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Sunday, January 22, 2006

Will The Sky Fall On The U.S. Economy?


The Danger of Complacency
Stephen Roach of Morgan Stanley gives his view





So far, so good, for an unbalanced world -- the sky has yet to fall. And the longer a lopsided global economy continues to chug along with impunity, the more the broad consensus of opinion becomes convinced that this is a sustainable outcome. This increasingly complacent mindset may be about to meet its toughest challenge: A likely turn in the liquidity cycle appears to be on a collision course with ever-widening global imbalances. This could well be a lethal combination that triggers the long-awaited capitulation of the American consumer -- heretofore the mainstay of a US-centric world. With the benefit of hindsight, the hows and whys of a benign outcome for the world economy in 2005 are crystal-clear. Basically, it was another year of “follow the leader,” as a US-centric world continued to draw sustenance from the seemingly unflappable American consumer. Sure, there were a number of other factors that came into play elsewhere around the world -- namely, the apparent healing of the Japanese economy, an improvement in Euroland late in the year, and the ongoing boom in China. But suffice it to say, were it not for another year of solid support from US consumer demand -- our latest estimates put real consumption growth at an impressive 3.5% in 2005 -- the rest of a largely externally dependent world would have been in big trouble. What did it take for the American consumer to deliver yet again? It certainly didn’t come from the traditional income-generating capacity of the US labor market. Private sector compensation outlays expanded only 2.5% in real terms over the 12 months ending November 2005 -- a full percentage point below trend and an especially disappointing outcome following the anemic pace of labor income generation in the first three years of this expansion. In fact, by our reckoning, in November 2005, private compensation remained nearly $390 billion below the composite trajectory of the past four US business cycles. With America’s internal income-generating capacity continuing to lag, US consumers once again tapped the home equity till to draw support from the Asset Economy. According to Federal Reserve estimates, equity extraction by US households topped $600 billion in 2005 -- more than enough to compensate for the shortfall of earned labor income. Comforted by this asset-based injection of purchasing power, consumers had little compunction in stretching traditional income-based constraints to the max. The personal saving rate fell deeper into negative territory that at any point since 1933, and outstanding household sector indebtedness -- as well as debt service burdens -- hit new record highs.

So much for what happened in 2005. The big question for the outlook -- and quite possibly the most important macro issue for world financial markets in 2006 -- is whether the American consumer can keep on delivering. My answer is an unequivocal “no.” Three factors lead to me to this conclusion, the first being the distinct likelihood that a shortfall in internal labor income generation persists. Specifically, I do not expect the US labor market to break the shackles of globalization and unwind the increasingly powerful global labor arbitrage that has played a key role in restraining employment and real wage growth over the past four years. Second, I believe that asset effects will be far less supportive to the American consumer in 2006 than has been the case in recent years. This reflects the likelihood of a distinct slowing in home equity extraction -- driven by the combination of moderating house price inflation and a sharp deceleration in home mortgage refinancing. Third, in an environment of subpar income generation, in conjunction with diminished wealth effects from the Asset Economy, the saving-short, overly indebted American consumer will instantly become more vulnerable to ever-present shocks. Look no further than 4Q05 for validation of the “vulnerability factor” -- a likely “zero” growth rate for real personal consumption expenditures in the immediate aftermath of a Katrina-related supply shock to the energy complex. Of those three factors, the asset effect is most likely to be the swing factor for the US consumption outlook. This is precisely where the liquidity cycle comes into play. In my view, the froth in asset markets -- first equities in the late 1990s and, more recently, property -- is a direct by-product of a powerful surge in global liquidity. In 2005, our global liquidity proxy -- the ratio of the narrow money supply to nominal GDP for the G-5 (US, Euroland, the UK, Japan, and Canada) plus China -- rose to a level that we estimate to be nearly 60% higher than that prevailing in 1995. That may now be about to change. Courtesy of central bank policy normalization -- led by America’s Federal Reserve -- in conjunction with an important shift in the mix of global saving, there is good reason to look for a much slower flow from the global liquidity spigot in 2006. A turn in the global liquidity cycle is likely to affect the American consumer through domestic and international channels. The domestic angle comes from a dramatic flattening -- and periodic inversion -- in the slope of the US yield curve. In my view, the slope of the curve matters a great deal in driving the equity-extraction effects of the Asset Economy. From the standpoint of financial intermediaries, a flatter curve alters the economics of the cut-rate lending programs that have been supporting such activities. A sharp recent deceleration of home mortgage refinancing activity -- down 45% from the mid-2005 peak -- is a perfect example of this development.

