[vinnomot] America's inflated asset bubble prices must fall

-----Original Message-----
From: Sino Economics
Sent: Jan 8, 2008 10:24 AM


America's inflated asset prices must fall
By Stephen Roach
Mon Jan 7, 1:05 PM ET
http://news.yahoo.com/s/ft/20080107/bs_ft/fto010720081324550910;_ylt=Aowq_52
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The US has been the main culprit behind the destabilising global imbalances
of recent years. America's massive current account deficit absorbs about 75
per cent of the world's surplus saving. Most believe that a weaker US dollar
is the best cure for these imbalances. Yet a broad measure of the US dollar
has dropped 23 per cent since February 2002 in real terms, with only minimal
impact on America's gaping external imbalance. Dollar bears argue that more
currency depreciation is needed. Protectionists insist that China - which
has the largest bilateral trade imbalance with the US - should bear a
disproportionate share of the next downleg in the US dollar.

There is good reason to doubt this view. America's current account deficit
is due more to bubbles in asset prices than to a misaligned dollar. A
resolution will require more of a correction in asset prices than a further
depreciation of the dollar. At the core of the problem is one of the most
insidious characteristics of an asset-dependent economy - a chronic
shortfall in domestic saving. With America's net national saving averaging a
mere 1.4 per cent of national income over the past five years, the US has
had to import surplus saving from abroad to keep growing. That means it must
run massive current account and trade deficits to attract the foreign
capital.

America's aversion toward saving did not appear out of thin air. Waves of
asset appreciation - first equities and, more recently, residential
property - convinced citizens that a new era was at hand. Reinforced by a
monstrous bubble of cheap credit, there was little perceived need to save
the old-fashioned way - out of income. Assets became the preferred vehicle
of choice.

With one bubble begetting another, America's imbalances rose to epic
proportions. Despite generally subpar income generation, private consumption
soared to a record 72 per cent of real gross domestic product in 2007.
Household debt hit a record 133 per cent of disposable personal income. And
income-based measures of personal saving moved back into negative territory
in late 2007.

None of these trends is sustainable. It is only a question of when they give
way and what it takes to spark a long overdue rebalancing. A sharp decline
in asset prices is necessary to rebalance the US economy. It is the only
realistic hope to shift the mix of saving away from asset appreciation back
to that supported by income generation. That could entail as much as a 20-30
per cent decline in overall US housing prices and a related deflating of the
bubble of cheap and easy credit.

Those trends now appear to be under way. Reflecting an outsize imbalance
between supply and demand for new homes, residential property prices fell 6
per cent in the year ending October 2007 for 20 major metropolitan areas in
the US, according to the S&P Case-Shiller Index. Most likely, this foretells
a broader downturn in nationwide home prices in 2008 that could continue
into 2009. Meanwhile, courtesy of the subprime crisis, the credit bubble has
popped - ending the cut-rate funding that fuelled the housing bubble.

As home prices move into a protracted period of decline, consumers will
finally recognise the perils of bubble-distorted saving strategies.
Financially battered households will respond by rebuilding income-based
saving balances. That means the consumption share of gross domestic product
will fall and the US economy will most likely tumble into recession.

America's shift back to income-supported saving will be a pivotal
development for the rest of the world. As consumption slows and household
saving rises in the US, the need to import surplus saving from abroad will
diminish. Demand for foreign capital will recede - leading to a reduction of
both the US current-account and trade deficits. The global economy will
emerge bruised, but much better balanced.

Washington policymakers and politicians need to stand back and let this
adjustment play out. Yet the US body politic is panicking in response -
underwriting massive liquidity injections that produce another asset bubble
and proposing fiscal pump-priming that would depress domestic saving even
further. Such actions can only compound the problems that got America into
this mess in the first place.

China-bashers in the US Congress also need to stand down. America does not
have a China problem - it has a multilateral trade deficit with over 40
countries. The China bilateral imbalance may be the biggest contributor to
the overall US trade imbalance but, in large part, this is a result of
supply-chain decisions by US multinationals.

By focusing incorrectly on the dollar and putting pressure on the Chinese
currency, Congress would only shift China's portion of the US trade deficit
elsewhere - most likely to a higher-cost producer. That would be the same as
a tax hike on American workers. If the US returns to income-based saving in
the aftermath of the bursting of housing and credit bubbles, its
multilateral trade deficit will narrow and the Chinese bilateral imbalance
will shrink.

It is going to be a very painful process to break the addiction to asset-led
behaviour. No one wants recessions, asset deflation and rising unemployment.
But this has always been the potential endgame of a bubble-prone US economy.
The longer America puts off this reckoning, the steeper the ultimate price
of adjustment. Tough as it is, the only sensible way out is to let markets
lead the way. That is what the long overdue bursting of America's asset and
credit bubbles is all about.

The writer is chairman of Morgan Stanley Asia

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