Thursday, May 04, 2006

Stephen Roach's Strange Conversion

Stephen Roach, who for the last few years have been the most bearish of all Wall Street economists have suddenly become bullish, which is a rather curious conversion. After all, he started warning about worrisome economic imbalances in America all the way back in 2001, when imbalances were much smaller than they are today. Then housing prices were far lower, the current account deficit was for example only about 4% of GDP compared to 7% of GDP today, the household savings rate was about 2% versus -0.5% today and household debt was less than 100% of disposable income versus 124% in the fourth quarter of 2005 (a number which likely grew further in the first quarter this year). The indicators that worried Roach then have all become much worse.

So, how does Roach explain his conversion? G7 and the IMF, he says, have admitted that there is a problem and is working to resolve it. But merely admitting that there is a problem won't solve it. Roach however added that something is done about this, by which he refers to the normalization of interest rates that have at long last begun. But while he is right that this is a good thing, it should be obvious that this is simply too little, too late to stop the imbalances from growing. Eventually, if interest rates continue to rise, this will stop the imbalances from growing further, but only at the cost of sending the U.S. economy into a recession.

As Peter Schiff points out in his commentary on the Euro Pacific Capital web site, this conversion is particularly strange, since we are now starting to see the beginning of the end of the bubble. As Schiff puts it:

"The most interesting aspect of his fox-hole conversion is his timing. Never before has his doomsday scenario been so close to unfolding or his bearishness so close to vindication. With the dollar resuming its fall, foreign central banks raising rates and seeking to diversify their reserves, housing supply overwhelming demand, and gold and other commodity prices soaring out of control, one would think Mr. Roach would finally be in the enviable position of saying "I told you so." Instead he has changed his tune, and now sings in near perfect harmony with Wall Street's "All Bulls Choir."

Why an intelligent man like Stephen Roach would do such a strange thing is truly puzzling, but it will only be himself that he will be hurting. Interestingly, Roach says that the last time he was bullish was in 1999. Which is to say, just before the tech stock bubble bursted.


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