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Generational Dynamics Web Log for 09-Jan-05
Morgan Stanley's chief economist Stephen Roach predicts a "sharp adjustment" ahead

Web Log - January, 2005

Morgan Stanley's chief economist Stephen Roach predicts a "sharp adjustment" ahead

In an article that's sharply critical of Fed Chairman Alan Greenspan, Roach blames Greenspan for today's historically astronomical levels of public debt and foreign deficit, and concludes: "Asia and Europe are increasingly dependent on overly indebted U.S. consumers, while those consumers are increasingly dependent on Asia's interest-rate subsidy. The longer these imbalances persist, the greater the likelihood of a sharp adjustment. A safer world? Not on your life."

The article will appear soon in Foreign Policy Magazine, according to an item in Forbes Magazine online entitled, "World On Brink Of Ruin."

Roach blames Greenspan for today's historically astronomical levels of public debt and foreign deficit, and concludes: "Asia and Europe are increasingly dependent on overly indebted U.S. consumers, while those consumers are increasingly dependent on Asia's interest-rate subsidy. The longer these imbalances persist, the greater the likelihood of a sharp adjustment. A safer world? Not on your life."

As I've previously written here, I've been highly critical of Greenspan myself, especially his disastrous conclusion in 1996 that the stock market bubble was being caused by productivity improvements in the computer industry.

And I've been highly critical of speeches and papers by Greenspan's colleague, Fed Governor Ben Bernanke, that claim that the Fed has stabilized the economy for the next ten years simply by publishing the FOMC minutes! No one can blame the Fed for having too little hubris.

But Roach's article raises the question: Once the "sharp adjustment" occurs, what will the general public think of Greenspan's legacy after that? Roach makes it pretty clear that Greenspan will be blamed for it.

But the fact is that an argument can easily be made that Greenspan and the Fed are not at fault.

The stock market bubble was caused by a massive generational change in the early 1990s, when the generation of risk-averse "depression babies" disappeared (retired or died) all at once, and were replaced as senior financial managers by risk-seeking Baby Boomers, who made one dumb investment after another. Greenspan's "irrational exuberance" remark didn't stop the bubble, and nothing else would have done so either.

Once the bubble burst in 2000, the Fed had no choice but to lower interest rates to near-zero, in order to prevent massive bankruptcies, unemployment and homelessness, and allow people to survive by incurring low-cost debts. Those debts created the foreign imbalance that Roach is rightly concerned about, but Greenspan can't be blamed for it.

Stephen Roach, whom journalists regularly tag with the "bearish" putdown, is one of the few high-profile analysts who is serving as an "early warning" system for the upcoming economic "sharp adjustment" tsunami. His negative treatment by the press shows that an early warning system wouldn't have done any good in Asia either.

I believe that a majority of investors today believe that "something" is coming, but they don't know when, and they believe that they'll be smarter than they were in 2000: This time they'll see the early warning signs, and they'll get out early before they're hurt.

Unfortunately, everyone is thinking that way, and "getting out early" is a zero-sum game.

So what form will the "sharp adjustment" take? My expectation is that the adjustment is likely to be a very rapid fall in stock prices, perhaps 50-75% in a single day, as international investors and foreign banks frantically race each other to pull out. It might be triggered by anything from a Palestinian war to a recession in China or Japan. This is based on a historical analysis of secular adjustments that come every 70 years or so (Tulipomania bubble (1637), South Sea Bubble (1721), French Monarchy bankruptcy (1789), Hamburg Crisis of 1857, and 1929 Wall Street crash).

Today, Greenspan, Bernanke, and the other Fed Governors are basking in the hubris of believing that they're responsible for the DJIA being close to 11,000 today, just as Icarus' hubris let him fly too close to the sun. But hubris exacts a big price. Icarus drowned when the crash came, and Greenspan's legacy is liable to drown as well. (09-Jan-05) Permanent Link
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Generational Dynamics Web Log for 09-Jan-05 Morgan Stanley's chief economist Stephen Roach predicts a "sharp adjustment" ahead

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Generational Dynamics Web Log for 09-Jan-05
Morgan Stanley's chief economist Stephen Roach predicts a "sharp adjustment" ahead