The international angle arises from a likely reduction in non-US saving, a natural outgrowth of increasingly successful efforts to stimulate domestic demand in the world’s major surplus saving economies -- Japan, Germany, and China. That would tend to absorb saving and, therefore, reduce the flows of private sector excess liquidity that have been recycled into dollar-denominated assets in recent years. That, in turn, would draw into question the overseas subsidy to domestic US interest rates, as well as the equity extraction fueled by such an abnormally low rate structure. Foreign central banks, of course, have the option to fill the void through official purchases of dollar-denominated assets. But, as recent public statements from monetary authorities in China and Korea suggest, the pendulum is swinging more toward increased diversification in the mix of foreign exchange reserve portfolios. All this points to a shift in the non-US liquidity cycle -- a development that could have important implications for America’s massive current-account financing needs. That would then heighten pressure on the dollar and US real interest rates, thereby putting America’s equity extraction cycle under even greater pressure. That does not bode well for the income-short US consumer. Experience tells us it is usually unwise to bet against the American consumer. While I think there are compelling reasons to go against the grain in 2006, I do so with great trepidation. Excess domestic liquidity is the high-octane fuel of the Asset Economy and the consumer-led growth dynamic it fosters. Excess global liquidity is also responsible for the funding of America’s massive current-account deficit. Yet as the liquidity cycle now turns, the rules of engagement in the Asset Economy are likely to meet their sternest challenge. That’s a big deal for the income-short US consumer, leaving households with little choice other than to cut back discretionary spending. From the start, that’s been the only real option for meaningful progress on the road to global rebalancing. The irony of complacency is about to strike again. The day of reckoning for an unbalanced world could be close at hand.



1 Comments:

  • Thousands apply for jobs at new Wal-Mart January 26, 2006

    BY LESLIE BALDACCI Staff Reporter

    Eighteen months after the Chicago City Council torpedoed a South Side Wal-Mart, 24,500 Chicagoans applied for 325 jobs at a Wal-Mart opening Friday in south suburban Evergreen Park, one block outside the city limits.

    The new Wal-Mart at 2500 W. 95th is one block west of Western Avenue, the city boundary.

    Of 25,000 job applicants, all but 500 listed Chicago addresses, said John Bisio, regional manager of public affairs for Wal-Mart.

    "In our typical hiring process, you're pretty successful if you have 3,000 applicants," he said. "They were really crowing about 11,000 in Oakland, Calif., last year. So to get 25,000-plus applications and counting, I think is astonishing."

    Assistant manager Rachael Fierro, who was still interviewing prospects Wednesday, said "we saw a little bit of everything -- people who hadn't worked for a long time, people who saw an opportunity to do something with themselves. That's the information I got from applicants."

    The 141,000-square-foot store has 36 departments, a "tire and lube express," vision center, Subway restaurant, pharmacy, garden center and drugstore. It will sell some groceries but no fresh produce or meats and no liquor. It is expected to generate $1 million in sales and property tax in the first year -- a windfall in a village that collects about $3 million a year in sales taxes, said Evergreen Park Mayor James J. Sexton. Evergreen Plaza, with 100 stores, generates about $2 million.

    Anticipating the usual protests over wages, benefits and anti-union practices, the Evergreen Park store was union-built. A protest over minority set-asides was defused in one day. Wal-Mart also came bearing gifts -- Tuesday night, the corporation donated $35,000 to the village library, local hospital, churches and other village institutions, Sexton said.

    'We can't beat them'



    The Chicago alderman who tried to bring a Wal-Mart to the Chatham neighborhood was left gnashing his teeth.

    "I always tell people I'm not for Wal-Mart, but I am for that project coming into the city and to my ward. We can't beat them," said Ald. Howard Brookins Jr. (21st). "The same things they talk about Wal-Mart doing to Small Town U.S.A when they build on the outskirts of town is the same thing they have done to the City of Chicago without fanfare. Nobody distinguishes that if I cross Western Avenue at 95th Street, I am no longer in Chicago. For all practical purposes, Wal-Mart is in the city of Chicago without us receiving any benefit. You're going to see the parking lot filled with cars with Chicago city stickers."

    Eighteen months ago, Brookins negotiated with Wal-Mart for a store at 83rd and Stewart, former site of the Ryerson steel plant. His plan fell apart when other South Side aldermen failed to support his request for a zoning change. The week before, aldermen gave the go-ahead for a Wal-Mart in the Austin neighborhood on the West Side. The vote came after a contentious 2-1/2-hour debate.

    Brookins said he planned to visit the new Wal-Mart himself this weekend "to see for myself" if the parking lot is filled with cars registered to Chicago residents.

    The Beverly neighborhood, long a hotbed for disputes over cul-de-sacs and one-way streets, now faces the prospect of increased traffic from Wal-Mart shoppers.

    No road improvements



    "Because of the single-family character of our community, we want to avoid cut-through traffic, whether it's our own residents or people coming from trains or highways," said Ald. Virginia A. Rugai (19th), whose ward borders Evergreen Park. "It is our No. 1 quality-of-life issue, traffic. I don't think anyone can predict what traffic will be like. We're not going to know until the opening."

    There have been no road improvements in anticipation of increased traffic on that stretch of 95th Street, which will have Wal-Mart directly across from Evergreen Plaza.

    "We will monitor the situation and see if additional lanes or turning lanes are appropriate," Sexton said.

    Rugai said a few small hardware stores expressed concern about competition from Wal-Mart, but other businesses in the area anticipate a bump from new customers driving to and from Wal-Mart, especially along 95th Street, which has gone upscale in recent years with a Borders bookstore and a Chipotle Grill. A complex planned for the southeast corner of 95th Street and Western Avenue includes Potbelly, Starbucks, Jamba Juice and a FedEx/Kinko's store.

    "I think most development projects [in Beverly] are not going to include goods or services that you're going to find at Wal-Mart," Rugai said.

    lbaldacci@suntimes.com

    By Blogger hope2endure, at 10:06 AM  

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