Global Aftershocks of America’s Election

Global

November 17, 2006

By Stephen S. Roach from Hong Kong

The world is nervous about the implications of America’s stunning political upheaval. At least, that’s the impression I have gleaned from a quick post-election spin around the globe that has taken me from our own conference in the Bahamas to Doha, Singapore, and Hong Kong. In a series of meetings with investors, business executives, and senior government officials, I detected growing concerns over Washington’s post-election posture toward geopolitical risks and trade policy. If these fears come to pass, liquidity-driven world financial markets could be taken by great surprise.

At my first stop in Doha, I had the opportunity to address a group of about 75 institutional investors from the Middle East. Doha, now emblematic of the failures of global trade liberalization, is another one of the Gulf region’s most rapidly growing cities. By Dubai standards, this capital of Qatar is a laggard, but considering what little was there just three years ago, the hyper-growth of Doha is nothing short of astonishing. This phenomenon is emblematic of a major difference in the Middle East when this oil shock is compared with the three that preceded it. In the early 1970s, the late 1970s, and even the early 1990s, the region was lacking the infrastructure to absorb the windfalls of surging oil revenues. Today, the region not only has major urban development projects and other commitments to local infrastructure, but it also has broader and deeper internal capital markets. That fundamentally changes the character of the well-known “petro-dollar” recycling phenomenon -- the inclination of Middle East oil producers to reinvest surging oil revenues in dollar-based securities markets. Due to dollar-pegged currency regimes, recycling still occurs in official channels. But private portfolio investors now have a considerably larger number of domestic options to consider than was the case during oil shocks of the past.

Notwithstanding the region’s newfound prosperity, the Gulf States remain fiercely loyal to the Great Protector -- the United States. Against that background, we asked the assembled group of investors to assess the impact of the November 7 elections in the US on current and prospective developments in the Middle East. By a relatively thin margin -- 56% to 44% -- the crowd did not believe the election outcome would have a positive impact on the Iraq problem. Moreover, by an even wider margin, fully 62% of the group felt the US election outcome would have no meaningful impact in resolving the broader Middle East conflict -- including, but not limited to, the Israeli-Palestinian conflict, as well as the Iranian nuclear threat. The pundits have billed the election of November 7 as a referendum on Iraq, with the American public voicing a clear displeasure with Bush Administration policies. For what it’s worth, this group of major Middle East institutional investors does not believe the political upheaval in the US will lead to a breakthrough in the wrenching problems that continue to plague this region.

I also couldn’t resist asking the assembled Middle Eastern investors where they thought oil prices were headed over the next year. The largest chunk of the crowd -- fully 36% of them -- thought oil prices would fluctuate in the $50 to $59 range. The balance of the group thought the oil price outlook was skewed more to the upside than the downside: 28% were looking for oil prices to fluctuate in the $60s, 13% in the $70s, and 6% thought oil would move above $80 over the next 12 months. By contrast, only 17% of this group looked for oil prices to move below $50 per barrel over the next year. The most astonishing thing about this informal survey conducted in Doha is that these results were virtually identical to the readings we obtained from our US-domiciled clients who attended last week’s Lyford Cay investment conference. That’s right, those closest to the largest deposits of oil in the world, whose livelihood depends almost exclusively on the price of “black gold,” have nearly the same exact outlook as those who observe (and trade) oil from afar. Talk about an amazingly tight consensus -- or a strong hint of the dreaded curse of a tightly bunched group of investors!

At my two stops in Asia, I drilled the assembled crowds on the outlook for US trade policy. In my view, externally-dependent Asian economies have far more at stake than any other region in the world in the future of trade liberalization. With trade-related economic pressures playing an important factor in the recent mid-term elections in the US, I asked those in Singapore and Hong Kong if they felt a pro-Democrat tilt would lead to any improvements in an increasingly contentious trade climate. By a margin of about 3 to 1, both groups answered in the negative -- expressing fears of an increasingly ominous tilt toward trade protectionism by a pro-labor Democratically controlled US Congress over the next year. Needless to say, these fears were immediately borne out in the form of Congressional resistance to a US-Vietnam free trade zone proposal on the eve of President Bush’s departure to APEC meetings in Hanoi. Make no mistake -- Asia hears the drumbeat of protectionism loud and clear in this post-US election climate. Meanwhile, protectionist fears or not, ever-frothy Asian equity markets were surging to new multi-year highs as I toured the region. We had record crowds at our Asian Summit in Singapore, and Hong Kong has a new swagger that several seasoned investors told me they haven’t seen since 1997. Go figure that.

In my in-depth meetings with Asian investors, business executives, and senior government officials, there was a fairly tight consensus of opinion that the US economy would be just fine over the next year -- thereby providing more than an ample offset to the recent shift in political winds. In particular, there was a strong belief that nothing would derail the American consumer -- the mainstay of external demand that continues to support this trade-oriented region. Post-housing bubble adjustments were viewed as largely over -- and most assuredly containable by the all-powerful income-generating machine of the Great American labor market. I took the other side of the debate on virtually all of those points, but my views were met with polite indifference as the multi-taskers present at my meetings checked their Blackberries for messages and market quotes as I spoke.

In Asia, long the land of some of the greatest boom-bust cycles in world financial markets, I sensed a gnawing suspicion that this boom may not last either. For now, however, there were virtually no concerns of what might lie on the other side. Hotel rooms were fully booked, flights were packed, and the buzz in Asia is as giddy as I have seen it in years. Meanwhile, the political winds have shifted in the region’s main engine of economic support -- the United States. With pro-labor Democrats clearly on the ascendancy and trade tensions likely to intensify as a result -- especially on the US-China front -- I suspect a year from now the mood in Asia will be very different than it is today. Moreover, despite the sharp recent decline in oil prices, it’s no different in the great new hubs in the Gulf region of the Middle East -- especially Dubai and Doha. Euphoria over booming economic development masks any concerns evident elsewhere in this war-torn region. Here, as well, there was a gnawing sense of unease about the implications of shifting political winds in the United States. But for now, economic triumphalism reigns supreme.

History teaches us to be mindful of the potentially potent interplay between economic and politics. That was certainly the message that historian Niall Ferguson left us at Lyford Cay. Yes, the political winds are shifting in America. The Middle East gets it, and so does Asia. But in these liquidity-driven days of froth, the message rings on deaf ears in the markets -- at least, for now.

http://www.morganstanley.com/views/gef/archive/2006/20061117-Fri.html