The contrarians

The lads over at Morgan Stanley’s Global Economic Forum are in the mood to challenge conventional wisdom today.

First off at bat, Stephen Roach, head economist and high priest of gloom, makes the case for Europe. That's not an easy task, as the Old Continent's list of problems is long: labor rigidity/high unemployment, slow growth, existential angst and growing doubts about the integrationist project, to name a few.

Yet, Roach argues that there is growth, after all, and it’s picking up (albeit to an underwhelming 2% pace in 2006). Reforms are making labor markets more flexible and European corporations are restructuring, increasing productivity through investments in information technology. If the French reject the proposed Euro constitution, the fallout will be very limited (the risks of a deeper Euro rift will rise, but they’re still very low).

I find this argument compelling. Most European nations are in an unsustainable position. You cannot have a generous welfare state with a rapidly aging population and labor market rigidities that keep unemployment high and labor participation low. Something has to give and my bet is that, like it or not, Europeans will realize they have to work more. Combined with high and rising productivity, this will lead to a significant acceleration in growth.

The markets certainly seem to agree: MSCI’s Europe index is up 1.5% in local currency terms since the end of March, when it became clear that the “Non” camp was winning in the French referendum, and is up 5% so far this year. Sure, the euro has fallen from the highs reached at the end of 2004, but it’s still quite a bit above the average level seen last year.

Not to be outdone, Richard Berner brings calm and sense to the housing bubble debate. Like Alan Greenspan, he’s a longtime skeptic of the bubble theory who has recently changed his mind somewhat (to the group that sees ‘froth’ in the market). Berner mentions that prices are not rising as fast as mentioned if house quality and the composition of the market are taken into account and that other metrics, such as the number of houses sold for investment purposes, are biased. As a result, he expects prices to ‘rust’, with perhaps some regional pops. However, he warns that any adverse shocks will mainly affect lenders, not borrowers.

Finally, Andy Xie pours cold water on the notion that the world is on the brink of an outburst of China-related protectionism. As always, he flatly denies that a revaluation of the yuan is in China’s interest and expects its government to ignore U.S. and European pressure to let the exchange rate rise. But Xie also states that the threats to raise trade barriers against Chinese products are hollow: most of these don’t compete directly with U.S. products, U.S. firms capture most of the value chain associated with Chinese imports and, in the end, reducing these imports won’t really cut the huge U.S. trade deficit.

I hope all of them are right.