When the arch bear turns bull, is it time to start worrying?

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The Independent Online

The gloomy prognosis for the world economy by Stephen Roach, the chief economist at Morgan Stanley, has been an enduring element of the global macroeconomic debate since the start of the century.

For years Mr Roach has been the Cassandra of global economics, telling anyone who will listen that the imbalance between the US current account deficit and the vast foreign exchange reserves held by Asian central banks risks destabilising the entire financial system.

Two years ago he told fund managers at a leaked private briefing that America had no better than a 10 per cent chance of avoiding economic "armageddon".

Now the great bear has turned into a bull - sort of. In a research note published this week, Mr Roach said he believed the world was moving in the right direction. "It seems like an eternity since I was last optimistic on the world economy," Mr Roach said, referring to his upbeat reaction to the rebound following the Asian and Russian financial crises of the late 1990s.

He said his optimism had faded rapidly after the cure to the crises - a massive injection of cheap money - in turn led to a multiple asset bubbles and the rebuilding of the imbalances.

But he says now: "While an unbalanced world has yet to shake its hangover from global healing, I must confess that I am now feeling better about the prognosis for the world economy for the first time in ages."

The reason? "The world is finally taking its medicine - or at least considering the possibility of doing so. Central banks are carefully adjusting the liquidity [tap], taking advantage of the luxury of low inflation."

He said the "stewards of globalisation" - the International Monetary Fund and Group of Seven (G7) - were finally determined to tackle the "perils" of global imbalances. A year ago he wrote a research note excoriating the IMF and G7 for using the 2005 spring meetings to issue "vacuous" communiques and "bury their heads in the sand" over the imbalances.

At their meetings in Washington last month the G7 fully accepted the need to tackle the imbalances, while the IMF proposed a new surveillance mechanism to bring together key countries over issues such as deficits and surpluses.

"That finally puts the teeth into the global rebalancing campaign," he says.

"While it doesn't eliminate the possibility of a disruptive adjustment, it does mean that an unbalanced world is now taking its collective responsibility more seriously."

This year has seen several of the bears come out of hibernation. The IMF itself last month said the economy was enjoying a "purple patch" and warned the Federal Reserve might have to take "stronger than expected" monetary policy action.

Mr Roach, a former Federal Reserve economist - he served for three years under the renowned Paul Volcker - said the odds were "shifting away" from a disruptive adjustment and a sudden slump in the dollar.

To be fair, this week's note, entitled World on the Mend, was confirmation of a more benign view that the New York University doctoral graduate has taken in recent months.

There is an obvious parallel in the UK with the record of Tony Dye. In March 1999 he stood down as the head of fund management at UBS Philips and Drew. He left because his famously bearish stance on equity markets had led to underperformance by the funds under his control. Nine months later the UK market embarked on a grisly bear market that saw it lose half its value before it troughed out.

Only a cynic would suggest that Stephen Roach's about-turn after six years of bearishness is a major sell signal for the US economy.

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