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Jim Cook



Every once in a while I switch the TV channel from Fox to CNBC to see what the liberals are saying.  After listening awhile I get a deep sense of hopelessness and foreboding for our country.  The most important thing for the left is giving money to people.  They are happy to see the growth of food stamps, disability payments, housing subsidies, free healthcare and all the other welfare benefits.  They utterly fail to see the damage it is doing to the recipients.  Whole cities that once flourished have deteriorated into rotting eyesores populated with shambling hulks of chemically dependent drones.  These people are no longer employable.  They have become incompetent and helpless and the liberals can’t see that it’s their doing.

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The Best of Jim Cook Archive

Commentary Of The Month
August 13, 2004
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Global: The Mythical Recovery

Stephen Roach (New York)

From my jaundiced perspective, renewed weakness in the US economy hardly comes as a surprise. It’s an unmistakable outgrowth of an upturn that has been of highly dubious quality from the start. The consensus view is that America has entered nothing more than a "soft patch" -- the momentary lapses that most recoveries experience before resuming their upward march. Now that the major equity market indexes have all hit new lows for the year, there will undoubtedly be a rush of buy recommendations from that same optimistic consensus. My advice: Look before you leap at the siren song of the mythical recovery.

This business cycle is different. The modern-day US economy has never had to struggle this hard to eke out an economic recovery. Plagued by an outsize shortfall of internal income generation, it has taken an unprecedented dose of fiscal and monetary stimulus to spark any semblance of cyclical revival. But the question all along has been, recovery at what cost? It’s a cost, in my view, that has been manifested in the form of an extraordinary array of imbalances -- record twin deficits (budget and current account), a massive household sector debt overhang, an unprecedented shortfall of domestic saving, and an asset-dependent support to aggregate demand. Lacking in the organic staying power of job creation and wage earnings, the US economy has become addicted to the steroids of extraordinary monetary and fiscal support. But with policy levers pushed to the max, the lifeline of support is now dangerously thin. For such an unbalanced and vulnerable economy, it doesn’t take much of a shock to put a low-quality recovery in trouble. As bad luck would have it, that’s precisely the risk as oil has once again entered the macro equation.

I have held this dour view for about five years -- since 2000, to be precise. My basic concern was that America’s post-bubble carnage would take a lasting toll on the recovery dynamic. An accelerated pace of globalization and the related pressures of what I have called the global labor arbitrage only intensified my concerns. This view served me well for the first four years of America’s post-bubble workout but didn’t work all that well over the four-quarter period from 2Q03 through 2Q04, when real GDP growth averaged 5.1%. But now with momentum on the wane again, it pays to ponder the downside. In my view, recent data unmask five key myths to the case for sustainable economic recovery in the US and in the broader global economy:

Myth #1: The US economy has achieved the critical mass of a self-sustaining cyclical recovery. The theory is very straight-forward: Jobless recoveries don’t generate enough income to drive consumer demand. Counter-cyclical policy stimulus -- fiscal as well as monetary -- can fill the void, sparking an inventory and production dynamic that spurs income and spending growth. From there, the "multipliers" take over, and the self-sustaining recovery can then successfully be weaned from policy stimulus.

It’s a good theory but it’s not working. It’s not just that job creation has averaged an anemic 55,000 per month over June and July. It’s that this recovery has been accompanied by the weakest employment profile on record. In only three of the 32 months of this recovery has job growth exceeded 200,000; by contrast, in looking at the average profile of the past six cycles, that threshold was exceeded 14 times over the comparable 32-month time frame. By our calculations, private nonfarm payrolls are currently 8.1 million workers below the path of the typical hiring-led recovery. Lacking in job creation, real wage and salary disbursements -- the key organic driver of household purchasing power -- are running $323 billion below the typical recovery profile. All this speaks of the absence of the critical mass for self-sustaining recovery.

Myth #2: Imbalances don’t matter. Few can deny the severity of America’s imbalances -- a 5.1% current account deficit, a 4% federal budget deficit, a sub-2% net national saving rate, and household sector indebtedness that now exceeds 85% of GDP. Where the denial creeps in is with respect to the implications of these imbalances. America is special, goes the logic. The rest of the world is desperate for high-return dollar-denominated assets in the world’s most productive economy. That makes current-account and budget deficits a cinch to finance. Debt isn’t a problem because interest rates are still low -- at least for the moment. And who needs old fashioned income-based saving, when ever rising asset markets will do the job?

