Agree or Disagree

Let’s play a game. The game is called “Agree or Disagree.” To play this game, we will look at a lengthy article by Stephen Roach entitled “On the Road to Global Rebalancing.” In italics are statements by Roach. My responses are in normal print. Here goes:

“It was exactly six years ago when I first coined the term ‘Global Rebalancing.’ The equity bubble had burst, America was heading into recession, and an unbalanced, U.S.-centric global economy was in trouble. A rebalancing was in order, I argued at the time — and the sooner the better!”


“An unbalanced world was able to buy time. With the benefit of hindsight, it is not that difficult to figure out how. Fearful of a Japanese-style deflation in the aftermath of a burst equity bubble, America’s Federal Reserve rushed to the rescue — spearheading a massive monetary easing that pushed short-term interest rates down to the unheard of 1% threshold. That prompted a seamless move from one asset bubble to another, as the property market took over where equities left off.”


“Courtesy of state-of-the-art financial technologies, U.S. homeowners were quick to extract equity from an increasingly frothy housing market — and use the proceeds to fund both consumption and saving.”

Violently disagree. It is pure insanity for any economist to suggest that extracting equity (borrowing against one’s home) can in any way, shape, or form “fund savings.”

“Time has finally run out for an unbalanced world. Just like the demise of the equity bubble over six years ago, America’s property bubble is now in the process of bursting. Moreover, a sharp resurgence of equity markets is unlikely as corporate profit margins now come under pressure. That means the days of asset-driven support to U.S. consumption are coming to an end. For American households, that spells a return to basics — the need to draw support from income generation, rather than wealth creation. That points to a likely increase in personal saving and, as a result, less of a need for foreign saving — setting the stage for a reduction in America’s gaping current account and trade deficits.”


“There are three key elements of a rebalancing policy agenda: First, U.S. authorities must act to temper the consumption excesses of an asset-dependent economy. Tax policy should be used to alter the tradeoff between consumption and saving. Some form of a consumption tax — either a national sales tax or a VAT — would make good sense in the current climate; not only would it encourage saving, but it would also broaden the tax base and lower the budget deficit — thereby boosting national saving and reducing the U.S. current account deficit. The U.S. must also run a tighter monetary policy aimed at curtailing the expansion [of] the excess liquidity that has long fed its multi-bubble syndrome.”

Generally agree, but very fearful of what politicians might do if we march down the road of new tax resources.

“Second, the non-U.S. world must move actively to embrace policies that boost private consumption. This will wean the world from excess dependence on the American consumer — tempering the damage from a U.S.-led export compression scenario.”

Disagree. The pool of real funding is most likely negative. The imbalances are not because of excessive savings abroad, but because of lack of saving in the U.S. It seems silly to promote consumption bubbles elsewhere just because the consumption bubble is bursting in the U.S.

“Third, the stewards of globalization — namely, G-7 finance ministers, the IMF, and the world’s major central banks — must remain committed to rebalancing. So far, so good. The IMF recently moved to implement a new multilateral surveillance and consultation process that initially includes the U.S., Europe, Japan, China, and Saudi Arabia. Major central banks seem firm in their resolve to withdraw excess liquidity. And German Chancellor Angela Merkel, the new head of the G-8 for the next year, seems determined to focus the policy debate on global rebalancing.”

Disagree. So far, so bad is more like it. The world trade talks blow up year in year out, and we have proven time and time again that talk (and talk is really all we have) is useless. Japan has tightened money supply, but has yet to do anything more than a token 25-basis-point hike, and some BOJ commentary seems concerned about that. Trichet is once again bitching about the strength of the euro, and the U.S. Congress is once again threatening 27.5% tariffs on China. It is a joke to suggest that anyone is serious about global rebalancing anymore than they are serious about solving trade issues. Actually, that is slightly incorrect — people may be serious about it, but no one is serious enough to do anything more than talk while hiding under the mask of blatant protectionism.

“There is no quick fix for an unbalanced world. Many harbor the false illusion that currency adjustments — namely, a significant depreciation of the U.S. dollar — could provide a shortcut to global rebalancing.”


“Lulled into a false sense of complacency by America’s prolonged bubble-induced consumption binge, the rest of the world is unprepared for a very different post-bubble climate.”


“Yet the rebalancing of an unbalanced world is far too important and far too delicate an operation to be left to the whims of overextended markets. Policymakers around the world must rise to the occasion.”

Violently disagree. The reason we are in the fix we are in is because policymakers thought they knew better than the markets. Greenspan blew bubble after bubble. The market was not concerned about Y2K, but Greenspan was. He fueled a massive bubble in dot-coms and fiber as a result. Even though consumers or housing were not tapped out, the Greenspan Fed fueled the biggest housing bubble the world has ever seen by slashing rates to 1%.

No! Steve Roach, you are dead wrong on this. The problem is that the Fed has no idea where interest rates should be, does not know “neutral” to save its soul, overshoots and undershoots every step of the way…yet for some unknown reason, you keep putting your faith in the very idiots who exacerbated the problem. It is not time for the Fed to be deciding things. It is indeed time, and long overdue, to abolish the Fed and let the markets decide things. Proof of that statement should be easy enough.

Is there any way we could possibly be more imbalanced if market forces, rather than the Fed, were attempting to control interest rate policy?

Roach clearly understands the problem. His unfounded optimism as of late is based on thinking that what caused the problem is going to cure it. Sorry, Roach, your optimism and faith in central bankers everywhere is simply unfounded.

September 11, 2006

The Daily Reckoning