The naive view of America’s prospects for economic recovery held that fiscal stimulus would restore economic activity. That is silly, even within Keynesian terms, for the collapse of asset prices in the US wiped $10 trillion (and counting) off the US household balance sheet, and prompted a sudden, catastrophic increase in what Keynes called the marginal propensity to save. In fact, the propensity to save is not marginal, for American consumers will save not only all income at the margin, but drastically re-arrange their lifestyles in order to save more. That is why the market for major consumer durables, e.g. houses and cars, will remain apocalytpically depressed for years, and why even the bulk discount stores like Wal-Mart will underperform. Anyone who does not take measures to buttress household finances today is mad. Not only is the average household drastically short of its requirement savings requirements after a decade of a zero savings rate, but the rainy-day savings requirement has just gotten a massive dose of steroids.

The slightly-less-naive version of the recovery story that was tossed around late last year held that demand in the stronger emerging markets (Brazil, Russia, India, China) would somehow compensate for the American consumer. Yesterday’s news about the Satyam fraud (see today’s report in Asia TImes Online) takes the “I” out of “BRIC” for the time being. Collapsing oil prices leave Russia gasping, and no-one should count on Brazil being anything but the perpetual country of the future.

China’s long-term prospects are good, but the rush on the part of Bank of America and other external investors to take profits on Construction Bank of China shows China’s near-term limitations.

The trouble with the US economy is that the world conspired to maintain the valuations on the household balance sheet in order to keep the US consumer borrowing and spending. Now that the US consumer does not wish to borrow and spend, but to pay down debt by curtailing spending, everyone is out of a job.

Who else in the world can replace the American consumer? In this respect the “BRIC” consumption thesis has merit: the consumers of the emerging markets have a bottomless demand. But the mechanisms to reach emerging markets are shaky, if they are there at all. If standards of governance were poor enough in the industrial world to allow the likes of Lehman Brothers to blow up the financial system, third-world standards of governance are orders of magnitude shabbier. The balance sheets of emerging-market companies really are a soup (in John LeCarre’s felicitous phrase) that should be eaten, but not stirred. And that is not to mention the political risk.

As Francesco Sisci and I argued last Nov. 15 in Asia TImes,

Recovery requires a great change in direction of capital flows. For the past decade, poor people in the developing world have financed the consumption of rich people in America. America has borrowed nearly $1 trillion a year, mostly from the developing world, and used these funds to import consumer goods and buy homes at low interest rates. The result is a solvency crisis of the American household, which shows up as a solvency crisis for financial institutions. If we reckon the retirement needs of households as a liability, the household sector is as good as bankrupt.

No recovery is possible unless American households can save, and they cannot save in an economic contraction when incomes spiral downwards. To save, Americans must sell goods and services to someone else, and a glance at the globe makes clear who that must be: nearly half the world’s population, and most of the world’s capacity for economic growth, is concentrated in China and the Pacific Littoral.

We will hear more about President-elect Obama’s intentions later today, but from the early reports, he will make the usual error of viewing the US economy in isolation from the global economy. A stimulus concentrated in the US will disappear into the bottomless pit of demand for financial assets. To save and work at the same time, Americans need to export. And the amount of financial and real infrastructure that has to be built to accomplish this is daunting.

It is not a matter of turning the supertanker around. First the supertanker has to be built.

This entry was posted on Thursday, January 8th, 2009 at 10:21 am and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.