Why the US economy's luck is running out
The US economy relies on the goodwill of its trading partners to keep it running, and yet protectionist sentiment continues to pour out of Washington. Morgan Stanley's Stephen Roach has recently returned from visits to China and Dubai - and what he found there will be very worrying for the US and its indebted consumers...
My travel schedule is planned months in advance. It was only by happenstance that I found myself in both Beijing and Dubai this past week two of the more recent flashpoints in a US-led pushback against globalization. What I found in both cities unsettled me disappointment and frustration over America's attitude toward two of its major providers of foreign capital. The United States has been having a good deal of trouble with its overseas image in recent years. The feedback from Beijing and Dubai is that this image is going rapidly from bad to worse something that a saving-short US economy can ill afford.
China is deeply troubled over the outright hostility from an increasingly xenophobic US Congress. The senior officials I spoke with this week in Beijing protested on two counts China's fragility and America's penchant for scapegoating.
On the first count, the Chinese don't believe that US politicians appreciate the potential risks that still lurk in this transitional economy. Instead, they are pressuring China as if it were operating from a position of much greater strength. China remains very much a tale of two economies a booming coastal region and a lagging interior. Most in Washington view China from the lenses of Beijing and Shanghai, and conclude that these two thriving metropolises personify the emergence of a powerful and mighty nation. What they don't realize is that only 100 km away from either city lurks a China that has changed very little in the past thousand years. Yes, 560 million Chinese now live in urban centers around the country, although probably less than half these city dwellers have seen meaningful improvement in their standard of living over the past 30 years. Meanwhile, the rural population of some 745 million Chinese still tries to get by on $1-2 per day.
At the same time, despite 25 years of 9.5% real GDP growth, serious vulnerabilities continue to plague the macro structure of the Chinese economy. The financial system has only just begun the long march toward liberalization and development. Growth continues to draw the bulk of its support from external demand (i.e., exports) and autonomous internal demand (fixed asset investment). Self-sustaining growth from the Chinese consumer is deficient, reflecting a pervasive sense of job and income insecurity that stems from ongoing reform-induced headcount reductions. Far from letting the invisible hand of market-based capitalism drive price-setting, the visible hand of administrative fiat still plays a major role in the determination of prices of goods and services in the real economy, as well as interest rates, the currency, and the prices of many other assets in the financial economy. All this speaks of a Chinese strain of market-based socialism that is still far too fragile to stand on its own.
China also feels that it is being victimized for America's structural problems. Premier Wen Jiabao was crystal clear on that point when he ended the recent China Development Forum by stating, "It is unfair to make China a scapegoat for structural problems facing the US economy." There's no dark secret what he was referring to China's important role as a provider of goods and financial capital to a saving-short US economy. As long as America has a serious saving problem and, of course, the US net national saving rate plunged into negative territory for the first time in history in late 2005 trade deficits are a given in order to attract the foreign capital to fill the void. If the Schumer-Graham bill closes down US trade with China through the imposition of steep tariffs, a saving-short US economy will simply have to divert a significant portion of its multilateral trade deficit elsewhere. Undoubtedly, that means a higher-cost producer would have to take China's place as a low-cost provider of capital to the US imposing the functional equivalent of a tax hike on the American consumer.
When I pointed this out to Senators Graham, Coburn, and Schumer in Beijing, Senator Schumer said, "I understand the structural point, but China still has to give." The editorialist in me says, if Washington or for that matter, beleaguered US manufacturers really wants China to give, then it needs to make that argument from a position of a macro strength and boost America's national saving rate. Until, or unless, that happens, US-led China bashing is nothing short of political hypocrisy. In the meantime, Washington could well be about to compound one of America's most serious structural problems at considerable expense both to the US and Chinese economies. These are the "lose-lose" outcomes of globalization that can only end in tears.
In Dubai, I was met by a similar sense of consternation. Fresh from the wounds of the rejected Dubai Ports World transaction, several major private equity investors in the UAE were blunt in expressing their sudden loss of appetite for US assets. As one seasoned investor in US companies and properties put it to me, "As practitioners, as investors, we have become very shy of the US we just turned down a recent deal for that very reason." Another added, "For us, foreign direct investment into the US has become far less palatable due to recent developments. The bulk of our dedicated offshore money is now going elsewhere." The comment that unnerved me the most took this exasperation to an even deeper level. One investor asked, "What can we do to push back, to send a signal?"
I certainly don't want to make too much out of an unscientific survey of a few private equity investors in Dubai. But up until recently, this was one of the Middle East's most pro-American investment communities. The individuals I met with this week are seasoned participants of many a cross-border transaction into the US. For them, the political shock wave from Washington has come from out of the blue, and they now see little reason to go back to the same well especially given the wide menu of less contentious alternatives available elsewhere in the world. In the broad scheme of things, Dubai is a small player in the world of international finance. But to the extent that the Dubai backlash is emblematic of similar distaste from other Middle East investors hardly idle conjecture, in my view the repercussion cannot be minimized. Net foreign direct investment into the United States hit $128 billion in 2005 an increase of $22 billion from the inflows of 2004. If that trend now starts to reverse course, America's already daunting current-account financing problem will only get worse.
From Beijing to Dubai, there is a growing undercurrent of economic anti-Americanism. The irony of it all is truly extraordinary: The US has the greatest external deficit in the history of the world, and is now sending increasingly negative signals to two of its most generous providers of foreign capital China and the Middle East. The United States has been extraordinarily lucky to finance its massive current account deficit on extremely attractive terms. If its lenders now start to push back, those terms could change quickly with adverse consequences for the dollar, real long-term US interest rates, and overly indebted American consumers. The slope is getting slipperier, and Washington could care less.
By Stephen Roach, global economist at Morgan Stanley, as first published on Morgan Stanley's Global Economic Forum