US has abdicated global leadership position in push for de-globalisation, says the faculty member, Yale University.
Last time when we spoke to you it was all gloom and doom, markets were in a free fall zone. The medical crisis in a sense had snowballed into a big economic crisis but now things are looking up. Are you pleasantly surprised with the force with which financial markets and especially US markets have made a comeback?
I have learnt over my long career that stock markets are designed to humiliate most of the people, most of the time and this has certainly proven to be consistent with that old. Most of us, myself included, thought that the US equity market in particular would retest the late March lows at some point over the subsequent few months.
Of course, the markets have defied that conventional test drawing support from extraordinary injections of liquidity by the US central bank and hopeful that the US economy just experienced a sharp but temporary break during the lockdown and now it is back to a V-shape vigorous recovery sort of analogous to that which occurs after a natural disaster; an earthquake or hurricane or something like that. I am suspicious of that optimistic prognosis but I certainly recognise that the markets are once again defying what seems to be logic and powering ahead in any sense.
I was too young to remember what happened in 1999-2000, but a lot of experts I have interacted with are saying that look there is a parallel between what we saw in 1999 and 2000 which is that markets remain here, economy was here and they remained disconnected for a long period of time. You have seen and analysed market cycles. Do you think we have gone through all the makings of a market which was similar to what we saw 20 years ago where the economy and market remained disconnected for a long period of time?
A cyclically adjusted stock market relative to earnings is that which was constructed by Yale professor and my colleague Robert Shiller. The market was more overvalued in early 2000 than it is today and nevertheless the markets did reach extraordinarily high levels in the period prior to the outbreak of the pandemic. So this is a correction from a high level at a time when the world economy was quite vulnerable.
You have made the point on various forums that you expect the dollar trade to unwind. Whenever there has been a crisis in the world in the last 10-15 years, the world has migrated towards the dollar. But you currently expect the dollar to unwind very sharply. What has prompted you to make this big call?
As I look at the US relative to the rest of the world, while the equity markets have gone up sharply and bond yields have plunged to unprecedented low levels in my view of the United States, something still has to give. When I look at the comparison of the US relative to the rest of the world from the standpoint of domestic savings and our current account balance, I see extraordinary disparities emerging in the United States. We started 2020 with an extremely low domestic savings rate of 1.4% of the national income adjusted for depreciation and that compares with a 7% average over the 45 years ending in 2005.
Lacking in saving and wanting to grow, we import surplus savings from abroad and run massive current account and trade deficits to attract the capital. Our domestic savings rate is going to go from bad to worse, our budget deficits are exploding right now and we will find our domestic savings in record negative territory by the end of this year. That will take our current account deficit to a new record greater than the 6.3% hit in 2005. So currencies move to facilitate current account corrections and that is what the US dollar is going to do.
I would add one another thing to that. It is not just the current account and the domestic saving that is driving the dollar lower but the US has abdicated its global leadership position leading the way in pushing for de-globalisation, decoupling trade protectionism and it has failed miserably in containing the coronavirus and is in the midst of a major racial upheaval.The dollar has always benefited from what we have called American exceptionalism and as the world’s dominant reserve currency has been given the benefit of the doubt for a long, long time. That benefit is also being drawn into serious question and in conjunction with a current account saving issue, I have noted that the dollar is probably going to correct by as much as 35% on a broad trade weighted basis over the course of this year and next. That would be a sharp correction but not an unprecedented correction. We have had three such corrections comparable to that since the 1970.
Last time when the dollar declined, it coincided with a sharp rally in commodities and emerging markets. Are we in for a reversal of the previous cycle or this time is it really going to be different?
Well everybody always says when the dollar goes down, what it is going to go down against? What other currencies in the world are likely to rise in this environment? The major beneficiary will likely be the euro. The euro is the most unloved major currency in the world. Everyone and myself included, has been a eurosceptic, waiting for the European monetary union to fall apart and it has not done that.
The recent agreement by Angela Merkel and Emmanuel Macron to establish a 750 billion euro next generation EU fund together with the likelihood of a pan-European sovereign bond issue emerging as a new riskless asset in the world points to considerable upside for the euro. I also think that Chinese renminbi which has moved up about 50% since late 2004, has further upside in store and it has been showing that in recent days as well.
I would also look for dollar weakness to be accompanied by strength in gold and possibly even the crypto currencies like Bitcoin. As for other emerging markets, a declining dollar environment might benefit a little bit at the margin but not as much as the alternatives I just mentioned.
Is the world prepared for a second wave of coronavirus? On the medical front, there is clear evidence that things have not plateaued out or peaked out like they say. If the virus is not peaking, what are the chances that a second wave of virus could have a fresh round of selling for financial markets or chaos for the financial markets?
The world markets are not pricing a major setback in economic activity. Even though the virus is once again creating huge problems in the United States. Today just looking at the numbers that were just published, we have a record 63,000 plus new cases. There are rumours of lockdowns but the markets do not seem to be taking those rumours very seriously at all. We know from the last lockdown from mid March through the end of April, that it will lead to serious problems for output, jobs, income and of course the budget deficit.
Given that we are nearing the next US presidential election cycle and we got the Democrats and Republicans as always indicating separate things that they want from the economy, what is their view on financial markets and financial regulation? What is the importance of this year’s presidential election? It is evident it is going to be Trump versus Biden or Biden versus Trump.
