Long the engine of global consumption, the American consumer should retrench in a post-property-bubble climate. While this could take a cyclical toll on US and global economic growth, it could also provide meaningful relief for a massive US current account deficit the principal imbalance of an unbalanced world. And if consumers elsewhere in the world finally step up, there might be a powerful and lasting impetus to global rebalancing. Sweet dreams for now, but ultimately the only way out for a US-centric global economy. What would it take to turn those dreams into reality?
Could the US consumer boom continue?
The American consumer has slowed. Over the three quarters ending 2Q06, annualized growth in real personal consumption has averaged 2.7%. This is hardly a collapse. It does, however, represent a meaningful deceleration from the 3.7% average growth trend of the past decade the most prolonged and vigorous burst of consumption in the modern-day history of the US economy. For ten years, spending by increasingly asset-dependent US consumers has exceeded growth in real disposable personal income by 0.5 percentage point per year. I suspect the recent downshift of US consumption growth is only the beginning. As the wealth effect fades in a post-housing-bubble climate and as a meaningful downturn now unfolds in the residential construction sector, I look for the relationship between income and spending to reverse with consumption growth falling below the underlying pace of income generation for at least a couple of years.
For the rational consumer, this is just another way of saying that the sources of saving will shift away from asset appreciation back to labor income. From time to time, growth could well accelerate back above the subdued pace of the past three quarters; that appears to be occurring right now, as real consumption appears to be tracking a 3.5% annualized gain in the current quarter on the back of the sharp recent decline in energy prices. But with the headwinds imparted by negative wealth effects likely to be long lasting and a cumulative contraction in homebuilding activity likely to unfold over a couple of years, it will take steady and sharp further declines in oil prices to keep the US consumption boom going. That is not a bet I am prepared to make.
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What will this mean for America's trade deficit?
As the US consumer goes, so goes America's demand for imports. With goods imports at a record 14% of real GDP and personal consumption still accounting for a record 71% of real GDP, there can be little doubt as to the impetus of America's seemingly voracious demand for foreign produced goods. And with goods imports fully 77% larger than goods exports, the same excess consumption is obviously central to the gaping US trade and current account deficits.
Moreover, if saving shifts back from being asset- to income-based, the national saving rate will also rise. That, in turn, reduces America's need to import surplus saving in order to grow and to run massive current account and trade deficits in order to attract the foreign capital. For a rebalancing fanatic like myself, a consolidation by the asset-dependent American consumer as long as it is orderly and contained is just what the good doctor ordered.
Yet America can hardly fix global imbalances by itself. The ideal rebalancing scenario has to involve consumers elsewhere in the world. I am actually quite optimistic that day will come. I just don't think it will happen quickly. For most of the past decade, the American consumer has provided the only real source of consumption dynamism in the world. Europe and Japan have been trapped in structural malaise, and the rapidly growing developing countries have relied much more on export-led growth models than support from internal private consumption. That's especially the case in emerging Asia, where IMF estimates show consumption shares of GDP falling from around 70% in 1970 to less than 50% in 2005.
Could developing world consumption grow?
The global shortfall of non-US consumption hasn't occurred in a vacuum. In the developing world, I suspect that consumers are inclined toward what economists call "precautionary saving" holding back on spending and setting aside funds out of fear. That arises because developing nations are lacking in the "safety nets" that are so essential to instilling consumer cultures. China is an important case in point. While it has a 35% household saving rate, a Gallup tally indicates that the Chinese have become increasingly dissatisfied with their saving positions. With massive layoffs arising from state-owned enterprise reforms headcount reductions totaling at least 60 million since 1997 and without social security, pensions, unemployment insurance, and worker training programs, fear-based precautionary saving in China is certainly understandable.
The good news is that China's newly-enacted 11th Five-year Plan makes provisions for funding many of the institutions of a safety net. The bad news is that it will take time for the programs to take hold, and quite possibly even more time for households to trust the security a newly constructed safety net may offer.
When will developed world consumption spring back?
In the developed world, a different type of precautionary saving motive may be at work especially in the restructuring economies of Europe and Japan. Headcount reductions, which are central to corporate cost-cutting strategies, instill a deep sense of job and income insecurity inhibiting consumption in the process. That was very much the case in the US during the early 1980s and again in the early 1990s when restructuring imparted stiff headwinds to both income generation and personal consumption.
Yet when restructuring finally stabilizes and the bulk of the work force comes to the realization that they will be spared, workers breathe a collective sigh of relief and consumption then springs back to life. That also happened in the US around 1983 and again in 1994. Here, as well, the consumption response to the restructuring all-clear signal response takes time deep-seated insecurities over job loss and income pressures don't disappear into thin air. As I see it, restructuring constraints are still very much a factor in Europe continuing to put a damper on any revival in consumer demand. Japan, which is more advanced than Europe in the restructuring sweepstakes, has a somewhat greater structural chance for a sustained pickup in personal consumption.
The risks and rewards of rebalancing
All this points to an asynchronous global rebalancing over the next couple of years. The post-housing-bubble retrenchment of the US consumer is likely to be far more immediate than any pickup of consumers elsewhere in the world. That, in turn, suggests more relief on the import side of the US trade equation than on the export side. That would limit the magnitude of any US trade and current account improvement and constrain the scope of global rebalancing. But it would be an important cyclical down-payment in any case. The big risk is that the rest of the world draws a false sense of comfort from this temporary reduction in the US external deficit and fails to make progress on its own consumption challenge. If that's the case, once the ever-resilient US consumer rebounds from a post-housing-bubble consolidation, global imbalances will then start deteriorating all over again
By Stephen Roach, global economist at Morgan Stanley, as first published on Morgan Stanley's Global Economic Forum
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