“Is this any way to run a modern-day world economy?”

Amusing commentary by Stephan Roach, chairman, Morgan Stanley Asia. It appears that Mr. Roach is less than sanguine about the global economy.

In a recent piece titled "A Subprime Outlook for the Global Economy," Roach notes a number of factors impacting both US and Global consumers. Roach sees real trouble ahead as "asset-dependent U. S. consumers
struggle to negotiate a post-bubble adjustment that’s bound to stifle
their insatiable yen to consume."

As to question of decoupling — whether the rest of the world can grow while the US slows — he has grave reservartions.

Via Barron’s Alan Abelson:

[Roach] notes that the bursting of the dot-com bubble seven years ago caused a mild recession but, more importantly, a collapse in business capital spending both in the U.S. and abroad. The subprime-mortgage fiasco, he warns, is only the tip of a much larger iceberg.

The consumer, who has indulged in the greatest spending binge in modern history, now accounts for 72% of our GDP. Steve reckons that’s five times the share of capital spending seven years ago. Reason enough to suspect the impact of a sharp contraction in consumer spending could be considerably more pronounced than the damage wrought by the end of the capital- investment boom at the turn of the century.

Of the two forces that spark consumer demand, wealth and income, it’s no contest which has provided the impetus for the mighty surge in Jane and John Q.’s spending. Since the mid-1990s, Steve points out, income has taken a back seat: In the past 69 months, Steve reports, private-sector compensation has edged up a mere 17%, after inflation, which "falls nearly $480 billion short of the 28% average increase of the past four business cycle expansions."

More than taking up the slack, however, has been the appreciation in housing assets. But with this source of wealth dramatically running dry with the bursting of the housing bubble, he sees no way that "saving-short, overly-indebted American consumers" can continue to spend with wild abandon. And for an economy like ours, so lopsidedly dependent on such spending, "consumer capitulation spells high and rising recession risk.”

The next issue strikes directly to where we are in the present cycle:  At an Earnings peak, which is now subsiding:   

Even a moderate slump in growth could prove strictly bad news for "the earnings optimism still embedded in global equity markets," and obviously for the markets themselves. Recent action of our own juiced-up stock markets, we might interject, strongly hints that such optimism is beginning to wear a tad thin.

No mystery how we got into this bind. Following the end of the equity bubble, scared stiff of deflation, central bankers opened the monetary floodgates and liquidity poured into the global asset markets.

What’s to blame? Derivatives:

As Steve relates, "Aided and abetted by the explosion of new financial instruments — especially what is now over $440 trillion of derivatives — the world embraced a new culture of debt and leverage. Yield-hungry investors, fixated on the retirement imperatives of aging households, acted as if they had nothing to fear. Risk was not a concern in an era of open-ended monetary accommodation…"

Steve plainly has doubts whether Fed chief Ben Bernanke’s recent rate cuts can stem "the current rout in still-overvalued credit markets." He worries that the actions were strategically flawed in failing to address the "moral-hazard dilemma that continues to underpin asset-dependent economies."

And he asks, "Is this any way to run a modern-day world economy?" All those who think it is, please raise your hand, and then lie down and wait for the fever to pass.



Buddy Capitalism
Barron’s October 22, 2007   

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What's been said:

Discussions found on the web:
  1. Owner Earnings commented on Oct 21

    Steve at Morgan and Dave at Merrill. Two guys who know what they are talking about.

  2. jake commented on Oct 21

    rick santelli warned the cnbc viewers twice that friday was going to be a terrible day in the stock market.how come a bond guru knows more than all the stock gurus?

  3. Bob_in_MA commented on Oct 21

    I predict that things will definitely turn, worldwide, about the time of the Summer Olympics. Beijing is spending heavily on all sorts of infrastructure improvements and renewal projects, partly to put its best face to the world. China’s growth doesn’t need to stall, just slow down somewhat to knock the markets there back severely.

    A slowdown in infrastructure there, coupled with a slowdown in consumer exports to the U.S., for just about every other country in the world, will make all markets look very over-priced.

    I’m not precluding a big correction before than, particularly in the US and the UK. But by fall it will have occurred just about everywhere.