The US presidential election is of enormous consequences to the future of the United States and the future of America’s leadership and then by inference to the world order as it stands right now. We are right now with President Trump pushing hard for de-globalisation, decoupling, trade protectionism, ignoring federal policies to control the coronavirus and also being insensitive to the outbreak of America’s racial upheaval. These are not good trends for the United States to stay on. If we remain on the path as indicated by President Trump’s actions in the first three-and-a-half years of his presidency, then America will face a very worrying future and the world will suffer greatly as a result.
If Biden is elected and the polls are pointing in that direction, we will have a very challenging set of problems and we can be hopeful that there will be a significant shift in all of the issues that I just mentioned, but it will not be easy. He will inherit a very difficult situation in the economy and a difficult situation in dealing with America’s public health and racial issues. It will require a very different approach and I hope he is up to that challenge if he were to be elected.
Last 10 years, the two largest consumption driven economies were India and China. China is slowing down, the GDP growth is certainly below its 10-year average and that is the story for India as well. We have plunged to a historical low. What impact do you think this could have on global growth and for this decade where do you think the next growth engine is going to be coming from?
Well, the post Covid recovery is going to be a weak one, just like the global recovery was very weak in the aftermath of the Global Financial Crisis.
I believe that it has been relatively straightforward to normalise the supply side in particular by raising production and bringing workers back to work. It is much tougher to normalise the demand side where consumers remain fearful of infection and participating and therefore in face to face activities like eating in restaurants, travel, leisure and shopping. The shadow of the behavioural shock will be an enduring feature of the post Covid recovery and keeping the global growth rate more subdued than we would like to think and hope for in the aftermath of the severe shock that we saw to the world in the first quarter and the second quarters of this year.
There is a very strong rhetoric against going global. In India, the government has now started a Atmanirbhar campaign which is a call for making India self reliant. In America, it is Go America First. What do you think will be the impact of this on global growth if globalisation gets stalled and what will happen to China because China is a factory of the world which in a sense was supplying to the world. If the Chinese products are not going to be accepted by the consumers, then how will this backfire for China?
Well by some measures, especially the one that is used by the IMF to add up the global GDP, China is the biggest economy in the world by purchasing power parity and since the world financial crisis, the growth in China is accounted for between 35% and 40% of the cumulative growth in the world. So, if the world is going to put pressure on China and the Chinese economy were to slow precipitously, that will lead to a major shortfall in global economic activity because there is no country that is going to fill the void.
What China has done is it has focussed increasingly on driving its economy through domestic demand especially personal consumption expenditures of its growing and rising middle class. This will insulate China somewhat but not completely from the pressures that have been brought to bear on its export business through countries like the United States and America's allies that are sympathetic to the trade war that President Trump has launched against China. While China’s dependence on exports, its dependence on global demand has moved down sharply over the past decade, exports still account for around 17% of Chinese GDP. So, it cannot take these external pressures lately. That raises problems for China and problems for the world economy.
Historically economies and markets follow a cycle and every cycle follows the same pattern. There is the zero phase, there is a peak phase, there is a participation phase, there is a bubble phase, then comes a drop in earnings and then comes bankruptcy and then the fresh cycle starts again. Do you think this time around the cycle could be different purely because interest rates are zero?
Central banks have figured out how to create money out of thin air and there was an article in one of our leading forum Affairs General that was titled Magic Money. I do not believe in Magic Money. I think as long as interest rates stay low and remain extremely low, near zero at the short end of the yield curve, there are no meaningful consequences in terms of debt service for countries that are taking on enormous increments of new debt.
So for the US, which is running budget deficits close to 17% of GDP this year and on an average, about 14% of GDP over the next couple of years. There is no real penalty for doing that if the debt service is low because of extraordinary accommodative monetary policy by the Federal Reserve. But if the day comes where the Federal Reserve has to normalise interest rates or even begin their process because of concerns of inflation which I do not rule out in a weak dollar environment, then the debt services pressures will be very constructive in terms of their impact on debt intensive economies like the United States.
As we learnt in earlier frothy cycles, you stay on the dance floor as long as the music keeps playing but when the music stops, you are in serious trouble and that is a risk certainly for the United States -- a massive build up in debt that is now underway.
But ultimately it boils down to one simple question that one day Fed will have to normalise rates how long do you think they will print money because this kind of zero interest rates environment where you are stimulating the economy by buying back bonds and corporate bonds it could be ETFs one day it is not going to continue?
As long as inflation is below target, the Federal Reserve will get away with printing excess money. But will inflation remain forever? I started out my career in the 1970s when we certainly believed that there is an inflation problem and then we emerged with a very very serious inflation problem that required extraordinary tightening by the US central bank under Paul Volcker’s leadership. I do not see inflation coming back the way it did in the late 70s or in the early 80s. But with the pressures for bringing supply chains back home, moving from offshoring to reshoring with the sharp and precipitous decline in the dollar, there is a possibility that inflation will not be as well behaved in the years ahead as the magic money solution requires.
If that is the case, then a modest build up of inflation will prove to be very problematic for debt intensive economies like the United States. This is what happened to us right after World War II. After World War II, our public sector debt to GDP ratio was an unprecedented high of about 104% of GDP. Over the next several years, we are going to break that record. As we did in the aftermath of World War II, we have reflated our way out by boosting our real growth rate a little bit but also allowing for a significant increase of US inflation. I think that reflationary outcome is very much a risk today.
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July 14, 2020 at 04:06PM
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Dollar may correct 35% in broad trade weighted basis over this year & next: Stephen Roach - Economic Times
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