the global view - morgan stanley

  1. 3,412 Posts.
    For many years, Stephen Roach of Morgan Stanley seemed bearish in his views of equity markets. And for all those years, I have disagreed with him, mainly due to the mining boom which I saw in early 2003 - (thankfully, for the sharp growth of my stock portfolio during the past 3 years). Every year that he called a slowdown in China, every year I disagreed with him. He seems to have changed his tune recently, albeit, mutedly.

    Global: China and the Worldview
    Stephen Roach (New York)

    There’s nothing like an 11-day spin around the world -- a brief touchdown in London, followed by lengthier stops in India and Australia -- to set the global prognosis in context. The world is struggling mightily with putting the theories of globalization into practice. There is broad recognition of ever-mounting imbalances of a US-centric world, but there is deep conviction that the global economy has a new savior -- China.

    The Chinese economy has a new image in the broader global community. After years of believing that the inevitable China crisis was just around the corner, the world has rushed to the other side of the ship. China’s booming economy is now widely expected to keep on booming for the foreseeable future -- an impression certainly validated by the latest batch of Chinese economic statistics on GDP, industrial output, and money and credit (see my 21 October dispatch, “Wrong on the China Slowdown”). There is even hope that the Chinese consumer is now positioned to fill any void left by the American consumer. Australians are especially enamored of China -- and with understandable reason: Australia has benefited dramatically from a Chinese-induced surge in its export prices. According to Gerard Minack, head of our new Aussie macro team, the rise in commodity prices has boosted Australia’s terms of trade enough to have added two percentage points to the country’s national income in the 12 months ending June 2005.

    India is also quite taken with China -- but for very different reasons. Basically, India wants to figure out how it can be the next China. Mindful of the huge gap that has opened up in the past 25 years in terms of infrastructure, foreign direct investment (FDI), saving, and the sheer scale of the Chinese production platform, there is a certain urgency in coping with the “left-behind” syndrome. In my recent conversations with senior Indian government officials, there was considerable focus on the FDI issue. With a 28% national saving rate that is only a little more than half that of China, India’s need for external capital can hardly be minimized. India’s new government seems especially focused on changing the closed FDI culture that has long hobbled the nation’s development. As I noted recently, broad-based movement now seems to be under way on the FDI front -- from telecom to retail (see Here Comes the Indian Consumer, 1 November 2005).

    The China fixation also plays a key role in shaping the ongoing debate in India between manufacturing and services. Given an “inclusive” India’s new priorities in coping with massive rural unemployment, the country’s focus is on labor-intensive manufacturing activities. That’s a tough calculus in today’s IT-enabled world, where manufacturing prowess has become increasingly capital intensive. That’s especially the case in India, which has a strong competitive edge in IT-enabled manufacturing. To be sure, there may be important labor-intensive exceptions for India, such as textiles, auto components, small office accessories, toys, shoes, and some household equipment and appliances. But the real question is whether the potential scale of activity in such small-scale industries is sufficient to make a meaningful dent in India’s high rural unemployment.

    But the conclusion that hit me hardest from this world spin was the belief that nothing could shake the China boom. Whether it is urbanization, industrialization, or infrastructure imperatives, the world seems increasingly convinced that very rapid Chinese growth in the 8-9% range is here to stay. Implicit in that conclusion is the belief that the Chinese economy has now developed a new immunity to the ups and downs of the global business cycle. That may be wishful thinking. As I pointed out to the groups I spoke with, China’s growth dynamic remains heavily skewed toward exports and export-led fixed asset investment. These two sectors now account for more than 85% of Chinese GDP and continue to grow at nearly a 30% y-o-y rate. By contrast, the Chinese consumption share of GDP seems set to fall further this year from the record low of 42% hit in 2004.

    This structure of the Chinese economy speaks of a stealth vulnerability that the worldview refuses to consider. China’s main source of end-market demand is not internal consumption but the American consumer. Fully 35-40% of Chinese exports currently go to the United States. The investment dynamic is also dependent on the need to expand export-producing capacity. Consequently, a lot obviously hangs on the staying power of US consumption. Therein lies the risk -- both for China and for an increasingly China-centric Asia-Pacific. Despite negative personal saving rates, record household sector debt burdens, and a lingering shortfall of labor income generation in the US, few in the world believe that a decade of nearly 4% real US consumption growth is at risk. Should that view turn out to be wrong, then Asia-Pacific would be in for a rude awakening. That would be true of Korea, Taiwan, Malaysia, Thailand, and Singapore -- all of which have become tightly intertwined in a China-centric supply chain. It would also be true of Japan, whose largest export market is now China. And it would have a major impact on Australia, where Chinese exports have become a major source of growth over the past several years.

    Needless to say, a few eyebrows were raised when I conveyed the latest estimates of our US team that growth in real consumer demand was on pace to slow to an anemic 1.2% annualized clip in the current quarter. I stressed that a saving-short, overly indebted, income-deficient US consumer was highly vulnerable to a shock. Sharply higher energy prices and/ or a bursting of the US property bubble would undoubtedly be much tougher to digest in that context. In my encounters overseas, most agreed that the American consumer is running flat out and is unlikely to deliver much added impetus to global economic growth. But there seemed to be little fear of a sharper adjustment to the downside. Nor was there much appreciation of what such a possibility could mean to China -- the new savior of an unbalanced global economy.

    There was one group I encountered on this trip that got it -- the Chinese. On the first day of this tour, I stopped off in London. One meeting was with a group of some 30 senior executives from leading Chinese businesses, who were immersed in the China Executive Learning Program (CELP) -- an intense 18-day curriculum run by Cambridge University. Mindful of the unbalanced structure of their own economy, they were quick to grasp the significance of a potential slowing of the American consumer. With support from internal Chinese consumption in an embryonic stage at best, the CELP participants did not rule out a slowdown in China’s overall GDP growth. The disconnect came on the rest of my trip -- with the belief that China was now an autonomous growth story, with little that could get in the way of persistently rapid 8-9% growth over the next several years.

    For sure, I don’t want to generalize on the basis of a week and half of global travel. But this year-end trek has just begun -- over the next six weeks, it’s two more trips to Asia with another dose of Europe and my first trip to the Middle East wedged in between. By then, if I can think straight from the jet lag, I will have a much more comprehensive sense of global sentiment. At that point, I’ll be very surprised if the world’s China fixation has faded. I’ll be even more surprised if I find concern over Chinese growth prospects. And I’ll be shocked if the worldview uncovers the link between the seemingly resilient Chinese producer and the increasingly vulnerable American consumer.

    There’s always the possibility that China could develop a self-sustaining internal consumption dynamic that would shield it from an externally-driven slowing in the US. Alternatively, other sources of global consumption -- such as Japan and Europe -- could fill the void. But in my view, these are all long-tailed developments, at best -- unlikely to temper the potentially imminent mismatch between the overextended US consumer and an externally-dependent Chinese producer. If such a mismatch comes to pass, global equities could quickly come under pressure and bond markets could be given another boost.

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