Friday, May 14, 2004

Stephen Roach once again wrings his hands over the failure of the global economy to show any signs of re-balancing.
Based on revised IMF data, it now appears that the United States accounted for fully 98% of the cumulative growth in world GDP over the seven-year period, 1995 to 2002 (the prior data put that share at 96%). America�s growth contribution over that interval was more than three times its 30% share in the global economy. Conversely, this calculation also means that the remainder of the world economy � some 70% of global output � collectively accounted for only 2% of the cumulative increase in world GDP over the 1995 to 2002 time frame. This is a truly astonishing result. Never before has the modern-day world economy experienced such a protracted period of unbalanced growth.
Roach recognizes that the underlying causes of this profound imbalance are [1] faster than average GDP growth in the US; and [2] a rising USD throughout the period. As Roach tells it,
America�s 98% contribution to the cumulative increase in world GDP growth over the 1995 to 2002 period can be broken down as follows: About two-thirds of it appears to reflect growth disparities, and about one third is traceable to currency shifts.
While Roach glances at the gargantuan US current account deficit which grew exponentially during this period (and after; 2003:I-II and 2004:I show the CA deficit as a percentage of GDP at over 5%), he fails to link it firmly to the imbalancing. The failure is crucial because there is one underlying factor that is at the root of all three phenomena: the unprecedented influx of global capital to the United States.

In order to float ever-growing current account deficits, the US needed to run ever-growing capital account surpluses. Capital investment thus supported US bond markets as well as direct production, and to a lesser extent stocks, helping to both generate inordinate growth in the US while reduce the possibility of growth elsewhere. Remarkably, investors weren't bringing capital to the US to make big profits; although the net investment position of the US in 2003 was approximately -30% of GDP, net capital income flows into the US remain positive. Foreign investments are remarkably more profitable than US investments.

The US benefitted during the East Asian financial crisis (and the aftershocks in Russia and Brazil) as global capital's 'safe haven', and it is after the 1997-98 crisis that the imbalances really begin to balloon. Capital flows to the US, lowering interest rates in the US and raising them elsewhere, fueling greater growth in the US and less elsewhere, fueling a growing current account deficit and a rising dollar, fueling more capital influx, and the cycle continued.

In short, the system has a negative feedback loop. Imbalance feeds off imbalance until you get a -$542bn current account balance and a rising dollar all at once.

Happy balancing!


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