The Global Economic Forum over at Morgan Stanley has begun their writings again after a year end break and one of the most notable articles is the recent piece by Stephen Jen on the US dollar and the prospect for 2007. Actually the prospects for 2007 are not in themselves interesting but what we need to consider here is the fact that we are looking at a short term and long term perspective. In the short term perspective or what we could call cyclical factors the Dollar, Euro and Yen are very much driven by expectations on interest differentials between the three big central banks these days as a function economic data releases. The thing is here; economists can't really seem to agree on how the three big central banks are going to behave in 2007. However, in the long term we need to look at structural economic factors as well and this is the real focus of Jen's piece I think.
In Stephen Jen's optic the relative US slowdown which began in the third quarter of 2006 will continue into the first half of 2007 and as such the Dollar will continue to be under pressure due to cyclical pressures. Yet, in the second half of 2007 the dollar will 'reassert' itself as the US returns to trend growth which also leads Jen to argue that the US economy currently is taking the global economy into a 'mid cycle slowdown.'
Generally, Jen presents two important discourses in his article.
Firstly, I think he is just about right on the dollar. What I particularly like about Jen is his ability to distinguish between cyclical and structural factors here and why this is important. It is exactly this consideration which tells why we should not expect a sudden and abrupt crash in the dollar. This is of course then presents the question of which structural factors to look at and then i clearly becomes a lot more interesting.
Secondly, Jen outlines the reason for his prediction that the US slowdown will only lead to a 'mid'cycle global slowdown. Here, Jen pulls out the classic argument of the global K/L ratio (capital to labour ratio). The focus here is the massive rise in global labour supply as a function of the rise of particularly China and India on the global economic stage. This has lead to a positive feedback effect with the developed world which have been able to import deflation in terms cheaper of goods which in turn has allowed major central banks to keep interest rates relatively low without a notable transmission mechanism to core price indices.The flipside story of this is of course the notion of excess liquidity and/or a saving glut and what this mean in a global content and crucially what in fact the anatomy of the global economy today is?
In Jen's opinion we need not look at the demand side but at the supply side in order to understand the global economy and why future growth without significant inflation is likely ...
To me, global AS will continue to grow at a rapid pace so as to keep the world in a ‘Goldilocks-like’ state for several more years. There could be differences in the growth trajectories of various countries, but the overall outlook for the global economy is very positive: the world will continue to be propelled more by AS than AD, in my view.
The global economy has already registered five consecutive years of growth above 4.0%, making this the longest string of growth on record, despite continuous skepticism from many circles on the sustainability of the global/US economy. Based on the K/L framework, I believe that we will see several more years of strong global growth with low inflation.
I don't think Jen is totally off the mark here but it seems clear to me that the extent to which global economic growth is a supply side story is only valid to the extent that this supply is countered by demand. I mean is this not what the global imbalances and the saving glut is all about? Jen argues that the re-equilibrium of the the K/L ratio will require the world to engage in high capex (i.e. investment) until some kind of equilibrium can be obtained. This might be all well and good but we need to realize what this means and once again it is initially about supply and demand. Consequently, if the increase in supply is met by an increase in capex (i.e. investment/capital accumulation) it also means that a lot of this supply effectively need to be exported, especially if supply exceeds demand in the domestic markets (remember the imbalances here). Indeed, this means that if we have global/regional/domestic capital accumulation (capex/investment) as a reponse to a rise in supply it effectively translates into a specific global growth path driven by excess supply and this is clearly not possible since we can't all be exporters at the same time, right? This is also why this becomes a demand story and the lack of it relative to the dynamics between capital accumulation and excess supply. This is ultimately also why we need to look at the global macroeconomic imbalances as a symptom of a wide structural global phenomenon in my opinion.
As such, I am inclined to believe Jen's analysis but the gizillion dollar question remains ... why will the global economy and most important certain developed economies transist towards such a distinct growth path driven by very high capex and thus exports? In short, what is the structural driver here?
Incidentally, I need not to venture beyond Morgan Stanley's own GEF department to find a country specific evidence of this. Consequently, Robert Feldman wrote the following on Japan at GEF some time ago (additional commentaries in the post linked just above):
The key reason for my optimism is simple: The combination of aging demographics and structural reform has created a new dynamic in Japan. This new dynamic will keep capex and productivity rising, and obviate the need for as much consumption growth as would have been necessary at an earlier stage of Japan’s economic history.
This is of course good for Japan and not necessarily an issue in itself but now Jen comes along an extrapolates this discourse to a global level and then it becomes very interesting indeed. Because, if Feldman is right on Japan and the effects of the ageing population and Jen is also right to point to the same economic dynamics on a global level we are really breaking down the whole edifice here are we not? I mean this would suggest that demographics in fact play a very significant role in the global macroeconomic imbalances discourse, of course not the only factor but still interesting eh?