We are very delighted to have Stephen Roach here. Many of you know that Steve has spoken here before. That was October 25th, 2002 I believe it was. And it was so well received and Steve was so happy that he gave me a gift a pack of bubble gum and the name of it its called Double Dip and that was basically the topic of his speech that day it was the Double Dip. The good thing Steve is nobody really remembers whether your prediction went true. But I suppose the fact that we invited you back, the fact that you are still around, the fact that you are now Chairman of Morgan Stanley in Asia, you must be doing something right. Great to have many of you here, especially those from Morgan Stanley, some of you know John Wadsworth, he was really the first guy in Hong Kong that started relationship with us. I was so proud to help introduce him to the Asian society what a decade and a half ago, and he eventually became a co-vice chair of the Asian Society with me. And he has been a great supporter of this organization for which I want to thank all of you from Morgan Stanley. Of course we also get something out of you guys, that is I get Steve to come and speak here and also when I asked when I heard that Steve will be going to India next month, right Steve in November, right away, I asked well almost the same day, I found all about it. I got a note from the Director of well Mumbai center, our India's center based in Mumbai wanted to invite Steve to speak. So I wrote Jack wrote, everybody else wrote and so Steve will be speaking at our Mumbai center pretty soon. Anyway for those of you who don't know Steve is writing an article, tomorrow it will appear in New York Times, it's called the "Save The Day". He is talking about the US dollar, whether it goes to hell further, or is it going to bounce back I don't know. But Steve all of us are waiting with the expectation to hear what you have to say. So ladies and gentlemen without further ado let's welcome Stephen Roach, Chairman of Morgan Stanley, Asia Pacific. Steve. Thank you very much Ronnie, it's truly a pleasure to be here. Well, those of you who know Ronnie you know he can be a rather persuasive individual, for those of you who don't know Ronnie; I am here to announce that he is a very persuasive individual. And we were chatting in his office a couple of weeks ago and Ronnie was usually as he is relaxed in these meetings, he was leaning over and he says, "So what about this Subprime problem?" And I said Ronnie, it's a lot more serious than your than you think. He said, "Well, how serious is it?" I said Ronnie have you ever heard of the Canary in a Coal mine? He says he says, I think so. Well tell me what it is. So for those of you who don't know and I was just told by some experts at my table that they are fully appraised on on where this comes from. It sort of dates back into the early part of the 19th Century, right around the time that I joined Morgan Stanley, when coal mining was very, very unsafe in United States and in the UK. And it wasn't so much the fact that the coal mines were collapsing. It's that in mining for the coal you would open up these various seams in the mine and there would be a quick release of lethal methane gas or carbon monoxide that would kill the miners very quickly. So I don't know who it was that made this discovery that figured out that that the Canary, the bird, that normally will sing incessantly, just beautiful songs, at the slightest whiff of methane gas or carbon monoxide, would die. So some brilliant miner decided that next time I am going to a mine I am taking a canary with me. And it spread, so they all these mines would be populated by canaries, but as soon as they would stop singing the miners would run for the exit and it saved an awful lot of lives. So the canary was the classic early warning sign of the disaster to come in the coal mines in the 19th century. And the question that I want to address to you today is whether or not the Subprime crisis qualifies as the canary in the coal mine for world financial markets, the global economy and yes, even those of you in Asia who courtesy of your surging stock markets believe nothing bad can ever happen again no matter what goes on anywhere else in the world. Right Ronnie already he signed up. Before I do that I just want to get just go back and cover a few logistics. I can see from looking out at the tables that many of you are sitting on this rather a large book that we presented you with today. And it's okay to sit on it, I mean they they were actually designed with that purpose on minds. It's a multifunctional volume. But you know I do I do have a new role in Morgan Stanley, a role that I am actually pretty excited about. For 25 years I was the firm's Chief Economist and about a dozen years ago I really got it I will admit, I got addicted to China. In the depth of the Asian crisis, China really told me a lot of things about the new Asia, the new Chinese economy; that I really had not been aware of and I have studied and traveled extensively in China for over 10 years. Hank Paulson, our Treasury Secretary, you all have heard of him and he works for he used to work for a company, I can't remember their name he likes the brag that he had been to China over 70 times. I think I have done that this year. But you know he is the Treasury Secretary and I am not. But it quickly became evident to me that something dramatic was happening in China with profound implications for you in Hong Kong, for the rest of the Asia, in fact for the the global economy. And it became my passion as an economist as a global economist over the years and about six months ago, I sat down with our Chairman, John Mack, who is also quite passionate about China and Asia. And we thought wouldn't it be exciting to be able to convert my passion into taking our opportunities that we see as a firm to a new and different level. I can assure you I have a new position with new responsibilities, but the DNA that has been