  4. Deborah commented on Oct 21

    The world has to face up to the fact that the *collateral* (commerical paper and real estate) has substantially dropped in value. No amount of liquidity or rate reduction is going to improve that. It’s like someone with a chronic ailment. You can take medication to mask the symptoms, giving yourself and the world the illusion that everything’s fine. OR you can go to the root of the problem which may require painful changes to be made but be healthier in the long run. Remember Japan waited forever to markdown bad bank loans.

  5. Winston Munn commented on Oct 21

    “especially what is now over $440 trillion of derivatives — the world embraced a new culture of debt and leverage.”

    Isn’t this, though, a zero-sum game? Is it now only a crisis because the wrong institutions hold the losing lottery tickets?

    Instead of orchestrating a bailout, wouldn’t these players be better served in the long run with a referral to Gambler’s Anonymous?

  6. me commented on Oct 21

    “I predict that things will definitely turn, worldwide, about the time of the Summer Olympics. Beijing is spending heavily on all sorts of infrastructure improvements and renewal projects, partly to put its best face to the world.”

    Good point that I subscribe to but here in Atlanta we didn’t crash until 5 years after the 1993 Olympics. We converted the dorms to college dorms, converted the pool to Ga Tech pool, converted the horse area to an outdoor amphitheater, converted the stadium to THE TED for the Braves, and converted Olympic Park to a more general use area park. A lot went on long after the party left town.

  7. edhopper commented on Oct 21

    Between Roach’s comments and Barry’s post about Margin Debt in the market I have a sick feeling in my stomach today.
    It may be time to put everything under the mattress and hug the pillow till it’s over.

  8. sn commented on Oct 21

    “friday was going to be a terrible day in the stock market.” Jake

    A terrible day is 20%, not 2%.

  9. Leisa commented on Oct 21

    I love Rick Santelli. He never drinks the kool-aid nor does he offer a cup to others.

  10. jan perlwitz commented on Oct 21

    “And he asks, ‘Is this any way to run a modern-day world economy?'”

    Is this the right question? Doesn’t it work the other way around anyway?

    Capitalist economy runs its participants. That is, everyone.

  11. dukeb commented on Oct 21

    Amen on the R Santelli comments! He is everything that d-bag Cramer and the other brainless blowhards could never be…intelligent and thoughtful. I love his fake smile, too. Seriously, it cracks me up. Santelli for president! (As for the others, how does CNBC find such annoying idiots? Dylan makes me insane with rage…he’s like some 6th grader on the wrong mix of meds.)

  12. Jimi commented on Oct 21

    Roach has been talking about this for at least half-a-decade – anyone trading on his “global disequilibrium” theory, however sound, did not make money listening to him over that time period. Further, invoking “$40 trillion” in derivatives sure sounds scary, but without some knowledge of their net cumulative net exposure, and the concentration of that exposure, it tells us nothing. Nothing. If I enter into a swap with you for $1 billion, and then immediately reverse that swap, with another party, who in-turn reverses their position with my original swap-party, leaving us all effectively exposed to where we were when we began, there will still appear several billion dollars of scary derivatives “exposure.”

    None of that detracts from the boatload of trouble we’re in – poster above who refers to the collateral has it right. Bad collateral is bad collateral. Full stop.

    Ultimately, to move beyond the crisis, that collateral must pass to stronger, better capitalized hands (like mine, for example) at a discount… or else, we may limp along for many years, as did Japan after its own asset bubble collapse.

    Finally, Rick Santelli is an honest, quality gem: he is the best that Econotainment offers in the morning.

    Erin Burnett, in contrast, is so clueless and in-over-her-head, it’s a reliable weekday morning trainwreck.

  13. JWC commented on Oct 21

    I really liked the CNBC redhead, Liz. Can’t believe that she would jump to Fox Business. I won’t watch anything Fox on general principals.

    I watch CNBC in the morning, for entertainment. Like Rick, getting used to Erin. But I consider it “entertainment”, not news. We moved and now have dish, so I also watch Barrons. Have to admit I like the graphics at CNBC better.. you can tell at a glance where the market is moving by their bar across the top.

