The gloomsters have a balancing role to play
The gloomsters have a balancing role to play
By Philip Coggan
Published: May 6 2006 03:00 | Last updated: May 6 2006 03:00. Copyright by The Financial Times
"Joy shall be in heaven over one sinner that repenteth, more than over ninety and nine righteous persons." That may be the message of the parable of the prodigal son, but does it apply to financial markets?
News this week that Stephen Roach of Morgan Stanley has "repenteth" from some of his more gloomy views on the global economy will give some people pause. The time to sell is usually when the last bear gives up.
Roach's change of heart is, in part, a recognition of the powerful forces that have been at work in the global economy. On one side has been the growing importance of India and China as producers of goods and services. This factor has cut costs for global business, by allowing companies to outsource production and to keep the lid on wage pressures at home.
The other force has been the surge in consumer credit in the US and the UK, fuelled by financial liberalisation and low nominal interest rates. Those same low interest rates have also boosted asset prices, particularly in the housing market. That has allowed consumers to keep spending, even though their wage growth has been subdued.
The result, in recent years, has been the perfect combination; growth has been robust but not so strong as to create inflationary pressures. It has become known as the "Goldilocks economy" in which growth is not too hot, nor too cold but just right.
But this rosy picture should not disguise the severe imbalances in the global economy, notably the US current account deficit, running at around 7 per cent of GDP.
The fear of many bears has been that foreign creditors would eventually lose their willingness to finance this credit, leading to a dollar collapse, soaring bond yields and a global recession. Others fret that central banks, unwilling to risk a recession, will try to inflate the debt problem away.
Roach does not believe those problems have gone away. But he does think the authorities have now recognised them, and that the necessary adjustments can now take place slowly and steadily, rather than in a dramatic crash.
April's meeting of G7 finance ministers agreed that the dollar should be allowed to fall. Asian countries seem to have recognised the need to stimulate consumer demand, rather than rely on exports. These two steps should help in reducing the US current account deficit (or, if you prefer to think of it that way, the Asian savings surplus).
Best of all, in Roach's view, is that subdued inflationary pressures are allowing central banks to move interest rates to "normal" levels rather than push rates to heights that might threaten a recession.
It is an interesting time for Roach to change his mind, as there are some superficial signs that his earlier views are being proved right. The dollar, having strengthened in 2005, is coming under renewed pressure while bond yields have edged steadily higher, with the 10-year Treasury bond now yielding more than 5.1 per cent.
Indeed, some see recent events as making a crisis more, not less, imminent. The same week's batch of e-mails brought the thoughts of Tim Lee of Pi Economics. He too has focused on global imbalances, particularly the US current account deficit.
"The acceleration of gold and commodity prices is telling us that this situation is no longer tenable," Lee writes. "Inflation is spreading beyond assets, reducing the excess liquidity available to support financial asset prices, and this is running up against central banks that are removing monetary accommodation."
Lee goes on to argue that the dollar needs to fall substantially in real terms and that "it is hard to see this achieved in any sort of smooth fashion". Furthermore "a 30 per cent decline in the US stock market would be the absolute minimum necessary to make inroads into the imbalances".
The problem for all those who use macro-economic trends to predict market movements is one of timing. The US current account deficit has been perceived as a problem for much of this decade and commentators were shaking their heads about the danger of rising consumer debt in the late 1990s. Neither factor has, as yet, resulted in economic disaster or market turmoil.
Anyone who comments on financial markets is thus faced with a problem. They might turn out to be right in their predictions of doom, given a 10-year horizon. However, most investors are interested only in the next year or so.
Thus, the gloomsters can easily be regarded as "the boy who cried wolf". The pressures to change one's view will increase.
Furthermore, the odds favour the optimists. Share prices tend to go up over the long run while economies spend a lot more of their time in boom, than in recession. Nevertheless, the pessimists play a vital role.
Humans have a terrible tendency for "confirmation bias"; seeking out views that agree with their own. Given the optimism of most of those employed by the financial services sector (it helps sell shares, after all). the gloomsters provide necessary balance.
And they may just turn out to be right, even when they lose heart. The global economy is in good health at the moment and corporate profits are strong.
But the enthusiasm of investors for commodities, emerging markets and corporate bonds all indicates a willingness to take risks.
