Stephen Roach: Global Tensions are 'Venting'

Excerpt from Morgan Stanley economist Stephen Roach's June 26th essay:

I continue to believe that the global economy is now in better shape than financial markets. The stewards of globalization have finally woken up to the perils of ever-mounting global imbalances -- the major macro issue that has concerned me for nearly four years. But the policy requirements of rebalancing are not without risks --especially since they entail a withdrawal of excess liquidity. In my view, the risk aversion trade that began in early May should be seen as a venting of the tension between global rebalancing and a potential shift in the liquidity cycle. Financial markets may not have seen the end of this adjustment...

April was a critical turning point on the global rebalancing watch. After years of denial, the stewards of globalization -- namely, the G-7 finance ministers and the IMF -- finally sounded the alarm over the threat of mounting imbalances. The rebalancing fix that was endorsed has three key ingredients -- the adoption of a multilateral global architecture of surveillance and consultation, general agreement on dollar depreciation, and a global tightening of monetary policies. This latter piece of the rebalancing fix is key to the liquidity withdrawal that now appears to be under way in world financial markets. One by one, all of the world’s major central banks -- in the US, Europe, Japan, and China -- have moved to the tightening side of the monetary policy equation since late April...

I don’t think it’s a coincidence that the near parabolic increases in commodity prices in late March and April occurred just when an already vigorous Chinese economy surprised to the upside. Investors and speculators quickly became convinced that China would do little to arrest its “commodity-heavy” growth model that had drawn disproportionate support from fixed investment and exports for the past 27 years. This ignored altogether the possibility that China might tighten its policies to contain another wave of overheating and embark on a major structural transformation of its economy that would see growth shifting away from its commodity-intensive investment and export sectors to more of a commodity-efficient consumer-led outcome. And yet there is now good reason to believe that both such shifts are now under way.