Interesting comment from Stephen S. Roach - his arguments on why the dollar decline has yet to affect the trade balance.
I personally believe the trade imbalance has more to do with the systematic destruction of internal manufacturing capability in the US; without a healthy internal manufacturing entity which can take advantage of the weak dollar, there simply is no pushback against the structural cost advantages enjoyed by export-driven industrializing nations.
Financial markets are giddy over the prospects that a $51 trillion global economy has once again displayed Teflon-like resilience in coping with a major problem. There are signs that a benign global rebalancing could well be at hand. A downshift in the US economy has been largely offset by improved economic conditions in Europe and Japan. Meanwhile, the dollar has resumed its five-year downward trajectory - tilting the world's relative price structure against the mother of all external deficits. My advice is to keep the champagne on ice - there is a critically important piece to the global rebalancing puzzle that has yet to fall into place.
A subtle change is now emerging in the mix of global growth. This shift has been concentrated in the three main economies of the developed world. The US growth engine is, indeed, slowing. Over the four years ending in 2006, average GDP growth of 3.2% in the US economy accounted for about 0.6 percentage point of world GDP growth based on the IMF's purchasing power parity metrics. Our forecast of a 2% increase in the US in 2007 would add just 0.4 percentage point to global growth - a reduction of 0.2 percentage point from the growth contribution of the prior four years. By contrast, Europe's global growth contribution is inching up - going from an average of 0.4 percentage point per annum over the 2003-06 time period to an estimated 0.5 percentage point in 2007. We are projecting a similar fractional increase in the Japanese contribution to 0.2 percentage point of global growth in 2007 versus an anemic 0.1 percentage point average impetus over the 2003-06 period. While the shifting mix between the US, Europe, and Japan hardly points to a major realignment in the composition of industrial-world growth, at least the wheels are turning in the right direction.
Economic growth in the developing world is expected to continue at its recent rapid pace and thereby not play a major role in driving any meaningful shifts in the mix of global growth this year. At 48% of PPP-based world GDP, our forecast of 6.6% growth in developing world GDP for 2007 adds 3.2 percentage points to global growth - accounting for fully 70% of the 4.5% growth in world GDP we expect in 2007. While this is down a bit from the 3.5 percentage point contribution in 2006, this reduction is largely an outgrowth of our call for a deceleration of Chinese GDP growth from 10.7% in 2006 to 9.3% in 2007. In light of the outsize 11.1% increase in 1Q07 Chinese GDP, the risks to our China forecast are very much on the upside. This suggests that the developing world contribution to global GDP growth in 2007 is likely to be quite similar to the strong impetus evident during the prior four years.
I have long argued that global rebalancing cannot occur without a meaningful shift in the mix of global consumption - more specifically, cutbacks in excess US consumption accompanied by increasing consumer demand elsewhere in the world. Here as well, there is evidence of small shifts in the right direction - especially in the developed world. Our baseline forecast calls for a modest slowing of US personal consumption growth to 2.8% in 2007 - down 0.5 percentage point from the 3.3% average annual pace of 2003-06. This is expected to be offset by an acceleration of private consumer demand elsewhere in the industrial world, with consumption growth in the advanced economies, excluding the US, projected at 2.3% in 2007 versus a 1.9% average pace over the preceding four years. In my view, this is only a down-payment on the major realignment that is needed - both in the mix of global consumption as well as in the related mix of global saving. But, here as well, at least the shifting composition of global consumption is headed in a constructive direction.
By now, global rebalancing has become part of the mainstream thinking on the global economy - a far cry from the initial reception that greeted my first missive on the subject nearly five years ago (see my 21 May 2002 dispatch, "Global Rebalancing"). Conventional wisdom has it that the currency mechanism lies at the heart of the coming rebalancing of the world economy. Leading academics have long argued that it will take at least a 30% decline in the dollar's real effective exchange rate to correct the principal imbalance of an unbalanced world - the record US current account deficit (see, for example, Maurice Obstfeld and Kenneth Rogoff, "The Unsustainable US Current Account Position Revisited," November 2005).
I still don't buy that line of reasoning. The broad trade-weighted dollar index is now off 16% in real terms from its early 2002 highs - slightly more than half the 30% decline that the models deem necessary for rebalancing. Yet, the US current account deficit has barely budged - holding steady at around 6.5% of GDP over the 2005-06 period, although edging down to 5.8% in the final period of last year. Moreover, with goods imports still more than 70% larger than exports, America's trade imbalance remains very much an outgrowth of a serious excess consumption problem. With personal consumption currently at a record 71% of GDP, high and rising import propensities underscore the structural aspects of the US trade problem. Consequently, I continue to think it will take a lot more than another 15 percentage point decline in the dollar to reduce the US trade gap to manageable proportions. Yet, the global powers that be have little appetite for such a "mega dollar correction" scenario, in my view. In short, don't count on the dollar to be the principal instrument of global rebalancing.
