Steve Roach's Economics Wisdom After the US Tragedy

[epistolaris at freemail.hu]

-----Original Message-----
From: michel.bauwens at belgacom.be [mailto:michel.bauwens at belgacom.be]
Sent: 2001. szeptember 13. 10:00


Here's an interesting thoughtpiece on the global effects of
September 11, from the very heart of  financial capital, Morgan Stanley's
Steve Roach,
 

Michel Bauwens, eBusiness Strategy Manager 
Belgacom, Internet Business Unit, Strategy & Business Dev. 




Picking Up the Pieces 

How can anyone make sense of tragedy?  I know I can't.  The events of
11September are truly unfathomable.  The sheer pain of human suffering
almost trivializes the business tasks we now face.  Yet healing comes only
by returning to what we know best.  So bear with me as I ponder the macro on
this morning after, attempting to discern some tentative conclusions that
bear on the economic underpinnings of financial markets.  I stress the word
"tentative" because I may be missing something or simply getting it wrong.
But in the spirit of the probing and searching that has always driven our
macro effort at Morgan Stanley, I think it's worth a try. 


Impact analysis of any shock -- even one as devastating as this -- is always
dependent on context.  A negative shock can turn a booming economy into a
soft one, whereas it can tip a stagnant economy into recession.  It's the
latter context we start with, of course -- our below-consensus prognosis for
the US and global economy.  Against that backdrop, I offer three broad
insights into how the tragedy of 11 September may effect the economic
underpinnings of world financial markets. 


First, a cyclical point: The terrorist attacks represent a severe negative
shock to US consumer confidence.  The vulnerability of the American consumer
has been the missing link in the downleg of this business cycle so far.
That's no longer the case.  As far as I am concerned, this shock seals the
fate of the American consumer.  The consumer was already beginning to labor
under the pressures of depleted saving, record debt burdens, negative wealth
effects, and rising unemployment.  The August surge in joblessness was a
particularly worrisome sign in this regard.  Moreover, the downside of
flexible compensation -- performance bonuses, profit sharing, and stock
options -- was also looming at yearend.  And now a devastating shock hits.
In my opinion, this shock, in conjunction with a very ominous set of
fundamentals, is a lethal combination for the American consumer.  Any
residue of consumer support to the US and global economy -- both for
discretionary spending as well as for  housing-related activities -- is
likely to be a clear victim of the staggering events of 11 September. 


Second, more of a secular point: My fear is that the world might turn inward
in response to this tragedy.  In my opinion, the lasting impacts of this
shock could well challenge many of the underpinnings of globalization --
rapidly expanding trade flows, surging global financial capital flows,
increasingly globalized supply chains, and the rapid expansion of
trans-national flows of multinational corporations.  I am worried that the
world, in general, and America, in particular, could well lose its appetite
for cross-border connectedness.  I hope I'm wrong on this point, because
such a road could be a most treacherous one for the world -- painfully
reminiscent of the events of the early 1930s. But openness requires
confidence in cross-border relationships.  And I worry that the private
sector's taste and appetite for global connectivity -- businesses and
individuals, alike -- may have been dealt a severe blow that could give rise
to a backlash against globalization. Globalization may have worked
brilliantly from an economic and financial point of view, but the social and
political consequences have not gone well at all.  The voices of the
anti-globalists, which have grown 
steadily louder over the past two years, now seem almost deafening. 


Third, is a ray of hope -- shocks always subside.  That offers a reason to
look beyond what could be an even deeper valley than we originally
envisioned.  The sigh of relief that inevitably must follow hints at the
possibility of both a sooner and a sharper upside to the U-shaped recovery
in the US and global economy.  The risk, however, is that such bounce will
be either muted or short-lived.  Consumers and businesses, alike, need the
wherewithal to step up and spend.  Income short, saving-short,
debt-burdened, and wealth-depleted American consumers will still be lacking
that wherewithal once the impacts of this shock subside.  The shaky
fundamentals of a post-bubble US economy have not suddenly vanished into
thin air.  I certainly can't rule out a more cyclical response as healing
occurs, but my best guess at this juncture is that any post-shock relief
will not be enough to transform an anemic recovery into a classic V-shaped
outcome. 


