The party is over, says Roach

Roach attacks global inequality

By Dan Slater | 19 November 2007

Morgan Stanley’s Stephen Roach says disproportionate profit allocation could spell the end of globalisation.

As the chairman of Morgan Stanley Asia, Stephen Roach, wrapped up his early morning talk at the Asian Private Equity and Venture Forum in Hong Kong on Friday, he put up a dramatic diagram. The slide showed two lines, one angling sharply upwards, the other angling sharply downwards. The upward sloping line was the share of corporate profits as a share of the national income of the G7 countries. The downward sloping line was the share of employee compensation as a share of national income. According to the graphs, the former accounted for just under 60% and the latter around 10%. The significance of the graph is clear: the benefits of globalisation have accrued in a highly disproportionate manner to “the wealthy and the owners of capital”, as Roach put it.

"That is unsustainable," says Roach, “and provides a challenge to the future of globalisation.” On the topic of globalisation, Roach asserts that Asia has been a major beneficiary – most easily seen through the inexorable rise of exports as a proportion of GDP. But that growth model, based on open markets, could be threatened if social imbalances are not rectified.

“Politicians are not happy with those income figures. They want their voters to get more,” says Roach. Disgruntlement in the countries most affected by globalisation could lead not only to the traditional problem of trade protectionism, but also to financial protectionism. Financial protectionism is a new term referring to the US government not selling its treasury instruments to buyers it considers potentially unfriendly.

Other imbalances could also hurt globalisation. Roach makes the now well-known point that the US consumer binge of the past years was fuelled by rising asset prices being converted into cash by home and stock owners. Incomes have been relatively stagnant. “Consumption accounts for 72% of GDP, the highest levels seen any time in history.”

As the debt that was fuelling the asset bubble unwinds, people's incomes will inevitably be pinched, Roach concludes. “We are seeing the bursting of the world’s biggest bubble – US property," he says. The result is that “the US consumer is toast”, and will be unable to generate further economic momentum.

Roach says that current problems should have been foreseen, and that the dotcom crash of 2001 should have acted as the "canary in the coal mine". Despite only accounting for 6% of US equity market cap, the S&P500 had lost 49% two years later. Roach says that the downturn then was far more serious than anybody initially expected.

“There were similar arguments in August, with some commentators suggesting that since securitised mortgages only represent 14% of outstanding mortgages, there was little to worry about,” he says, predicting that the credit fall out would continue to worsen.

Consequently, Roach also sees a recession in the US next year as being "more likely than not”.

A crash now could be far worse than in the early-2000s, since business capital spent by the dotcoms accounted for 14% of GDP at the time. But the current personal consumption bubble is many times as large, since consumption represents 72% of GDP.

Nor will Asian consumption fill the gap left by the US consumer. “China accounts for around $1 trillion in personal consumption and $650 billion in India. The US accounts for $9.5 trillion of personal consumption.”

The impact on Asia of a US slowdown will be inevitable. “Asia is not an oasis from the US problems,” Roach says, given the steady rise of emerging Asia exports, from an average of 17% to 45% of GDP currently. Contrary to what many analysts say, Roach says consumption in emerging Asia has been trending down, while exports have been trending up. China has an export-to-GDP ratio of 37%, of which 21% goes to the US. Taiwan has a ratio of exports-to-GDP of 59%, of which 14.4% goes to the US. ASEAN has a corresponding figure of 72% of which 13.6% goes to the US. Japan registers a figure of exports-to-GDP of 22%, of which 13% goes to the US.

“Equity capital markets in Asia are frothy, because investors are assuming no impact on Asia. I suspect they are wrong,” he says.