From the start, my take on global imbalances is that they are much more an outgrowth of saving-investment disequilibria than currency misalignments. America's gaping current account deficit didn't just appear out of thin air. It is an unmistakable outgrowth of an extraordinary deficiency of domestic US saving - a net national saving rate that plunged to a record low of just 2% of GDP over the past three years. Lacking in national saving, the US, with its penchant for strong growth, had no choice other than to import foreign saving from abroad - and run massive current account and trade deficits to attract the foreign capital.
As seen from that vantage point, the prospects for global rebalancing should be more dependent on a shift in the mix of global saving rather than on a realignment of the world's relative price structure through currency adjustments. This is especially the case in the United States, whose record current account deficit easily qualifies as the major imbalance of an unbalanced world. To the extent I'm right and America's external gap is directly traceable to an extraordinary saving anomaly, it should hardly be surprising that a tidal wave of US wealth creation has encouraged a substitution of asset-based saving for income-based saving. How else can you explain a record 71% consumption share of US GDP juxtaposed against an income-based personal saving rate that has now been in negative territory for two years in a row for the first time since the early 1930s? Or, how else can you explain record household debt service burdens in a low interest rate climate? To me, this all hinges on America's love affair with the culture of the Asset Economy. To the extent that the wealth effects of the US housing boom have depressed income-based domestic saving, America's gaping current account deficit emerges as a key by-product of an asset-dependent real economy. That has led me to conclude that the US current account adjustment will eventually have to be driven more by corrections in asset markets than by realignments in foreign exchange markets.
That suggests that the ramifications of the ongoing contraction in the US housing market could well be the acid test of the asset-led rebalancing hypothesis. To the extent American homeowners cut back on the equity they extract from their housing investments, they will need to return to more of an income-based mindset in shaping their saving and spending decisions. I will confess that I am surprised this has not yet happened - especially since the property-driven wealth effects have already gone the other way. According to Federal Reserve estimates, net equity extraction has now fallen from a high of more than 8% of disposable personal income in early 2006 to a little over 5% by the end of the year. Yet the income-based personal saving rate has stayed in negative territory to the tune of -1.2% in early 2007.
My guess is that US consumers won't wake up to the urgency to rebuild income-based saving until they face some sort of a shock that raises questions about job and income security. As long as the unemployment rate hovers near its cycle low - precisely the message from a 4.4% reading for the jobless rate in March - that won't happen. But if and when the unemployment rate starts to rise - as I fully expect will be the case in the second half of 2007 when long-deferred construction sector layoffs finally kick in - then consumers will need to come to grips with the excesses of asset-based spending. If that prompts an increase in income-based saving, as I suspect, then America's overall domestic saving position will also improve - thereby limiting US demand for foreign saving. A US current account adjustment would then be a perfectly normal outgrowth of such a development - a major breakthrough on the road to global rebalancing.
So it all boils down to the macro question of the hour - the consumption response to the bursting of the US housing bubble. Not only does this hold the key to the US current account adjustment but it is also the linchpin of the US growth prognosis, as well as the global decoupling debate (see my 9 April dispatch, "Spillovers versus Linkages"). Global rebalancing can't occur without a US current account adjustment. As I see it, it will take the negative wealth effects of a post-housing bubble shakeout to trigger the sustainable saving and current account responses that global rebalancing requires. Contrary to widespread perception, the dollar is a bit player in all this. If, however, US consumers remain unflinching, imports will remain excessive and any cyclical tendency toward global rebalancing will quickly be short-circuited. A lasting global rebalancing cannot occur unless the excesses of the Asset Economy are finally unwound.
A lot of ink gets spilled over relative currency valuation, and that is a part of it, but few address the tax issue. Much of the trade imbalance is due to our own lopsided tax system actually putting domestic producers at a huge disadvantage. This is why most of the talk about "protectionism" misses the point.
Excellent links. Here's another: http://www.fairtax.org/site/PageServer?pagename=about_main.
This is the real missing link to global rebalancing. The globalist emphasis on cutting trade barriers and tariffs has been all one-sided - cutting tax and regulation on trade crossing our national borders. But try to trade freely with the guy across the street, and you find free trade in the US is in the worst shape it's ever been in. You have the income tax, FICA, HITS, the mininum wage, the Patriot Act, etceteras ... no wonder American producers are having a hard time competing. Not to mention things like a 25% tariff on American cars and parts in China against an only 2.5% tariff on Chinese-made equivalents in the US. The Fair Tax would be a huge step in the right direction because for the first time in memory the same level of tax would be applied to foreign imports as those produced right here.
Removing these impediments and righting these imbalances isn't protectionism, unless you define protection as putting down the loaded gun aimed at your own foot.