programmed in to me as a macro economist has not changed and I will continue to observe, write and comment on developments in Asia and the broader global economy with the special emphasis on China. So I thought it was appropriate as I enter this new job, and put together just some of the essays that I had written over the last couple of years and that's what this new book, The Next Asia is all about because the one thing that I have learned about Asia is it is by far the most dynamic region in the world, and what you know about Asia today is not necessarily the key to what Asia will be tomorrow. So it's very important to be forward looking and understanding the challenges, the opportunities and yes, even the risks of the new Asia and that's pretty much what I have tried to address in this volume. So I hope you enjoy it. We have your you don't realize this, but when you signed up for this lunch we have taken all of your credit cards, so we have charged you all for this volume. And Ronnie has agreed for those of you who will not pay that to cover the balance on his personal account. That's just a joke, we are delighted to give that to you and welcome your thoughts and comments. Let me just say a few things about the subject in hand. I think we have you know, screens up here, but I think I am going to dispense with that and just sort of give you a summary of my remarks. For those of you who want more detailed graphs, analytics, to support my logic you know, please contact me, we will happy to send you a packet of material that goes into it, but just in the interest of making this relaxed and efficient presentation, let me just try to talk talk my way through this. Why would Subprime be the canary in the coal mine? That is the question. My general take on this development is don't look at Subprime in a narrow sense itself. Subprime personifies the excesses that had built up in financial markets really over the past seven years. It is the tip of a much bigger iceberg. It's emblematic of bubbles that built up in the US property market, the US mortgage finance market, the leverage finance market, which have profound implications for what I think is the most important element on the demand side of the global economy, the American consumer. It's very reminiscent this debate is very reminiscent of the same debate that we had literally seven years ago. Think back seven years ago, what was going on? It was the fall of 2000. Six months earlier, the NASDAQ bubble had burst, and there was a general view that prevailed in the fall of 2000, that this was not that big a deal. Not even for the US and certainly not for the global economy. After all if you look at the dot-com phenomena as it existed in late 99'- early 2000, the dot-com stocks were only six percent of the total market capitalization of the US equity market. So the logic from the optimist, and I will admit I was not an optimist at the time for a change was that 94 percent of market was fine and the stock market and the economies around the world would be able to withstand the bursting of the dot-com bubble. That was the logic and people bought it from Alan Greenspan, you remember him, on down. Well fast forward two years into I guess then September 2002 and guess what, the S&P 500 had fallen 49 percent from its peak and the US and global economy had gone through a mild, but nevertheless a meaningful recession. Here we sit today, Subprime 14 percent of total securitized mortgage debt outstanding, and the logic is don't worry about it, the other 86 percent of the mortgage market is fine, no spill over, risk has been distributed widely, economy is fine, the world is fine. That's certainly the logic out here in Hong Kong. And one other sort of data point to think about was the sector that transmitted the weakness to the US economy on the real side US economy seven years ago was the IT induced collapse in business capital spending; a sector that amounted at the time to only 14 percent of the US GDP. The sector at risk today in the United States is the American consumer a record of 72 percent of the US GDP, a consumption binge the likes of which no major country in the modern history of the world has ever seen. The sector that today is five times the size of the sector that transmitted the dot-com bubble into the real economy seven years ago. So if I am right and Subprime is the canary in the coal mine and it goes through the American consumer, you've got a much, much bigger problem on your hands than than you may think. Now, why would the consumer in my home country who is addicted to shopping ever want to stop shopping? Well, in a nutshell, here is a story. When you look at the consumer demand and dynamic in the Unites States there are two sets of forces that drive it. There is the income, largely generated by an increasingly rare commodity called work; and then there is wealth, generated by your investments in assets. The consumption bench we have in America is not income driven, I can assure you that. The labor income that has been generated over the now nearly five years five and half years of this economic expansion, the labor income has been woefully sub par when compared with any other business cycle expansion in our modern post-World War II era. Sub par job growth and of course the big issue, stagnant real wages for the guy in the middle the median American worker. So consumption binge has gone to record but not because of the income generating capacity of the US Labor market. It has been a wealth story. Extra-ordinary, unprecedented, property bubble in the United State and courtesy of freely available credit, a very easy option to extract the equity from your ever rising asset, your home, through home mortgage refinancing. And so the equity extraction from the property market has really accounted for the margin for the bulk of the consumption binge in the last five years. Okay, that's the way we explain what has happened. Going forward, just a couple of points