The World Drops Its Guard (Steven S. Roach)

  After four fat years, convictions are deep that nothing can derail a Teflon-like global economy.  That’s the time to worry the most.

  Stephen S. Roach -- Morgan Stanley Global Economic Forum

  Feb. 26, 2007 -- NEW YORK -- A new level of complacency has set in.  It’s not just a financial-market thing -- extremely tight spreads on risky assets and sharply reduced volatility in major equity and bond markets.  It’s also an outgrowth of the increasingly cavalier attitude of policy makers.  That’s true not only of central banks but also -- and this is a major concern of mine -- by the global authorities charged with managing the world financial architecture.  Meanwhile, by flirting with the perils of protectionism, politicians are ignoring some of the most painfully important lessons from history.  After four fat years, convictions are deep that nothing can derail a Teflon-like global economy.  That’s the time to worry the most.

  I am especially concerned about a new lax attitude that has crept into the mindset of the so-called stewards of globalization -- namely, the IMF and the broad collection of G-7 finance ministers.  Last spring, in an uncharacteristically bullish lapse, I became more optimistic on the global economy than I had been in a long time (see my 1 May 2006 essay, “World on the Mend”).  I was especially encouraged that the Wise Men had finally woken up to the perils of ever-mounting global imbalances -- namely, the widening disparity between America’s gaping current account deficit and large and growing surpluses in China, Japan, Germany, and the major oil producers.  With great fanfare at the April 2006 G-7 and IMF meetings, institutional support was thrown behind a new framework of multilateral surveillance and consultation -- in my view, materially raising the odds of an orderly, or benign, rebalancing of an unbalanced world. 

  Unfortunately, the multilateral approach is now rapidly losing momentum.  The first joint consultations between the US, Europe, Japan, China, and Saudi Arabia were held last summer, and there was a noticeable lack of “deliverables” following this effort.  IMF Managing Director Rodrigo de Rato’s mid-November 2006 report on the “work program” of the Fund’s executive board was a further disappointment, relegating the problems of global imbalances to just one paragraph of a 49-paragraph document.  And in the past few months, many of the individual participants at the various G-7 finance ministries and central banks have admitted privately to a lack of progress and conviction in the multilateral approach.  With the global economy and world financial markets turning in yet another good year, suddenly, the urgency to act is now seen as less critical by the stewards of globalization.  Complacency has claimed an important victim -- thereby undermining the major rationale for my bullish change of heart on the global prognosis.

  Meanwhile, central banks -- basking in the warm glow of success on the inflation-targeting front -- are pouring more and more fuel on the global risk binge.  America’s Federal Reserve seems to settling for a long winter’s nap -- likely to keep monetary policy on hold through at least the end of this year, according to our U.S. team.  While the Fed has expressed repeated concerns about last year’s minor upside breakout of inflation, it has also been quick to stress the coming deceleration on the price front.  We could well be in the midst of a period like that which prevailed in the early 1990s, when the US central bank left the federal funds rate unchanged at 3 percent for a 17-month stretch from September 1992 to February 1994.  Unfortunately, that experiment did not end well for the financial markets, as one of the Fed first “normalization campaigns” led to the worst year in modern bond market history.

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