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Tuesday April 14, 2009

Averting depression as the US consumer fades

Comment by Stephen Roach


DEBATE rages over the endgame for the Great Recession.

The broad consensus of policymakers, financial market participants, business leaders and academics concurs that the world is in the midst of its worst decline since the 1930s.

In making that comparison, there is a presumption that another depression is a distinct possibility if immediate steps aren’t taken to contain the downward spiral.

This debate misses the point – and dangerously so. While I have been as bearish as anyone over the past several years, I would still assign a very low probability to a 1930-style depression for the United States and the broader global economy.

Monetary and fiscal authorities have made it quite clear that they are prepared to do everything in their power to avoid such an outcome.

Ultimately, I suspect they will get their way.

Yet there is a serious and worrisome risk to this policy strategy. By fixating on the anti-depression drill, authorities are failing to address the root cause of the current crisis and recession – the lethal unwinding of unsustainable global imbalances.

As one leading G-7 official put it to me recently: “In the short term, we get the world moving again. Then, over the medium term, we will tackle global imbalances.” This is the essence of the “Depression Foil” – a single-minded pre-occupation with avoiding a 1930s-style collapse at all costs while putting off the requisite heavy lifting for that proverbial next day.

Short-sighted politicians

Unfortunately, the myopia of the political cycle pre-ordains such a policy response. A resumption of economic growth is all that ever seems to matter for poll-driven politicians and their surrogate policymakers.

Tough problems are always deferred with a vacuous promise to tackle them in due course.

Then that due course always is pushed out further and further in time.

This is precisely the mindset that got us into this mess. I well remember the debate over America’s current account deficit – one of the most glaring manifestations of an economy built on quicksand.

Some argued that there was nothing to worry about in a world that was now joined in a new “Bretton Woods II” paradigm, where a symbiotic relationship between the creditor (mainly China) and the debtor (the United States) would sustain this imbalance in perpetuity.

There were others, such as Alan Greenspan, who worried about the long-term sustainability of America’s external shortfall but stressed that such imbalances were likely to persist for much longer than most thought.

The problem with the apologists is that they failed to appreciate the deeper meaning of these imbalances. The US current account deficit did not emerge out of thin air.

It was the outgrowth of an unprecedented shortfall of domestic saving.

In short, America’s external imbalance was joined at the hip to the toxic interplay between asset and credit bubbles.

Moreover, denial was global in scope. Export-led economies were delighted to draw support from bubble-dependent American consumers. And now, that house of cards has collapsed.

Repeating mistakes

Unwittingly, the Depression Foil might well end up recreating this madness. With the risk of a depression viewed as completely unacceptable to the global body politic, the full force of the policy arsenal is being aimed at jump-starting aggregate demand – regardless of the consequences such results might imply for a new build-up of global imbalances.

Fortunately, the American consumer is smarter than the quick-fix Washington mindset. Shell-shocked families – especially some 77 million baby boomers for whom retirement planning is an urgent imperative – know they have no choice other than to save. The personal savings rate has risen from 0.8% to 4.2% in the past six months alone, and is on its way to a new post-bubble equilibrium that I would place in the 7.5% to 10% zone.

Yet policymakers fear such an outcome. It certainly doesn’t fit the script of the Depression Foil.

Global rebalancing

A retrenchment by the American consumer should be viewed as a wake-up call for other nations to fill the void by stimulating their own consumers. A globalised world needs to move from one consumer to many.

The Depression Foil blinds policymakers and politicians to the imperatives of global rebalancing. This crisis and the wrenching recession it has spawned are all about a destabilising shift in the mix of global savings and aggregate demand. That mix needs to be redressed. The excess spenders need to save and the excess savers need to spend.

Policies that encourage such rebalancing will put the world economy on a more stable and sustainable path and go a long way in avoiding another crisis like this in the future.

The Depression Foil makes it exceedingly difficult for an unbalanced world to get its act together. The recently concluded G-20 summit was notable for its failure to address this critical challenge.

Policymakers and politicians need to move beyond their depression fixation and aim at achieving better balance in the global economy before it is too late. — Bloomberg

  • Stephen Roach is chairman of Morgan Stanley Asia. The opinions expressed are his own.

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