When asked how he knew to sell all of his shares shortly before the 1929 Crash, Joe Kennedy is supposed to have replied that he knew that the time was ripe when his shoeshine boy began asking him for stock tips. One wonders whether this anecdote might not hold out useful lessons for today’s markets especially when Stephen Roach, Wall Street’s long-standing and lone Cassandra, finally throws in the towel and starts musing about seeing a plausible case for a benign global rebalancing. If there are no serious bears left out there, can global markets really continue their relentless upward march?

Resident Fellow Desmond Lachman

The reasons for and the timing of Mr. Roach’s bullish conversion are curious to say the least. It seems to have been triggered by a Group of Seven Communiqué following the IMF’s recent Washington Spring Meetings. In that communiqué, the G-7 finally came out of denial about the risks posed to the world economic recovery by today’s unprecedented global payment imbalances. Mindful of those risks, the G-7 instructed the IMF’s Managing Director to work on modalities for multilateral consultations with the relevant countries aimed at encouraging actions needed to reduce those imbalances.

To be sure, one must applaud the G-7 for having finally recognized the real risks to the global economy stemming from a possible disorderly unwinding of the massive US external current account deficit. However, are we really to believe that multilateral consultations at the IMF will indeed do the trick, especially when Mr. Rato, the IMF’s Managing Director, keeps insisting that he does not want the IMF to play the role of global umpire in arbitrating between countries on what need to be done to address today’s global imbalances?

And even if the IMF did want to play the role of global economic umpire, are we really to believe that the IMF’s exhortations will either induce the US to cut its government budget deficit or get the Chinese to meaningfully revalue its currency? If the IMF has not been effective in influencing industrial countries’ policies since the late 1970s, why should we now believe that it will get real teeth in telling large and powerful countries what to do? And without the main players being willing to take measures to unwind today’s global imbalances in an orderly way, no amount of IMF exhortation will amount to much.

Perhaps what makes Mr. Roach’s bullish conversion all the more surprising is that it is taking place a time that the risks to the global economy have seldom been greater. For these risks go well beyond those related to today’s global payment imbalances as has been recognized by the IMF in its most recent World Economic Report. These risks include the present tightness in the global energy market, the potential bursting of housing market bubbles in the Anglo Saxon countries, the rise of protectionist sentiment in the major industrialized countries, the risk of global terrorism, and the risk of an outbreak of avian flu.

Perhaps the most immediate of these risks is the very real possibility of a further spike in international oil prices. Phillip Verleger, an oil expert at the Institute for International Economics, correctly notes that the real problem in today’s global energy market is the virtual lack of spare capacity in both crude oil and refined product production. This sorry state of affairs is the result of the gross under-investment over the past decade by the international oil companies, which seriously underestimated the strength and durability of China and India’s economic growth resurgence.

The lack of spare capacity in the oil industry makes the world economy highly vulnerable to the slightest of disruptions in oil supply. And given the fact that oil is disproportionately produced in politically troubled countries like Iraq, Iran, Nigeria, Russia, and Venezuela, there is no shortage of candidates where one could get a supply disruption. Verleger’s best guess is that, barring a sharp global economic slowdown, oil prices could spike to US$100 a barrel before the end of the year.

The danger to the world economy of another oil price shock is that it would be occurring at the same time that the US housing market is cooling. Most forecasters are now expecting US house prices to flatten out in 2006 following a 15 percent rise in 2005. If that were to occur, the US economy would be losing a full percentage point of support to GDP growth at the very time that it would be being hit by yet another oil price shock.

For whatever reason, today’s ebullient markets seem to be ignoring the host of real risks to the global economic recovery which are staring them in the face. In so doing, they seem again to be validating Keynes’ quip that markets can stay irrational for longer than one can stay solvent. A seasoned Wall Street bear like Mr. Roach should know better that the risks confronting us today have a nasty habit of materializing with all too untoward consequences when one least expects them.

Desmond Lachman is a resident fellow at AEI.