Sunday, May 31, 2009

Time: Stephen Roach on Asia - No Sail

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Very strange to see multiple interesting items touching on the financial world in Time, but here we have an interesting opinion piece by Stephen Roach. For those not familiar with Roach I guess I'll point you to the ultimate fact based resource on the internets (sic) - Wikipedia. ;) Essentially he was the Chief Economist for Morgan Stanley for a long time (16 years) but about 2 years ago was "promoted" to Chairman of Asian operations. Many say his pessimistic views landed him the 'promotion' ;) - after all in the business of financial snake oil sales, you want to put a good spin on as much as possible.

We've been speaking often about the "China will lead us" thesis, and I wrote a quite exhaustive piece this week on my updated views (really no different than my views the past year+) [May 27: How is China Spending their Stimulus... and How Many of their Loans Will Go Bad?] Much like Roach I just have to scoff at anyone believing in 6 months an economy based so heavily on exports with a nation of savers with little safety net will suddenly "turn American" and drive internal consumption (ex government handouts). This is a process that will happen over years and in fact a decade+. Until then many of these Asian economies still need Europeans and especially Americans to shop 'til they drop.

So as you read this piece from Roach keep in mind his general 'pessimistic' view (or as people off Wall Street call it: realistic) and the fact he "knows" Asia ... much more than the stock jockeys who are driving stocks up on "thesis".
  • (Apr 2007) Morgan Stanley is betting that Roach’s strong connections in Asia, built through frequent travel in the last decade to regional conferences and calls on high officials, will help it win more business. He is known to enjoy regular one-on-one audiences with Singapore’s minister mentor, Lee Kuan Yew. Last month, he met in a small group with Chinese Premier Wen Jiabao to hear firsthand about China’s latest economic tightening measures. Roach, who has spent the last 25 years at Morgan Stanley, will assume his new job in June and move to Asia in September.
  • In addition to predicting China’s stunning ascendance politically and economically onto the world’s stage, he was also an early bull about India.
But also always remember, reality does not matter to Wall Street; only its perception of reality matters. At least in the short to intermediate run.

Via Time
  • The spin game is on as the world tries to talk itself out of the worst recession since the end of World War II. The good news is that there is a slowing in the rate of deterioration in the global economy. The tougher news is that this is hardly surprising. In the aftermath of unprecedented annualized plunges in real global GDP on the order of 6% to 7% in the fourth quarter of 2008 and the first quarter of 2009, the pace of deterioration almost had to moderate.

  • With history books replete with tales of V-shaped recoveries following steep downturns, financial markets have become giddy, hoping that signs of bottoming beget the long-awaited rebound. Nowhere is that more evident than in Asia, an increasingly China-centric region convinced it will lead the world out of its long nightmare.

  • If it were only that easy. Contrary to the lore of the Asia century, the region continues to suffer from a lack of internal support from its 3.5 billion consumers. The private-consumption share of developing Asia's overall GDP fell to a record low of 47% in 2008 down from 55% as recently as 2001. (key point) In other words, Asia remains an export machine.
  • Developing Asia's export share rose from 36% of pan-regional GDP during the financial crisis of 1997-98 to a record 47% in 2007. And recent research by the International Monetary Fund shows that Asian exports continue to be underpinned by demand from consumers in the industrial world especially from the U.S. Despite a surge of trade within Asia, the bulk of these intraregional flows have been concentrated in parts and components that go into finished goods eventually consumed by developed economies.
So to summarize.... the whole world need easy money thrown from the heavens to make the US consumer once more spend over his head. He/she is the world's lynch pin - in fact much of the global economy is based on these 300M people acting without care of the future or in their own self interest. They must consume and buy cars on 7 year mortgages... err loans [Feb 13, 2008: Car Loans Being Stretched to 7 Years] [September 2007: Is a 10 Year Car Mortgage Far Off?], draw equity out of their house, and not worry about the future - then the world economy hums. But we really need home prices to go up at ANY COST for our magic to return. That's where your Uncle Ben is coming in. When this era returns, CNBC pundits can repeat what they've been saying for going on 2 decades "never doubt the US consumer".

Now if you come back to me in 2 decades, I can give you a different story. But to believe this transformation has happened in 2 quarters? Only in snake oil salesman (or cheerleader) land. You know what TV channel to watch if you want to believe that fairy tale.

