

The endgame is not in doubt, in my view. The American consumer will ultimately cave. It is the only means by which the US will ever “fix” its twin saving and current account problems. It is the timing and circumstances of that fix that we endlessly debate. But the clock is ticking -- especially now as interest rates and energy prices rise. Yet another in a long string of crummy US labor market reports only serves to underscore the obvious: Excess consumption is on a collision course with subpar labor income growth. Courtesy of an unrelenting global labor arbitrage, the “big squeeze” is getting tighter and tighter on the world’s only real consumer.


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