And it is just when investors have gone furthest out on a limb that the branch tends to be sawn off behind them.
philip.coggan@ft.com
By Philip Coggan
Published: May 6 2006 03:00 | Last updated: May 6 2006 03:00. Copyright by The Financial Times
"Joy shall be in heaven over one sinner that repenteth, more than over ninety and nine righteous persons." That may be the message of the parable of the prodigal son, but does it apply to financial markets?
News this week that Stephen Roach of Morgan Stanley has "repenteth" from some of his more gloomy views on the global economy will give some people pause. The time to sell is usually when the last bear gives up.
Roach's change of heart is, in part, a recognition of the powerful forces that have been at work in the global economy. On one side has been the growing importance of India and China as producers of goods and services. This factor has cut costs for global business, by allowing companies to outsource production and to keep the lid on wage pressures at home.
The other force has been the surge in consumer credit in the US and the UK, fuelled by financial liberalisation and low nominal interest rates. Those same low interest rates have also boosted asset prices, particularly in the housing market. That has allowed consumers to keep spending, even though their wage growth has been subdued.
The result, in recent years, has been the perfect combination; growth has been robust but not so strong as to create inflationary pressures. It has become known as the "Goldilocks economy" in which growth is not too hot, nor too cold but just right.
But this rosy picture should not disguise the severe imbalances in the global economy, notably the US current account deficit, running at around 7 per cent of GDP.
The fear of many bears has been that foreign creditors would eventually lose their willingness to finance this credit, leading to a dollar collapse, soaring bond yields and a global recession. Others fret that central banks, unwilling to risk a recession, will try to inflate the debt problem away.
Roach does not believe those problems have gone away. But he does think the authorities have now recognised them, and that the necessary adjustments can now take place slowly and steadily, rather than in a dramatic crash.
April's meeting of G7 finance ministers agreed that the dollar should be allowed to fall. Asian countries seem to have recognised the need to stimulate consumer demand, rather than rely on exports. These two steps should help in reducing the US current account deficit (or, if you prefer to think of it that way, the Asian savings surplus).
Best of all, in Roach's view, is that subdued inflationary pressures are allowing central banks to move interest rates to "normal" levels rather than push rates to heights that might threaten a recession.
It is an interesting time for Roach to change his mind, as there are some superficial signs that his earlier views are being proved right. The dollar, having strengthened in 2005, is coming under renewed pressure while bond yields have edged steadily higher, with the 10-year Treasury bond now yielding more than 5.1 per cent.
Indeed, some see recent events as making a crisis more, not less, imminent. The same week's batch of e-mails brought the thoughts of Tim Lee of Pi Economics. He too has focused on global imbalances, particularly the US current account deficit.
"The acceleration of gold and commodity prices is telling us that this situation is no longer tenable," Lee writes. "Inflation is spreading beyond assets, reducing the excess liquidity available to support financial asset prices, and this is running up against central banks that are removing monetary accommodation."
Lee goes on to argue that the dollar needs to fall substantially in real terms and that "it is hard to see this achieved in any sort of smooth fashion". Furthermore "a 30 per cent decline in the US stock market would be the absolute minimum necessary to make inroads into the imbalances".
The problem for all those who use macro-economic trends to predict market movements is one of timing. The US current account deficit has been perceived as a problem for much of this decade and commentators were shaking their heads about the danger of rising consumer debt in the late 1990s. Neither factor has, as yet, resulted in economic disaster or market turmoil.
Anyone who comments on financial markets is thus faced with a problem. They might turn out to be right in their predictions of doom, given a 10-year horizon. However, most investors are interested only in the next year or so.
Thus, the gloomsters can easily be regarded as "the boy who cried wolf". The pressures to change one's view will increase.
Furthermore, the odds favour the optimists. Share prices tend to go up over the long run while economies spend a lot more of their time in boom, than in recession. Nevertheless, the pessimists play a vital role.
Humans have a terrible tendency for "confirmation bias"; seeking out views that agree with their own. Given the optimism of most of those employed by the financial services sector (it helps sell shares, after all). the gloomsters provide necessary balance.
And they may just turn out to be right, even when they lose heart. The global economy is in good health at the moment and corporate profits are strong.
But the enthusiasm of investors for commodities, emerging markets and corporate bonds all indicates a willingness to take risks.
And it is just when investors have gone furthest out on a limb that the branch tends to be sawn off behind them.
philip.coggan@ft.com
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