Oops, sorry - this is where I say decoupling failed in 2008 but in 2009 it's back and better than ever. Green shoots.
  • Little wonder that in the aftermath of a record contraction in U.S. consumer spending in late 2008's 4% average annualized declines in the final two quarters of the year in real terms every major economy in Asia either slowed sharply or tumbled into deep recession. More than ever, the region's fate remains made in America.
Someone please send a decoupling boquet to Mr. Roach.
  • This is where hopes of an Asia-led rebound are most tenuous. After a dozen years of excess, the overextended American consumer is tapped out. The green shoots crowd, those believing global recovery is nigh' drew special encouragement from a 2.2% rebound in real U.S. consumer expenditure in the first quarter of 2009. That encouragement is about to be dashed. Outright contractions in retail sales in March and April point to a renewed decline of at least 1% in real consumption in the current quarter.
  • Hit by the triple whammy of collapsing property values, equity-wealth destruction and ongoing unemployment shock, the American consumer is unlikely to spring back overnight. In fact, with asset-dependent U.S. households remaining income-short, overly indebted and savings-deficient, subdued consumption growth is likely for years. This is because the U.S. consumption share of real GDP, which hit a record 72.4% in the first quarter of 2009, needs, at a minimum, to return to its pre-bubble norm of 67%.
  • That spells a sharp downshift in real consumption growth from the nearly 4% average pace of 1995 to 2007 to around 1.5% over the next three to five years. There will be years when the consumer falls short of that pace. The contraction of more than 1.5% over the past four quarters is a case in point. And there will be years when consumption appears stronger. But the die is cast for a protracted weakening of the world's s biggest spender.
A very similar thesis to what I wrote in [Dec 29, 2008: What Happens if America Returns to a Historical Savings Rate?] [May 10, 2009: NYT - Shift to Savings May be Downturn's Lasting Impact] - the current group of cheerleaders and pundits thinks 0-3% savings rate is historically normal. It is not, we once were a nation of quite solid savers; but our recent behavior changed as encouraged by government, and Federal Reserve policies to keep a bubble economy from ever feeling a real recession ahead. [Sep 15 2007: Consumer Spending Continues, Where is the Money Coming From? Credit Cards] [Apr 10, 2008: Americans Keep Piling on Debt] [Jun 3, 2008: Credit Card Usage is Surging, Risking Another Debt Crisis] While it would be much healthier to have a one time correction, get back to 8-10% savings rate so we can invest out of savings rather than debt... it is not politically convenient. So we'll drag this out much longer than it needs to take and say we are not Japan. Again my thesis is not that the American consumer will CHOOSE to make this change in behavior... it has been that the American consumer will be FORCED to make this change in behavior. Aside from median wage pressure our "wealth creation" via asset inflation has destroyed our balance sheets via multiple bubbles gone bad (stock market, real estate) [Feb 4, 2009: Americans Lost $10.2 Trillion in 2008]

Solution? The Federal Reserve is pursuing policies that will make those bubbles look like a sissy. Time for our next bubble - enjoy it kids. Just remember the to memorize the words "nominal" versus "real" in the years ahead - since most Americans only focus on nominal this is the last great parlor trick to show the us peasants we indeed are still 'prosperous'. i.e. "wow, my Etrade account is up another 28% - that is cool; now why the heck are my eggs costing 45% extra ?!"

Back to Roach
  • Therein lies a critical challenge for Asia. Unless it comes up with a new source of demand to support its export-led growth model, Asia will face stiff and enduring headwinds. Nowhere is this more evident than in China, where the mood has turned particularly upbeat. While I no longer doubt that China's performance will be better than expected in 2009, there is good reason to be wary of extrapolation. China's s incipient rebound relies on a timeworn stimulus formula: upping the ante on infrastructure spending to support growth in anticipation of a return of global demand for Chinese-made goods. It's the latter presumption that remains iffy as the U.S. opts for prudence over profligacy.
  • If export-led China does not get a kick from the American consumer, a relapse for China-dependent Asia is a distinct possibility next year. Don't be fooled by catchphrases such as green shoots... In the aftermath of the modern world's worst financial crisis and recession, an Asian-led global healing remains a real stretch.

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