Morgan Stanley’s Stephen Roach on the Popping of the Housing Bubble and Its Effect on the US and Global Economies

Stephen Roach, Chief Economist at Morgan Stanley, had some noteworthy things to say about the bursting of the housing bubble and its effects on the US and global economies in his most recent two commentaries at Morgan Stanley’s Global Economic Forum.  On Friday (Aug 25) he wrote:

Five and a half years ago the equity bubble popped.  Within six months, the US economy went into mild recession, and the global economy was quick to follow.  Today, America’s housing bubble is finally bursting.  Is the die cast for another bubble induced downturn in the US and global economy?

All asset bubbles are alike….. A bubble is the outgrowth of powerful amplification mechanisms – both real and psychological – which create an unsustainable condition whereby ‘…. price increases beget further price increases’ [Robert Shiller, Irrational Exuberance, 2nd Edition, 2005].  The rise and fall of the US housing market fits the Shiller script to a tee. 

Please refer to his commentary for his argument why this is so.

The bursting of the housing bubble, he goes on to argue, will cause a slowing in US economic growth via a slowdown in residential construction and consumer spending:

The property based wealth effect became especially important in driving consumer demand in recent years….. According to the Federal Reserve estimates, mortgage equity withdrawal exceeded $700 billion (annualized) in the first half of 2006 – more than enough to provide an ‘extra’ stimulus to consumer demand…… In the frothy house price climate of the past five years, the propery based wealth effect probably boosted growth in total consumer demand by at least .5 percentage points per year.  In a stable to falling home price climate, that impetus could quickly fade to zero…….

In his follow up commentary today (Mon Aug 28) he continues:

It’s hard to imagine that a US centric global economy wouldn’t be at risk in the aftermath of a bursting of the US housing bubble.  Lacking in internal support from private consumption, the non US world remains heavily reliant on selling exports to wealth dependent American consumers.  As the United States now comes to grips with the aftershocks of another post bubble shakeout, so, too, must the rest of the world.

There’s no consumer in the world like the American consumer.  In 2005, US personal consumption expenditures totaled $8.7 trillion.  At market exchange rates, that was about 20% higher than consumption in Europ, a little more than three times that in Japan, nine times that in China, and fully 17 times consumption levels in India.

A slowdown in the spending of US consumers will be especially hard felt in the export led economies of Asia, which have been driving global growth in recent years:

Exports now account for more than 35% of Chinese GDP and the largest portion goes to the US…….. The rest of Asia is in a similar position.  According to Andy Xie, about 10% of the total GDP for Asia ex Japan is earmarked towards shipments to the US (Andy Xie, “Asia: The Decoupling Myth“, Morgan Stanely Global Economic Forum, August 23, 2006).  China’s ever expanding Asian supply chain means that component producers such as Korea, Taiwan,and even Japan are vulnerable to a consolidation of US consumption.  The same, of course, can also be said for non-Asian external sourcing of Chinese materials requirements – a pipeline that now stretches into South America (i.e. Brazil), Australia, Canada, and, more recently, Africa.  In short, if the American consumer sneezes, economies in both the developed and the developing world could easily catch a cold. 

The penultimate sentence deserves a bit of explanation.  Over the last decade China has increasingly become a manufacturing powerhourse.  Their demand for raw materials (for manufacturing) has been a primary driver of the commodities boom (oil, copper, nickel, zinc, steel, etc…..) of the last few years.  Commodity producing countries such as Brazil, Australia and Canada have experienced a boom as demand and prices for the commodities they produce has sky rocketed. 

The potential slowdown in US consumption, then, would have ripple effects throughout the entire global economy.  Asia’s export dependent economies would slow as demand for their goods from the US slows.  In turn, Chinese demand for raw materials from Brazil, Australia and Canada would slow, slowing down their commodity dependent economies.