Tuesday, June 13, 2006

Stephen Roach's reading recommendation


As I looked over my notes on the flight home, one over-arching impression of the mood of the assembled investors jumped off the page -- denial. As always, we start these seminars with a round of introductions, asking each of the assembled investors to pose the most serious issue that was on his or her mind. The state of the global liquidity cycle was at the top of the list. Fully 40% of the assembled cast of investors identified this as one of their biggest concerns. This was hardly shocking. I have found over the years that the mood of these conferences -- whether we hold them in America, Europe, or Asia -- is heavily conditioned by the latest wiggle in the markets. With this meeting coming in a week of tough anti-inflation talk and/ or outright tightening by at least seven central banks, there was an understandable fear of a significant policy-induced withdrawal of excess liquidity from world financial markets. Ironically, this fear did not drive the investment conclusions that were presented at the end of the gathering. Two of the big themes most in favor were commodities and emerging markets -- the same risky assets that have the most to lose in a liquidity-withdrawal scenario. In effect, the powerful risk-reduction trade that has battered these very assets over the past several weeks was treated as a long-overdue, but painfully healthy correction. There was still deep conviction in the potential of powerful "super-cycles" spawned by globalization and concomitant mismatches between aggregate supply and demand.

I found the globalization debate to be the most stimulating aspect of this year’s conference -- in large part, because it shed considerable light on the denial that was to surface in the investment picks at the end of the conference. Of course, I’m letting my own biases come though here, having fixated over the past several years on the interplay between globalization, ever-mounting global imbalances, and world financial markets. We had the benefit of a great provocateur this year, historian Naill Ferguson of Harvard and Oxford, who has just completed his latest opus on contemporary global history, The War of the World: History’s Age of Hatred (Penguin, London, 2006 -- not available in the US until September 2006). Inasmuch as I only received my copy the night before the session, I will confess to only having read about half this 700-page tome. But I will also tell you it is as close to a page-turner in history as you will find -- I have a hard time putting it down. Ferguson treats the 1914 to 1953 era as a critical continuum in modern world history -- punctuated by two related World Wars but also involving brutal cross-border and internal conflicts in Asia, sub-Saharan Africa, and the Middle East. He dates the end of the world’s bloodiest era of conflict with the conclusion of the Korean War in 1953. But he leaves you with the gnawing sense of concern that this endpoint is still very much an open question.

Ferguson’s gift is not to describe -- although he does plenty of that -- but to analyze. In a provocative introduction to The War of the World, he suggests that this lethal period in contemporary history is an outgrowth of a combination of several powerful forces -- namely, ethnic conflict, extreme volatility in economic conditions, and declining empires. He tied it to our debate by noting two obvious bookends to this devastating conflict -- the globalization of 1880 to 1914 and the new era of globalization we are living through and investing in today. This led to the burning question of the hour: Do the apparent self-destructive tendencies of that earlier era of globalization offer important lessons as to what to expect this time around? For those fully invested in the great secular stories of this globalization -- China, India, commodities, and big-cap multinationals -- this is the question. The overlay with the debate on the global liquidity cycle makes it all the more relevant in the current financial market debate.

Ferguson offered four hypotheses as to why the first globalization met its demise: The failure of central banking; financial crises due to defective market structures; populist backlashes against globalization; and geopolitical crises. He leaves you with the uncomfortable feeling that he fears a similar outcome this time around. In his view, central banks are fighting the old war (i.e., inflation) and are in danger of being blindsided by a new war. He fears the current protectionist backlash against globalization -- not just Washington-led China bashing but also a gathering sense of European nationalism -- is strikingly reminiscent of that earlier period. And the Middle East is his prime candidate for a destabilizing geopolitical crisis. He had little to say on the financial risk issue, but he raised his eyebrows a bit when presented with arguments that the advent of derivatives makes the world a safer place by diffusing the distribution of risks. He asked if any of us had heard of an incident not all that long ago (1998) involving Long-Term Capital Management.

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