The problem with this logic is that it turns orthodox macro inside out in an effort to justify the notion of sustainable imbalances. These new theories are always seductive. Supply-side economics promised self-financing tax cuts. The New Economy promised an ever-rising US equity market. And now yet another new paradigm argues that foreign investors will gladly foot the bill for a US economy that continues to push the envelope in living beyond its means. Let the record show that that the personal saving rate fell back to a rock-bottom 1.2% in June 2004. Lacking a cushion of income-based saving, over-extended and asset-dependent American consumers suddenly have their backs against the wall. As for the external financing conundrum, as they say in the mutual fund business, past performance is no guarantee of future returns. The likelihood of a saving-short US economy continuing to run ever-wider current account deficits without suffering dollar and/or real interest rate consequences is close to zero, in my view. Imbalances matter -- now more than ever. Take a look a Pete Peterson’s latest book if you want the clearest and most honest explanation as to why (see Running on Empty, Farrar, Straus and Giroux, New York, 2004).

Myth #3: Oil doesn’t matter. Every time oil prices go up, we are always subjected to the same dismissive cop-out: Since the energy efficiency of US GDP has continued to improve, the role of oil in shaping both production and consumption has steadily diminished. As such, the impact of a given increment in oil prices is not what it used to be. So don’t worry.

I have never bought this one either. The record is pretty clear on this risk factor: Each of the five recessions since the early 1970s has been preceded by an oil shock in one form or another. The key question, in this instance, is whether the US has experienced a true oil shock. I have previously argued that while $40 oil hurts, it does not qualify as a full-blown shock; however, relative to the post-2000 average of $29 per barrel, a $50 price tag would have to be considered a shock (see my May 10 dispatch, "Global Wildcards"). Right now oil is hovering near the midpoint of those two possibilities -- hardly a comforting development. For an unbalanced US economy that lacks much of a cushion, the pain of $44 oil can hardly be minimized.

Myth #4: Nothing stops the American consumer. This is widely perceived to be the Golden Age of US consumption. Recent trends add a good deal of credence to this presumption. Over the eight-year period, 1996 to 2003, real consumption expenditures rose at a 3.9% average annual rate -- well in excess of the 3.3% pace of real GDP growth over the same period. Nor did the consumer flinch in the aftermath of the burst equity bubble in early 2000. Lacking in income, consumers have become increasingly creative in levering their balance sheets and extracting purchasing power from assets in order to keep the magic alive. Most believe that this creativity remains an enduring feature of our times.

No pun intended, but I continue to worry that the American consumer is living on borrowed time. Yes, debt is a key concern. Even with interest rates near 40-year lows, debt service burdens -- interest expenses relative to disposable personal income -- are near historical highs. The personal saving rate, as noted above, is near historical lows. Wage income generation, also as noted above, is lagging as never before. And, as the US property cycle nears its secular peak, asset-driven consumption strategies will be challenged as never before. All this speaks of a US consumer that is lacking in staying power and therefore vulnerable to the slightest of shocks. Oil is an obvious and immediate threat in that regard. Personal consumption expenditures rose at only a 1% annual rate in 2Q04 -- one-fourth the post-1995 trend and equaling the weakest quarterly increase since 1Q95. I have long been wary of betting against the American consumer. That bet is now more tempting than ever.

Myth #5: The world is now on the cusp of synchronous recovery in the global economy. The hope here, of course, is that an unbalanced US-centric world has now been rebalanced, thereby providing the global economy with a broader platform of support. That, of course, would come in quite handy in the event of a shortfall in the US economy. On the surface, a broadening out of the global growth dynamic offers encouragement in this regard -- underscored by our estimates of 5% growth in the Japanese economy in 2004, 6.4% in Asia ex-Japan, and 4.7% in Latin America. Even in Europe, we have raised our sights recently to 2.1% in 2004.

Don’t kid yourself. The world, in my view, remains very much a two-engine economy -- the US consumer on the demand side and the Chinese producer on the supply side. The American consumer, as just noted, is already on thin ice. And the Chinese producer is now being hit with a sharp blast of policy austerity in an effort to tame the excesses of a severely overheated economy. One lesson I have learned over the past decade is that it pays to heed the wishes of the Chinese leadership. We’ll get another slug of data from China this week, but in my view the case for a significant slowdown remains very much intact. Absent the twin dynamic from the US and China, the outlook elsewhere in this externally-dependent world should slow appreciably. The persistence of massive external imbalances in the global economy speaks of a non-US world that has failed to develop autonomous sources of domestic private consumption growth. Lacking in new growth engines, weakness in the US and China should put to rest the myth of a new synchronous recovery in the global economy.

I’ve been on holiday for the past two weeks. Lots of family time and plenty of opportunity for reading, exercise, and something called relaxation. I stayed minimally connected and glanced at the screens once or twice a day. Re-entry is always a challenge and an opportunity -- a chance to see the world through a different lens. For my money, there can be no mistaking the reality check of this summer’s disappointing data. This recovery now looks more mythical than ever.