War, uncertainty, and disease are a tough combination for any economy. But for a stalling and vulnerable global economy, this confluence of shocks hurts even more. The result could well be a weak recovery or the world's second synchronous recession in three years. This could be a critical tipping point for a low-inflation world that is already on the brink of outright deflation. Is there a way out?
Such is the question that Stephen Roach asks us today. The problem is now on the table for all to see. The global economy is not growing fast enough to keep pace with all that increased capacity. This means only one thing: deflation. So what is the remedy. For Stephen this is clear enough, forced by the pressures of a high currency the 'ancien regimes' of the planet will reform. As I keep indicating, this is unlikely (see last post below). Is there a way out: there has to be. Can we see it clearly yet: I'm sorry my answer has to be no. I think we are all going to have to live through a period of more or less complicated re-adjustment. I would say that this is my most important difference of opinion with Krugman and Roach (Brad has really still to pronounce!!). Paul says 'push this button', I say maybe, but if that's all you do you won't fix it. These are uncertain times, and the uncertainty isn't only in the forecasting, we have strategic uncertainty in a more profound sense. Remember we haven't been here before, history and theory can only take us so far. As I keep saying, I personally refuse to speculate much farther forward than 2005, the degree of uncertainty is just too big. Is this a weakness: I don't think so. As someone once said, the first step for getting from here to where we want to be is coming clean on what we don't know. After all if I was claiming to tell you everything that was going to happen, now life would be boring, wouldn't it.
Finally Roach allows his mind to wander over what might happen if the 'cure-all cure' doesn't work. Fissures in the globalisation process. Here he may have more of a point, but I'm not totally convinced, perhaps the degree of global 'connectivity' has already gone one link to far this time. After all, what would happen to the first one out?
A weaker dollar could save the world from deflation. For the United States, a shift in the “currency translation” effect would transform imported deflation into imported inflation. For Japan and Europe, stronger currencies would initially be painful. The appreciation of the yen and the euro would undermine external demand, the only source of sustainable growth in these economies in recent years. That would leave Japan and Europe with no choice other than finally to bite the bullet on reforms in order to stimulate domestic demand. The gain would be worth the pain. It would eventually result in a more balanced mix of global growth -- less domestic consumption from a saving-short US economy and more domestic demand from the saving-surplus economies of Japan and Europe.
There is always a chance such a currency realignment might backfire. If the non-US world chooses to deflect the pain of a weaker dollar, the risk of competitive currency devaluations might intensify. That would take the world down a very slippery slope of trade frictions and protectionism. The recent outbreak of China bashing in Japan is particularly worrisome in that regard. The Chinas and Indias of the world are not a threat. To the contrary, they enable high-cost producers and service-providers in the developed world to realize efficiencies through outsourcing. They also enable rich nations to expand their purchasing power by buying cheaper, high quality goods and services. There will also come a day when the supply-led impetus of countries like China and India hits a critical mass in boosting income generation and domestic demand -- completing the virtuous circle of global rebalancing.
A dysfunctional global economy is at a critical juncture. An intensification of deflationary risks is a real threat if an imbalanced world stays its present course. As globalization continues to expand the supply side of the world economy, a deficiency of aggregate demand becomes the real enemy. If concrete actions are taken to boost the demand side of the global economy, the deflationary time bomb will be defused. The heavy lifting of structural reforms and global rebalancing is the only way out.
Source: Morgan Stanley Global Economic Forum
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