Friday, November 07, 2003

Global - Another New Paradigm?

Pretty hard to beat Steven Roach for leveling the reality playing field. He mentions a favorite of mine, Richard Duncan. Have a glance.

Morgan Stanley

The current New Paradigm goes something like this: Global imbalances don’t matter. Never mind, America’s unprecedented current account deficit -- let alone massive current-account surpluses in Asia. Pay no heed to the shaky foundations of a saving-short US economy and its runaway federal government budget deficit that lies at the heart of America’s massive external imbalance. Don’t worry about the ever-rising overhang of private sector indebtedness in the US, especially for the household sector. This is what the New World Order is all about. America is supposed to consume beyond its means, as those means are delineated by the economy’s domestic income-generating capacity. Awash in surplus saving, a demand-deficient rest of the world will gladly finance America’s gaping external imbalance -- and will do so willingly and in a relatively costless fashion. The result will be open-ended foreign demand for dollar-denominated assets. US Treasuries -- the most riskless segment of this superior asset class -- will benefit the most. That will keep US interest rates low, providing even more support to American aggregate demand. In a unipolar world, the dollar -- the world’s reserve currency -- can’t fall. After all, what other currency could rise?

Asia is particularly enamored of this New Paradigm. That’s to be expected. After all, Asia has taken the lead in funding America’s gaping external imbalance. China and Japan, alone, accounted for over $150 billion of net purchases of long-term US securities in 2002; in the first half of 2003, their combined demand hit nearly $120 billion -- nearly double the pace in the first half of 2002 and enough to fund nearly 45% of the entire US current-account deficit over that period. The thinking in Asia is that this is a mutually advantageous relationship: China, for example, benefits from selling goods to American consumers, and the US benefits from getting low-cost, high-quality Chinese products that expand private sector purchasing power. China gets paper in response -- and US Treasuries have a natural bid. It’s the ultimate in global virtuous circles.....

.....The ultimate trial of any New Paradigm comes from the unintended consequences that arise along the way. They provide the stress test that any theory must withstand. I firmly believe that such a test is coming for the US economy -- now the world’s debtor of first and last resort. And I also anticipate a challenge to Asian economies that are now accumulating massive reservoirs of official reserves. Such reserves don’t come out of thin air. They are the functional equivalent of excess liquidity creation that has the clear potential to spill over into product or asset markets. That, by the way, is a particularly important distinction between the first phase of the Bretton Woods era and the one we are supposedly in today. Richard Duncan, author of The Dollar Crisis (Wiley , 2002), points out that while total international reserves increased by only 55% over the 1949-69 period, since 1969, the increase has been more than 2000%. In other words, lacking the anchor of a gold-backed currency, today’s post-Bretton Woods system of international finance is far more biased toward excess liquidity creation and a related potential for asset bubbles. Unfortunately, the record speaks for itself -- Japan’s monstrous bubble, a multitude of asset bubbles in pre-crisis Asia, and, more recently, the property bubble in China. I have a hard time calling this the ultimate virtuous circle of a dollar-based world. Nor does there appear to be much virtue in a regime that encourages the United States to embrace a growth strategy characterized by an unprecedented drawdown in net national saving and a concomitant build-up of household sector indebtedness. ....Article Continued

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