In this season of unbridled public rage directed at Wall Street, it is worth taking a moment to mark the exit of Stephen Roach from the gladiatorial world of high finance. Morgan Stanley’s former chairman for Asia and chief economist is retiring from the firm, leaving the red-in-tooth-and-claw profession of investment banking for the red-in-tooth-and-claw groves of academe, according to a memo release on Feb. 16 by Morgan Stanley CEO James Gorman. In a industry brimming with cable TV carnival barkers, Roach stands out for his wry humor and cool stock-taking of the big macro trends of the day.
Back in the aughts, Roach sounded the alarm more than once about the massive capital imbalances emerging between savings-rich Asia and spendthrift America that helped fuel an epic U.S. consumption binge and property bubble. In one research note posted in May of 2006, Roach described the co-dependency problem between U.S. consumers and Asian (particularly Chinese) producers. “The relationship is cemented by Asia’s quasi dollar pegs, which guarantee an automatic recycling of the region’s massive build-up of foreign exchange reserves into dollar-denominated assets. To the extent that this recycling pushes US interest rates lower than might otherwise be the case, asset-dependent US consumers enjoy a special subsidy from their foreign lenders,” Roach wrote.
This massive transfer of wealth, Roach continued, allowed the American consumer to “push consumption up to a record 71% of GDP over the past four years.” In late 2005, the Federal Reserve estimated that home equity loans had topped $640 billion, Roach wrote. And, he went on: “The US housing market has been pushed into bubble territory; in late 2005, fully 55 metropolitan areas were experiencing house price inflation of 20% or higher. With the housing market now rolling over, downside risk to equity extraction and wealth-dependent consumption can hardly be minimized.”
Translation: We’re screwed, folks.
That was an insight worth knowing back in 2006-two years before the full force of the subprime mortgage crisis and the collapse of Lehman Brothers had their way with jobs and incomes around the globe. Roach, of course, wasn’t the only one to see the eventual shape-shifting economic crisis of 2008-2009 that toppled money center banks in London and New York and touched off a severe global downturn that we are still living with today. Other variables-Fed monetary policy, Wall Street and Main Street greed, lax regulatory financial oversight and so on-certainly mattered as much as the bizarre vendor finance relationship between the U.S. and Asia. Yet Roach was one of the very few who saw the outlines of the firestorm so early.
What will be interesting to watch is whether another Roachian thesis plays out. Six year ago, he predicted that China’s massive recycling of dollars into yuan on that country’s money supply and real estate markets would create big problems. “There are several reasons why this state of affairs in not in China’s best interest: First, lacking a well-developed debt market, China has a hard time sterilizing its purchases of dollar-based assets. As a result, excess liquidity leaks into its financial system — contributing to its bloated money supply and fueling froth in its asset markets, especially coastal property,” Roach suggested. Let’s hope the Professor gets this one wrong. A Chinese economic collapse is the last thing planet earth needs at the moment.