US economy still in 'balance sheet recession,' economist Roach says

Here's the real problem with US economy: Roach

American consumers are still unwilling to really spend money and that's the main reason the economy has not recovered faster, influential economist Stephen Roach told CNBC on Wednesday.

"We've been in a balance sheet recession, and we're still in it. That's the bottom line," Roach said. "The big story in this recovery that's holding us back is the 1.5 percent consumption growth we've been on for seven years plus."

In a balance sheet recession, consumer spending is put on the backburner in favor of saving and paying down debt.

"Consumers were battered by a levered asset bubble, sounds like China, and they have yet to fully recover," Roach said on CNBC's "Squawk Box." If the unemployment rate really reflected the jobs situation, he said, "we'd have consumption growth tracking at 3 percent to 3.5 percent."

The government earlier this month said nonfarm payrolls increased a slightly weaker-than-expected 223,000 in June. The unemployment rate ticked lower to 5.3 percent. The July jobs report is out Aug. 7, about five weeks before the September meeting of the Federal Reserve's policymaking committee.

The Fed concludes its two-day July meeting Wednesday afternoon, with the release of its policy statement. No interest rate increase is expected this time, but investors will be looking for clues on whether the first rate hike in nine years might happen in September or December.

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How much longer can China rescue its markets?

Roach, former chairman of Morgan Stanley Asia, also offered his views on the recent meltdown in the Chinese stock market, which actually was able to finish a volatile session higher overnight, on hopes Beijing will indeed be able to stem the exodus with its intervention tools. The Shanghai composite rose about 3.5 percent—snapping a three-day losing streak, which had featured a near 8.5 percent drop on Monday.

"This is a classic unwinding of a levered asset bubble," Roach said, driven by relatively young and inexperienced retail investors "who boosted margin purchases of stocks by three-fold in the 12 months ending June 12."

The Shanghai composite had surged 147 percent in the 12 months, hitting seven-year highs in mid-June. Since then, the market has fallen nearly 26 percent based on Wednesday's close.

Read MoreWhy China, commodities won't sway Fed: Ex-Fed prez

Despite the freefall in Chinese stocks, Roach does not see a hard landing for the China's economy. "The way that markets impact the economy is through what economists call the wealth effect, which hits consumers. The irony of China is the consumer sector is de minimis," about half the GDP impact of the consumer sector in the U.S.

He also said the wealth effect created in the run-up of Chinese stocks before the crash happened so quickly that investors didn't have enough time to adjust their lifestyles by spending money.