Wrong Time for Gridlock
November 09, 2006
By Stephen S. Roach | New York
Conventional wisdom in ever-cynical financial markets has it that gridlock is good. The implicit assumption is that a dynamic US economy is in such great shape, the best thing that Washington can do is nothing. With a split Congress at worst and a Republican White House, such an outcome now seems quite possible — at least on paper. In my view, that would be tragic — gridlock is the last thing America needs. Granted, there are times when government can, indeed, get in the way. But there are also circumstances which demand leadership and decisive policy actions. This is one of those times.
The policy challenges facing the US economy are daunting, to say to the least. At the top of my list is America’s chronic saving problem. In 2005, the net national saving rate — the combined saving of individuals, businesses, and the government sector adjusted for depreciation — plunged to a record low of +0.1% of national income. As best we can tell, this is also a record low for any leading global economic power in the modern history of the world. Lacking in domestic saving, the US must import surplus saving in order to grow. In 2005-06, our estimates suggest that America absorbed about 70% of the surplus saving elsewhere in the world. And, of course, in order to attract the foreign capital, the US has had to run massive current account and trade deficits. With the current account deficit at an $874 billion annual rate in the second quarter of 2006, or 6.6% of GDP, such external financing requirements boil down to about $3.5 billion of capital inflows each business day of the year. Washington can no longer afford to take lightly a saving shortfall of this unprecedented magnitude. For starters, it exposes the US to currency and real interest rate risk in the event of a sudden loss of confidence by foreign lenders in dollar-denominated assets. It also raises serious questions about the wherewithal for America to fund retirement for its aging generation of some 77 million baby-boomers — the first of whom will start to retire in just three years. In a gridlocked climate, Washington must rely increasingly on the “kindness of strangers” to keep funding a saving-short US economy without demanding currency or real interest rate concessions. It must also count on manna from heaven to fill the retirement funding gap. By contrast, in an activist climate, Washington must face the imperatives of a saving agenda head-on. That takes me to item number two on my list — plugging that portion of the saving hole attributable to the Federal government’s structural budget deficit. The Bush Administration, of course, claims it has cut the budget deficit in half — comparing the $248 billion deficit just recorded in FY2006 with its initial forecast of a $521 billion gap for FY2004. Significantly, this so-called improvement came off an overly-inflated base — the actual deficit was $413 billion in FY2004, or 20% smaller than the unrealistic bogey presented by the Administration. Moreover, all of the subsequent windfall that then occurred can be traced to revenue flows generated by the temporary, or cyclical, improvement in the economy. There were, in fact, no meaningful changes in either tax or expenditure policies that would have a lasting impact on the structural budget deficit. In fact, CBO’s latest estimates place the “standardized” structural budget at -2.2% of GDP in 2007 — identical to the -2.2% average over the preceding four years, 2003-06. In a gridlocked climate, that means a slowing in the pace of economic activity would put pressure on growth-sensitive revenues — leading to yet another round of cyclical deterioration in the federal budget deficit and renewed pressure on national saving and external financing. In an activist climate, the imperatives of deficit reduction would be an important down-payment on America’s saving agenda. Trade policy is the third item on my personal action list. Protectionist pressures are as serious a problem as I have seen in my years in this business — especially in the context of what is historically a low unemployment rate. These pressures are unlikely to vanish into thin air now that this election has come and gone. By our count, fully 27 separate pieces of anti-China trade legislation have been introduced in the US Congress since the beginning of 2005. Most of these bills have broad bipartisan sponsorship and are an outgrowth of the perceived plight of the American worker in this new and fast-moving era of globalization — underscored by subpar job creation and relatively stagnant real wages. With fully 25% of America’s massive trade deficit traceable to the bilateral imbalance with China, Washington is convinced it has an ironclad case to hold the Chinese accountable for all that ails the American worker. Never mind that 63% of China’s sixfold increase in exports over the past decade is traceable to “foreign-invested enterprises” — in effect, Chinese subsidiaries of global multinationals and joint ventures. Never mind also that if Washington were to shut down trade with China completely, a saving-short US would have to source its deficit elsewhere — most likely with a higher-cost producer that would impose the functional equivalent of a tax hike on American consumers. And then, of course, Washington may be forced to face a very different attitude from its Chinese lenders. In a gridlocked climate, trade policy runs a real risk of moving further down the very slippery and dangerous slope of protectionism. In an activist climate that faces up to America’s saving imperatives and globalization’s new realities, such a mistake stands a much better chance of being avoided. America’s competitiveness agenda is another priority that shouldn’t be held hostage to gridlock. Globalization is the most powerful macro force that we face in the world today. It challenges many of the basic premises that the economics profession has held near and dear to its heart for generations — namely, the “win-win” theory of trade liberalization that presupposes the seamless migration of workers in the high-wage developed world