-->> Global: First to Go?
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> Stephen Roach (from Cap d'Antibes)
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> -->
> I continue to see the world economy as a two-engine story - the Chinese
> producer on the supply side and the American consumer on the demand side.
> While there are signs that growth is now picking up elsewhere in the
> global economy, I maintain my view that most of these spillover effects
> are traceable either to the US or China. With both of the world's growth
> engines having gone to excess, a downshift in global momentum is a
> distinct possibility - especially in light of recent (China) and
> prospective (America) policy actions. Who will be the first to go?

> China gets my vote. Unlike America's Federal Reserve, which at this point
> is still all talk, the Chinese authorities have moved forcefully to rein
> in an overheated economy. The monetary tightening campaign of the People's
> Bank of China began in earnest in late August 2003, with an adjustment in
> reserve requirements. Since then, the PBOC has made two additional
> modifications to banking system reserve ratios - one in March and another
> in April. More recently, the State Council - the functional equivalent of
> the Cabinet in the Chinese government - has entered the fray with a series
> of administrative actions: First, in late April, capital requirements were
> imposed on investment activity in several overheated industries - steel,
> aluminum, cement, and real estate; then came a temporary moratorium on all
> bank lending; those actions were subsequently followed in early May by
> targeted price controls at the provincial and local levels of
> jurisdiction.

> This flurry of activity speaks of a two-pronged campaign of policy
> restraint in China: The central bank is relying on traditional instruments
> of macro stabilization policy (i.e., reserve requirements), whereas the
> central government is implementing a series of micro measures targeted at
> those sectors that have overheated the most. This blended strategy is very
> much in keeping with the mixed character of the Chinese economy - a
> combination of state-owned enterprises, newly privatized entities, and an
> increasing number of homegrown private companies. This approach is also
> tailor-made for a highly fragmented Chinese economy. Beijing can only do
> so much at the top - provincial and local officials still have great
> autonomy to march to their own beat. That's especially the case for the
> banking system, where local branches gather their own deposits and build
> their own loan books.

> By operating in both the macro and the micro realms of policy restraint,
> the Chinese authorities are addressing the inherent tensions between the
> top (i.e., Beijing) and the bottom (i.e., municipalities) of this vast
> economy. I heard it directly from Premier Wen last March, when at the
> China Development Forum he expressed a very strong determination to slow
> an overheated Chinese economy (see my 24 March dispatch,"China -
> Determined to Slow"). The actions that have since followed demonstrate the
> conviction of that determination. And I remain confident that they will
> work. We continue to have an active debate over the character of the
> coming slowdown in China. I remain in the soft-landing camp and Andy Xie
> is more worried about a hard landing. But rest assured, there will be a
> landing in one form or another - and sooner rather than later. For the
> major force on the supply side of the global economy, the coming landing
> in China represents a serious about-face.

> I wish I could speak with equal confidence about the prognosis for the
> American consumer. I continue to believe that US consumption demand will
> turn out to be the weakest link in America's macro chain as the Fed now
> embarks on its long-awaited campaign of policy normalization. The problem
> with this call is that it sounds like a broken record - I have been
> bemoaning the vulnerability of the American consumer ever since the equity
> bubble popped over four years ago. That's not to say there wasn't a
> meaningful post-bubble shakeout for the American consumer; after all, real
> consumption growth slowed to a 2.8% annual rate in the three years
> following the bursting of the equity bubble - more than 35% slower than
> the five-year growth rate of 4.4% that occurred while the bubble was
> expanding over the 1996 to 2000 period. But the post-bubble consumption
> downshift was certainly milder than I had expected, and, of course, it has
> since been followed by a 4.3% resurgence of real consumer demand over the
> most recent four-quarter interval (ending in 1Q04).