  14. Philippe commented on Oct 21

    May be the comments of an economist ,Mr Roach have no relevance for a trader whom nurses a paper for a day or two, but should have had more impacts for policy makers driving a country towards bankruptcy?
    415 Trillion dollars of derivatives still represent around 800 Pct of the world GDP (JP Morgan accounts for only ten percent of this total) as it is now proved CEO of banks have a complete grasp of their derivatives exposure.
    Even though these derivatives are including interest rates, interest rates swaps, one may as well find a couple of ABX and their translation in “mark to believe” in Banks balance sheets.
    I find courageous and honest the comments of Mr Roach when knowing »no one is prophet in his own country »

  15. Dave commented on Oct 21

    While I don’t necessarily know what I’m going to do with all my cash; I do know placing the $$ under the mattress isn’t the solution.

    With all the ways they’re going to try and solve this mess, a common theme emerges: throwing $$ at the problem. That means the $USD will continue to weaken.

  16. s0mebody commented on Oct 21

    “With all the ways they’re going to try and solve this mess, a common theme emerges: throwing $$ at the problem. That means the $USD will continue to weaken.”

    Can they throw money at the problem faster than it disappears? It seems pretty clear the banks don’t have anywhere near the money they say they have, and we still have plenty of bankruptcies and foreclosures to look forward to.

  17. Estragon commented on Oct 21

    Jimi – “[circle swap] leaving us all effectively exposed to where we were when we began”

    Not entirely. If something were to impair the ability of one or more parties to the circle to pay up on the risk they’ve sold, the impairment could cascade. That’s true of debt as well, but debt counterparties have better visibility into others debt structures than derivatives counterparties have into others net risk exposures.

    You’re entirely right that just knowing gross notional value of derivatives doesn’t tell us much. That’s the problem though. Nobody really knows where the counterparty risks are or how to price them properly.

  18. 12th percentile commented on Oct 21

    my favorite quote today that basically says the public is smarter than the institutions if you believe what is being said in this post by Barry. And the public ain’t that smart.

    “The public might not be very bullish looking at what happened this week, but institutions are because there’s a feeling that you can’t miss the upside in trading.”

    You can’t miss the upside. Until you do.

  19. techy2468 commented on Oct 21

    i am unable to find about how much mortgage loans were written between in 2004,2005 & 2006.

    i am assuming around 6 trillion.

    imagine if 40% was given to credit risk people. that will be 2.4 trln.

    if 60% of these go into foreclosure, its going to cost atleast 30% on an average to the banks.

    add leveraging by the banks, and i feel that most banks will go bankrupt (or very huge loss) if they were to mark to market.

    but i wonder how long can they avoid spilling the beans, maybe as long as there is no bank run.

  20. Winston Munn commented on Oct 21

    There is a saying in Alcoholics Anonymous that “Time takes time”. How much time before other credit structures begin to show strain? How sustainable is revolving credit exposure, and then commercial real estate?

    The impression I get from this overall debt bubble is of a tsunami, with this summer’s correction possibly nothing more than prelude, like the tide receding prior to the oncoming havoc; many at that time rushed into the freshly exposed sand bottom to pick up treasures, unaware that a mountain of water was barreling their way.

    And if it is a tsunami, there will be wave after wave after wave, each more fierce.

  21. upchuck commented on Oct 21

    All I can say is that I’m glad I haven’t been a follower of ANY advice from Ableson, or Raoch over the years….

    Their track records are pathetic. Why do you constantly highlight that hack Ableson?

  22. D. commented on Oct 21

    “Isn’t this, though, a zero-sum game? Is it now only a crisis because the wrong institutions hold the losing lottery tickets?”

    It is a zero sum game but there are 2 big issues that are overlooked:

    1. Many used leverage to play that zero sum game

    2. If you netted out all the accounting gains and losses, you’d end up with a positive GAAP value because accounting is inefficent when it comes to derivatives.

  23. marianne commented on Oct 21

    Not all subprime loans are the same. I believe that subprime lending is a lot like Jessica Rabbit…not bad, just drawn that way on some occasions. There are companies, like Ocean Capital in Rhode Island, that make financing available for sole proprietor businesses that would not be able to secure financing in the traditional marketplace. We’ve all got to start somewhere and oftentimes a stated income loan is the only means to start one’s business.

  24. mack macdaniel commented on Oct 22

    (re: quote in article above) Implying that there are economies other than “asset-based” ones seems…contradictory.

  25. me commented on Oct 22

    “The Atlanta olympics was in 1996 not 1993.”

    Yep, I moved in 1993, got confused, old age setting in. Thanks.

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