Greenspan talks, economists balk

The American Federal Reserve bank, with Greenspan at its helm, has argued that continuing disappointing American economic data is only part of “a soft patch”. In other words, poor job figures, a record American budget deficit and ballooning household debt are just part of a momentary lapse.

Previously, Greenspan was hailed by economists and media around the world not only as one of the most powerful men on the planet, but also as an economic miracle-maker. Now they are not so sure.

None less than Morgan Stanley’s chief economist Steve Roach is currently pursuing a very bearish or pessimistic outlook on American finance.

“Ironically, America has not had to pay a price for its extraordinary profligacy, at least not yet. The US has borrowed freely from abroad and converted asset-based saving into newfound purchasing power.

“In my view, this cannot continue. There’s nothing sustainable about the growth dynamic of an increasingly saving-short US economy,” he said.

Fundamentally flawed?

In other words the cheapness of American goods and services, promoted by a very weak dollar, attracts a lot of money from abroad. For now. The weak dollar, part of the overall economic strategy of the current Bush administration, means that American goods and services are cheap.

“Ironically, America has not had to pay a price for its extraordinary profligacy, at least not yet … In my view, this cannot continue” Steve Roach, Morgan Stanley chief economist

Yet, in Roach’s view, this does not compensate for the fact that the American economy is fundamentally flawed.

“In a world where saving must always equal investment, America’s saving shortfall has profound implications. Lacking in domestic saving, the US had had to import surplus saving from abroad in order to keep its economy growing.”
 
Roach’s analysis sees a path through the economic maze.

Firstly, the US dollar is the de facto world currency. You can use it anywhere in the world. Everyone needs to trade in dollars. So a huge deficit for the American economy does not really matter – everyone else is still using the dollar, even though it is weak.

That weak dollar in turn sucks up foreign cash, because of the cheapness of American goods, thereby sustaining the US economic outlook.

“The flows into dollar-based assets are continuing in large part because the rest of the world has no alternative uses for its surplus saving. This condition is part and parcel of the lopsided character of today’s global economy, dominated by the US consumer on the demand side and externally-dependent producers elsewhere in the world on the supply side,” Roach said.

No alternatives

However, his views are not shared by every economist. Even within Morgan Stanley, others argue that a weak dollar and American budget deficit are sustainable, but only at the current level. 

China’s expansion is still volatile and thus not a viable alternative

The basic premise being: What else are you going to invest in? A fragile, moribund Europe? Volatile and highly politicised Chinese expansion? Asian currencies that are in reality pegged to the dollar by state intervention? That intervention keeps Asian currencies artificially low, thereby allowing cheap Asian exports to keep flowing to US consumers.

Yet Roach is by no means alone.

Commerzbank’s foreign exchange section says: “The US economy has reached a plateau; evidenced by peaks in indicator studies and recent sluggish activity data. A judgment on the prospect a robust expansion is set to resume cannot be made without a great deal of crystal ball gazing. Data at hand suggests caution at taking the assertion of Greenspan and his team at face value.”

Triggers

If the American economy is to survive its double deficits – trade and savings – it must avoid any trigger events that could cut off its financial oxygen.

One of those trigger events could be sustained high oil prices. If oil prices remain high, a chain of events could unfold that will throw the US and global economy into deep water.

High oil prices will increase commodity costs. This in turn will mean less foreign “spare” money, or liquidity, available to invest in the US economy.

Worryingly, commodities such as tin, lead, zinc and copper have surged in 2004 as increased demand and heightened transportation costs have driven up prices.

Sustained oil prices could be the trigger to put the US in deep water

The Bank of International Settlements (BIS) – the “bank of central banks” – though not as pessimistic as Morgan Stanley’s Roach, also has worries.

“Concerns persist about imbalances in the … United States … and their possible longer-term implications. In the [US], consumer spending was maintained by heavy borrowing in the face of unusually restrained growth in labour income. Associated high levels of debt could weigh on future spending, particularly if interest rates were to rise and asset prices moderated or even fall from current lofty levels.”

Sustaining savings

Plus, in the medium term the rich economies of the world, who provide the US with the cash to make up their trade and budget deficits, will be aging.

If those economies start to spend more of their money on pensions, say in Japan or the United Kingdom, then this too may exacerbate the American position.

Throw in a similarly “greying” America, possible trade disruptions with China, property price collapses and a morale sapping conflict in Iraq, and Roach is not optimistic.

“Saving is the sustenance of long-term growth for any economy. And yet America is lacking in saving as never before. It has financed that shortfall by consuming the wealth generated by asset appreciation and by drawing heavily on the world’s pool of surplus saving. 

“In my view, there is nothing stable about this arrangement.  In fact, there is a growing risk that America’s saving shortfall will only intensify in the years ahead, especially given Washington’s total lack of fiscal integrity. 

“As always, the flows will give the impression that this outcome is sustainable. In the end, nothing could be further from the truth.”

Greenspan may not agree.