> Notwithstanding the shaky fundamentals of weak labor income, low saving,
> and excess debt, the American consumer has continued to plow ahead. I have
> attributed this remarkable outcome to Washington - namely, the truly
> remarkable confluence of open-ended deficit spending (i.e., tax cuts) and
> extraordinary monetary accommodation (i.e., a negative real federal funds
> rate). And I believe as this policy stimulus now fades, the overly
> extended American consumer will no longer have the wherewithal to keep
> driving the demand side of the US and broader global economy. Sure, jobs
> are on now on the rebound and that should provide some compensation for
> the withdrawal of the Washington"steroid effect." But, in my view,
> courtesy of unrelenting cost-cutting and the global labor arbitrage that
> this encourages, that compensation will be partial, at best (see my 7 June
> dispatch,"The Baton Pass"). Moreover, as the Fed now raises interest
> rates, I also worry that the big surprise could be the carnage brought
> about by the ever-ticking household debt bomb (see my June 5 dispatch,
>"The Mother of All Carry Trades").

> Yet at this point in time, the consumer downshift call is only a forecast
> - and one with not much credibility in this Brave New Era. Addicted to
> shopping and the debt it engenders, the American consumer remains
> unflinching in the face of adversity. Last month was a classic case in
> point: As oil prices surged through the ominous $40 threshold, consumers
> bought motor vehicles with a vengeance - sales hit their high for the year
> at a 17.5 million annual rate. Figure that one out? Over the past weekend,
> I couldn't get into my local filling station in Connecticut - three
> gas-guzzling Hummers had effectively blocked the pumps simultaneously.
> This is America.

> When the Chinese authorities want to get their way, they usually win -
> suggesting that the China slowdown bet is a good one. When the American
> consumer wants to get its way, it normally wins as well - implying that
> the consolidation bet is risky. Consequently, with the resilience - or
> should I say denial - of the American consumer hard to crack, there's
> little doubt in my mind that China deserves the vote as the"first to go"
> in the global growth dynamic. Yet there's an ominous feature that both of
> these overextended engines have in common: The recent growth excesses of
> the American consumer and the Chinese producer have both been driven by
> spending on durable goods. Durable goods consumption is now greater than
> 10% of US GDP - an all-time high and well in excess of the
> pre-equity-bubble share of around 7% in 1995. Half way around the world,
> Chinese fixed investment has risen to more than 40% of that nation's GDP.
> Over the long sweep of history, durable goods spending cycles have
> followed a very predictable pattern. Such spending is"lumpy" - it
> involves the accumulation of long-lived assets such as cars and trucks
> (America) and property, plant, equipment, and infrastructure (China). When
> these cycles go to excess, spending typically borrows from outlays that
> would have occurred in the future. The payback from what economists call
> the"stock adjustment effect" -- the tendency of durables goods to
> gravitate toward a long-term optimal, or equilibrium, stock -- is a
> time-honored feature of the business cycle. And there can be no mistaking
> the excesses of the recent spike of durables demand in both countries.
> Fixed investment in China spiked to a 53% Y-o-Y comparison in January and
> February 2004, whereas growth in US durables consumption accelerated to a
> 10.6% annual rate in the year ending 1Q04. In both instances, China and
> the US have upped the ante on their long-standing durable goods binge; the
> most recent burst of above-trend vigor is now flashing a warning of a
> looming payback effect.

> Needless to say, the two-engine global economy would be in tough shape if
> the stock adjustment effect were to hit in both China and the US
> simultaneously. Yet that possibility cannot be ruled out. Such a tough
> combination would certainly take financial markets by great surprise. The
> consensus expects a slowdown of one sort or another in China, but has all
> but given up on the case for any capitulation by the American consumer.
> There's an even more ominous twist to this tale: If US consumption slows
> when China is coming in for a landing, the Chinese economy could be hit by
> a double whammy - an investment-led slowdown to domestic demand and a
> US-led slowdown to external demand. Such an outcome would seal China's
> fate in the eyes of investors - the hard-landing play would be on with a
> vengeance. And even I would then have to concede that Beijing would more
> than have its hands full.

> An unbalanced global economy has to be very careful in staging the coming
> rebalancing. The odds favor the Chinese producer leading the way. The
> risks point to the American consumer as a wild card entrant in this
> realignment. Yet in a two-engine world, there may only be room for one of
> these slowdowns.