between tradable and nontradable sectors. While that transition may well be occurring, it is taking place on very different terms than our theories presumed: White-collar knowledge workers no longer enjoy the shelter and security once promised by nontradable services. Courtesy of IT-enabled connectivity, competitive pressures are moving up the value chain at hyper-speed. Five years ago, white-collar offshoring was confined to data processing and call centers — low-value-added, commoditized functions that trade theory correctly argued should flow to workers in the developing world. Today, the offshoring includes software programmers, engineers, designers, medical professionals, lawyers, actuaries, business consultants, and financial analysts. In a gridlocked climate, Washington in effect says no to globalization and threatens sanctions on offshoring. In an activist climate, the long overdue heavy lifting on educational reform, basic research incentives, and reskilling begins in earnest. These issues, of course, just scratch the surface of the many challenges that face the US economy in the years ahead. Others have written far more eloquently than I on matters of healthcare reform, retirement funding, regulatory reform in a post-Sarbanes-Oxley world, income inequality, and environmental issues — just to name a few (see for example, Dick Berner’s May 2004 essay, “America’s Long-Term Challenges”). And, of course, this is just the economic agenda — there’s obviously plenty to chew on in the foreign policy arena these days. But the point is a simple and very powerful one: Can the United States afford to crawl into the shell of gridlock and do nothing on matters of great national and global importance over the next two years? If you believe the answer to this question is “yes,” I suspect that you risk making some very heroic assumptions about the way a saving-short US economy is likely to squeak by in the years ahead. Insofar as financial markets are concerned, gridlock is not good news for a saving-short US economy. In particular, it underscores the potentially ominous current-account funding implications for both the dollar and real US interest rates at precisely the time when most investors have concluded that there are no consequences from America’s gaping external imbalance. Rarely does a nation have an opportunity to take a deep look inside itself when it is operating from a position of unprecedented strength. America cannot afford to squander that rarest of opportunities. This is the wrong time and the wrong place for gridlock.
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China: Slowing Imports versus Resilient Exports Give Record Surplus
November 09, 2006
By Denise Yam, CFA | Hong Kong
Energy and resources led import slowdown in October. China’s import growth slipped to 14.7% YoY in October, the smallest gain since July 2005, with shipments totaling US$64.3 billion. After two strong months driven by purchases of crude oil, refined products and iron ore, the same categories led the slowdown in October. Slower purchases of crude oil (US$4.8 billion, -2% YoY versus +42.6% in September) and refined products (US$1.2 billion, +22.2% versus +36.3% in September) accounted for half of the 7.3-percentage-point slowdown in import growth compared with September. Iron ore imports (US$1.5 billion, +3.4% versus +30.2% in September) also slowed, taking 0.6ppts off overall import growth. Export growth more resilient than expected. Exports totaled US$88.1 billion in October, up 29.6% YoY, showing limited deceleration from 30.6% in September. The gain beat our expectation following the weak October trade reports out of Korea and Taiwan released earlier. Exports to major markets continued to show robust growth, including that to the US (US$18.5 billion, +22.1% versus +25.7% in September), EU (US$16.9 billion, +31.4% versus +35.6%) and Japan (US$8 billion, +15.4% versus +13.1%), contrary to respective macro indicators that suggest slower developed market demand. Intra-regional shipments to Korea (+35.1%) and ASEAN (+41.2%) continued to see explosive growth. Trade surplus shot to another record, of US$23.8 billion. While China’s large trade surplus is consistent with our view that heavy investment in production capacity over the past few years has made China more dependent on external demand to absorb its output glut and reduced the need for imports, the recent surge in the trade surplus is exceeding our expectations, and has brought the year-to-date surplus to US$133.6 billion, spelling upside risk to our already-aggressive forecast of US$155 billion for the full year. Trade surplus reduction will take time. The surplus has always been used by trade partners to pressure China for a stronger renminbi. Indeed, China has allowed its currency to accelerate faster in the last couple of months, although the movement has been far from satisfying the US and Europe. Nevertheless, we reiterate that China’s large trade surplus has resulted from overinvestment; a stronger currency alone will not lift China’s imports of consumer goods and resolve global trade imbalances. Shifting growth from exports and investment to consumption will take time, in our view. We believe that Chinese goods will likely continue to flood export markets until domestic consumption eventually catches up. We expect the large trade surplus to sustain for at least the next two years. More October data in the coming week. The trade report kicked off the stream of data releases for October, after the 3Q06 report suggested mild deceleration in the economy and allowed the government to simply maintain the ongoing macro controls and take a breather from further tightening measures. With the gradual slowdown in fixed investment, exports will probably be a significant driver of China's growth in 4Q06. We have to admit that slower imports in October and the cooling export growth momentum in the region suggest that China’s export growth could soften in the coming months. Nevertheless, we do not see economic growth having any difficulty reaching our forecast of 10.5% this year.
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