It's tempting to model the current set of circumstances after those that
prevailed a decade ago -- before, during, and after the Gulf War.  That
shock, of course, toppled an already weakening US economy into brief
recession.  However, I would resist the temptation to draw too much from
these apparent similarities.  For Americans, the Gulf War was an external
shock half way around the world.  The tragedy of 11 September is an internal
shock that shatters a sense of security at home.  The 
aftershocks of this latest event are likely to be far more serious and
lasting, in my view. 


What are the tentative conclusions that can be taken away from all this?
Insofar as the world is concerned, this tragedy deepens my conviction
regarding our synchronous global recession call for 2001. Our baseline
scenario currently calls for world GDP growth of just 2.1% in 2001.  In
light of the shock, I would lower my downside risk assessment to this
estimate from 2.0% to 1.5%. A world that moves to the lower end of this
range would put this global recession on a par with 
the deep worldwide downturns of 1975 and 1982.  As for 2002, I wouldn't rule
out a temporary rebound in the early months of the year, but I feel that any
such bounce would be limited and short-lived.  The persistence of negative
fundamentals in an engineless global economy continues to point to a
U-shaped world, in my view.  Our baseline scenario currently calls for 3.4%
world GDP growth in 2002, and I would maintain my view that the risks remain
skewed to the downside -- possibly to 3.0%, or even lower. 


Insofar as the US economy is concerned, I suspect that the negative shock to
consumer confidence could well be the transforming event of this business
cycle.  .  It changes the cyclical dynamic in the US economy from being
investment-led to consumer-led.  As such, it takes the fundamentals of an
already weakened US economy from bad to worse. We have been out on a limb
all year with our US recession call.  Before the shock of 11 September,
America had moved to the very brink of that 
outcome.  This tragedy could well be the tipping point to the recession of
2001. 


As for policy and the financial markets, I would hazard the following
guesses: The Federal Reserve seems likely to be more predisposed toward
monetary accommodation than would otherwise have been the case.  The US
central bank was attempting to signal that it was nearing the end of its
easing cycle.  I suspect it will no longer want to qualify that message.  In
a period of crisis, it takes its role as a liquidity provider most
seriously.  Fiscal policy should turn more expansionary, 
as spending is stepped up on defense and on internal security.  Layer that
on top of the lower revenue base of a weakened economy, and the budget
deficit could suddenly make a comeback in the eyes of the financial markets.



Initially, I would look for global investors to seek safety in
dollar-denominated assets.  That would put a bid on Treasuries across the
maturity spectrum, and also provide support to the dollar.  As the initial
shock subsides, however, the safe-haven allure of long-dated assets should
fade.  That, in conjunction with newfound budget deficit 
fears, could lead to relative under-performance of longer-term fixed income
instruments -- the stuff of a steepening yield curve. 


Let me end by underscoring the note I began on -- these are tentative
thoughts, at best.  Like the rest of you, I, too, am in a state of shock.  I
send this dispatch from a hotel room in Milan, where I have been ensconced
for the past 24 hours, trying to distill any sense of meaning out of all of
this.  A long-scheduled European roadshow had temporarily been put on hold.
My first inclination was to crawl into a shell, stare at CNN, say nothing,
and go nowhere.  But the human soul needs more.  We find solace in community
-- in collective engagement. We need to talk to our families, our friends,
our colleagues, and our clients.  And so it is in that spirit that we now
attempt to pick up the pieces and discern what lies ahead in the macro
realm. 


The world is a resilient place.  And America stands for a special resilience
and resolve that has shaped its destiny for 225 years.  I have no doubt that
the United States will weather this storm and come out the other side with
an even greater sense of renewal and determination.  That doesn't mean it
will be easy.  Yet as day follows 
night, healing follows pain.  And recovery will also follow recession. This
time is no different.  Sadly, it's just a lot more painful. 


Stephen Roach (from Milan) 


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