to make, incomes forget it, the income dynamic is is clearly coming under greater pressure right now. We had a decline in employment in the month of August you know, I want to assure you there may be a rebound in September. But there are more declines out there; especially from the home building sector itself where jobs have only just begun to recede. And real wages are going nowhere in this climate. So the income generating outlook is is not good. The wealth story is worse because the property bubble has burst, house prices are now declining in most parts of the world in the US. And I would be so bold as to predict that for the nation as a whole, house prices will be down in 2008, and most likely in 2009 the first time in our modern history, we would have two back to back years in nation wide home prices in the US. So the asset value is under pressure. And finally, courtesy of Subprime the whole mortgage refinancing businesses changed overnight and consumers home owners are having a much, much more difficult and expensive time extracting wealth from their asset. So long story short, the days of open ended consumption in the United States are over done. And we are going to be moving into a slower period of consumption growth, which is actually essential for a saving short US economy is running a massive current account deficit that you all were helping to finance, which we know is not sustainable. So, for those who like myself who have been looking for the rebalancing of the US and global economy, the coming capitulation of the US consumer will be a very important piece in that that equation. What about the rest of the World? What about China? What about Hong Kong? What about Asia as a whole Japan? What about Europe? I wish I could say as many of the optimists say these days, that finally the World has decoupled, what happens in America doesn't matter. I find that a rather curious statement because many of the same people who extol the virtues of a decoupled Asia are great advocates of another construct called globalization. Globalization of course is premised on the growing integration of the world economy, in trade flows, capital flows, information flows what happens here happens there. How can you pound the table in favor of globalization and speak of a decoupled world? I am yet to really figure that one out. But as I look around developing Asia and again I have charts that show this in great detail, and I add up the export shares and add up the private consumption shares, I see that internal private consumption in developing Asia is now below 50 percent of pan developing Asia in GDP. It had been as high as 70 percent in the late 1970's now below 50; driven a large part by China where the private consumption share of Chinese GDP last year fell to a record low of 36 percent. Meanwhile the export share continues to be on the rise and for the region as a whole, this is developing Asia, it's between 35 and 40 percent of pan developing Asian GDP. And the number was as low as 20 percent in 1981. So there has been an ominous for those of you that are decoupling apostles an ominous tilt of the mix of developing Asia GDP, away from internal demand and toward more and more reliance on external demand and of course the biggest in market for China is the United States directly accounting for 22 percent of it's imports, indirectly more than that. And then the rest of the Asia bless you is very linked to China through an increasingly China centric supply chain. Now if the US consumer catches a cold, the biggest end market for developing Asia is going to send signals that will reverberate throughout the region. Different countries will be more or less of vulnerable depending up on the structure of their economy. For China, I don't think it's going to be that big a deal. I mean China has an 11 percent growth economy; they try to slow the economy in earnest since 2004, it hasn't worked at all. And so may be you get Chinese a slow down made in America. The growth rate goes from 11 to I don't know, eight percent eight and a half percent for a while. I mean everything else in America is made in China, it seems perfectly appropriate that a Chinese slow down is made in America. But you take a country like Japan that doesn't have the growth cushion that China has, and if there is a slow down in the US that reverberates China, that's that's a big challenge for the Japanese economy. It can take a one and a half to two percent economy pretty close to zero. Other economies; Korea, Taiwan, you know they have the better growth cushions than Japan; but are simply not the growth cushions of China. India were as Ronnie has said, that's next on my Asian Society Tour. I am convinced that you know if if there was an Asian Society in Baghdad, Ronnie would have me speaking there. He is an incredible salesman for this group. What was I talking about, oh yeah, India, certainly a much smaller external sector and probably within developing Asia, least exposed to the American consumer. But I I am pretty convinced here that if the world's biggest consumer a nine and half trillion dollar consumer slows down, that does spell tougher growth prospects going forward for Asia. That certainly seems to be the case today and that certainly is being discounted in your extraordinarily frothy equity markets. The I want to close with just a few comments on on two key risk factors that do keep me up at night. If if I haven't scared you enough, I mean I have got a couple more issues that I I want to just draw to your attention and and I do want to tell you that we I have some colleagues by the door who when I am done will be dispensing Prozac to help you deal with the message that you will receive from me from me today. And one is the dollar and the other is protectionism. These are both global developments and then they do pose a fairly significant risk to the markets and to the World Economy. As Ronnie noted in his introduction, in the in New York Times coming