Global Investor: Stephen Roach

The world is unprepared for a slump made in America. That's the distinct impression I gather from six weeks of globe-hopping that took me to Japan, South Africa, the Middle East, Singapore, Hong Kong, China and Australia.

Most I met believe that the world has now "decoupled" from the United States--with increasingly robust economies from Asia to Europe fully capable of standing on their own in the event of an American soft patch. Two key questions come to mind: What if the U.S. soft patch isn't all that soft after all? What if a supposedly robust world turns out to be more dependent on American than it is willing to admit?

The overseas view is that America is fine--that there's no need to sweat the current downshift. There is deep trust in the line of analysis favored by Fed chairman Ben Bernanke--that any slowing is nothing more than a housing-related pullback that shouldn't spill over to the rest of the $13 trillion U.S. economy.

Oh really? The recent data argue very much to the contrary. Both retail sales and manufacturing production declined in September and October. Moreover, with Wal-Mart sales showing their weakest November growth in 10 years and consumer confidence now sagging, the preholiday buying season hardly got off to a good start.

But the big shocker came on the business fixed investment front--the sector that was never supposed to falter. A sharp pullback in capital-goods orders and shipments in October now raises serious questions about the business spending outlook. Sagging sentiment among purchasing managers and softer employment growth in October and November are also worrisome. Nor does anyone know if housing starts have hit bottom. We do know, however, that the impacts of the drop that has occurred so far are only just beginning to show up in weaker building activity, construction employment and income generation.

The lesson here is that there are no firewalls in the U.S. economy. When a booming sector goes bust--dot-com six years ago, housing today--the ripples eventually spill over into other sectors. Only 15 percent of the surge in residential-construction employment over the past five years has been unwound so far. Undoubtedly, there is a good deal more to come. As housing-related jobs continue to disappear, wage income will come under pressure--putting the squeeze on consumers. Businesses will then become increasingly wary, further slowing capital spending.

America's soft patch already appears to have turned into a "growth recession"--when the rate of expansion slips below the 2 percent threshold. All it would take would be another shock for the U.S. economy to tip into outright recession.

If that comes to pass, a complacent world could be in for a rude awakening. Take China, for example--the world's fourth largest economy and an increasingly dominant manufacturing engine driving the global supply side. China's export share is about 35 percent of its GDP--the highest of any major economy. And its biggest market is the United States. Other developing countries in Asia are major suppliers to a China-centric supply chain driven by demand from the United States. A U.S. slowdown could, as a result, prove problematic for the Asian region as a whole.

Take also Japan, the world's second largest economy. It is also heavily reliant on exports, and the United States and China are its two largest external markets. In Canada, the eighth largest economy in the world, exports to the United States account for fully 27 percent of its GDP. And in Mexico, the second largest economy in Latin America and the 13th largest in the world, U.S. exports account for 24 percent of GDP.

Consequently, it is a myth that there won't be significant global ripple effects from a U.S. growth shortfall. It is equally incorrect to believe that economies in Asia and Europe are supported by free-spending consumers who could fill the void left by a U.S.-led export shortfall. Consumption in the developing countries of Asia now stands at less than 50 percent of the region's GDP--down dramatically from the 70 percent share in the early 1970s. At the same time, growth in private consumption is adding only about 1 percentage point to Pan-European GDP growth. If the U.S. growth engine slows, any attempts by the consumption-deficient economies of Asia and Europe to decouple might quickly find them running off the tracks.

Over the past four years, the global economy has enjoyed a boom the likes of which it hasn't seen since the early 1970s. Caught up in the froth of liquidity-driven financial markets, the view around the world is that more of the same lies ahead in 2007. A U.S. slump is about to challenge that widespread sense of complacency.