The Economy's Perfect Storm?

The risk of a hard landing is rising

To economist Stephen S. Roach of Morgan Stanley Dean Witter & Co. (MWD), the task of bringing the $9 trillion U.S. economy in for a soft landing is "akin to landing a space shuttle on an aircraft carrier at night in rough seas." Still, only a few months ago he was confident the Federal Reserve was up to the task.

Now he fears that the coincidence of negative developments will pull the U.S. and global economies into a recession, much as the 1991 collision of three separate weather fronts produced the worst storm in the North Atlantic in a century. "I think the risk of a hard landing next year has risen to 40%," he says.

Roach is especially haunted by the events of 1990. In the first half of that year, he notes, investors were confident that the U.S. and global economies were entering a soft landing in the wake of protracted tightening by the Fed and European central banks. In actuality, he says, U.S. growth had slowed to a pace that left the economy vulnerable to a recession-inducing shock--which materialized in August when Iraq invaded Kuwait and oil prices took off.

Roach sees an eerily similar explosive mixture of events taking shape today. These include political instability in the Mideast, a rising risk of U.S. involvement, surging oil prices, and developing slowdowns in Europe and the U.S. as the effects of past monetary restraint start to bite.

To those who contend that energy efficiency has lessened the threat of an oil shock, Roach notes that conservation efforts sparked by the quadrupling of oil prices in the early 1970s were largely completed by the late 1980s. "The global economy is as vulnerable to an oil shock today as it was in 1990," he says.

The Morgan Stanley economist also worries about possible reverberations from falling stock prices as overseas investors start pulling cash out of U.S. equities, and consumers who see their wealth gains evaporating start curtailing their spending. "With the baby boomers about to retire and so much of retirement saving now tied up in stocks," he notes, "the effects of a bear market on consumption could be quite severe."

The past decade, observes Roach, enjoyed a virtuous circle as technology-fueled productivity gains, a surging stock market, wealth-inspired consumption, a strong dollar, subdued inflation, and inflows of foreign capital all tended to reinforce each other. Now, as growth slows, some of these forces are waning or going into reverse. And with storm clouds forming overseas, that implies that the economy is sailing into increasingly treacherous waters.

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