out shortly, actually available electronically right now, I do have a piece on the op-ed page talking about what I believe could be a perfect storm building for the US Dollar. The Dollar has been weak as you know since this Subprime issue came to a head it has been weakening rather ominously in the last few trading days and I think there could well be more to come for three reasons. One mounting recession risk and associated fed easing risk in response to that. Mr. Bernanke showed his hands very clearly last week when he really opted for the market friendly large monetary easing, right out the script of his predecessor Alan Greenspan. Point two is again a Subprime point courtesy of the Subprime and the contagion that has hit a lot of structured products that no one understands, the foreign appetite for structured products made in America is sharply diminished. It's funny you know. There has been a big political uproar in the United States over the product quality the issue with China and there have been some legitimate problems that have arisen in the past six months. You know in America we don't really make too many products any more, we are a service economy. But I would say a record on product quality has been tainted by the Subprime instruments we have been sending to all of you. So we have a little bit of product quality issue of our own. And the third issue is the final point I will talk about its trading protectionism and the odds of that are building the odds in Washington will pass anti China trade legislation are high and rising. So when you look at these forces you know, together recession and fed easing risk foreign aversion to buying structured products and protectionism, you can make a compelling case that there is a good deal of more to go on the down side of the dollar don't try to draw a comfort from metrics that tell you that dollar is fairly or unfairly valued. When markets move vigorously they often overshoot up both the upside and the the downside; and I think there is a good chance of a significant downside the downside overshoot for the US Dollar. The the final point to think about, and this so critical to you and I guess I should now say us in Asia, because I have been I very much feel a part of this community. Yes, the growing risk of trade protectionism. This does not come out of a vacuum. I do believe it it does reflect what could be monumental policy blunders made by opportunistic politicians. But it's deeply rooted in the following very observable and painful reality. And that is across the developed World, from Europe to United States, Canada, Japan all the major countries of the developed world, their labor shares are at record lows and the shares of their national income accruing to the owners of capital are record highs. So globalization like it or not, is being blamed for that. The problem of the United States is even more acute, because the labor share of the US National Income is in a record low after 12 years of spectacular productivity growth. And economics teaches us that as productivity growth accelerates, workers are normally rewarded commensurately and they have not been in the United States. We have had 12 years of stagnant real wages. And then the plot thickens when you juxtapose real wage stagnation against the record trade deficit, the biggest piece of which is against China. And so the politicians put two and two together and they get 12 and you know, I will no mistake you know, I mean it is tragic in Washington. We do not sent our brightest people to the Congress especially now. But they believe that the pain in the middle class of the American workforce is so acute that they must stand up and do something now and they have identified the enemy and the enemy is China. So this year 18 pieces of legislation have been introduced into the United States Congress that will impose some form of trade sanctions on China. And recently two of these bills passed by overwhelming bipartisan majorities from two of the key Senate committees, finance and banking, and the odds of one of these bills were a combination and the two becoming law, unfortunately are high and rising, because even if President Bush you remember him, even if he vetoes the legislation there are enough votes in the US Congress to override that. And this is a very disconcerting development for those of us who are believers and advocates of the globalization processes. It certainly does represent I think a legitimate threat to the trade liberalization that has been so critical in driving globalization. It's a political miscalculation in my view, based on some very real economic problems that have existed in I had personally testified in front of the US Congress three times in this year on this issue and I have made the simple point each time that America with no savings has a multilateral trade deficit problem. We have trade deficits, United States with over 40 of our major trading 40. And you cannot fix a multilateral problem by putting pressure on a bilateral exchange rate with one country. Unless we raise our saving, the Chinese piece, which you can alter by putting pressure on the Chinese will simply go somewhere else. And there is a lot more than that, but I can assure you the Congress is in no mood to listen and this train has left the station. So my message I have joked a little bit, it's a sobering message, because the world right now has enjoyed four and half years of extraordinary prosperity, rapid growth, Asia has been a major beneficiary of that. Asia has come a long way from the financial crisis of 10 years ago. But with the US consumer still in the driver's seat on the demand side of the global economy and that engine now in danger of sputtering, courtesy of the canary that's no longer chirping in the coal mine, I think that's an early warning sign that we need to take more seriously in the United States, China, here in Hong Kong and in the broader Asian economy. Thank you very much.
member. 
