Physician heal thyself

By Julian Delasantellis

Deep in the middle of another US Presidential campaign, and the air is muddy thick with the pieties and promises of politics. Since it is self-evident that the blood of the D-Day heroes who scaled the cliffs at Pointe du Hoc still flows freely through all 300 million current-day Americans, the country’s politicians are well justified in promising the voters the absolute maximum amount of focus-group-vetted government services to be paid for with the absolute minimum of taxes.

But, if Americans ever choose to expose themselves to some foreign voices and views (which they rarely do - for most local American news broadcasts, coverage of train crashes and the displays of 10,000 dominoes set up for a chain reaction just about does it for their overseas news coverage), they will see that some very-informed observers are looking at the country’s response to the economic slowdown generated by the subprime mortgage crisis very differently than do many Americans.

To sum up these views, here America is being seen as the wimps of the world, like little boys hiding under a pediatrician's desk so as to not to have to suffer an inoculation shot.

Who says the American government is dysfunctional? You certainly wouldn’t believe it from witnessing the alacrity that the US Congress moved with in order to give US$168 billion of the people’s money to the people, otherwise known as the "stimulus package".

True, there was a bit of partisan bickering leading to its passage. The Republicans wanted the package to focus on more tax breaks for business, proving once more that they don’t understand the subtle difference between being for capitalist principles and being whores for capitalists. Some Democrats wanted the package to include government largesse for recently released felons unable to find work; the Republicans would have probably signed off on that had the felons in question only been guilty of crimes such as bank fraud and insider trading.

In the end, the two sides worked out a truly Solomonic compromise. Disabled veterans will also receive the tax rebate checks to be sent out this spring - assuring that this fall every pamphlet and television advertisement produced by an incumbent will feature the freshly scrubbed solon handing a government check to a beaming veteran in a wheelchair.

In the United States, many prominent economists, including Clinton-era Treasury secretary Laurence Summers, are proclaiming that the US economy desperately needs this assistance. In a January 6 opinion piece in the Financial Times, he laid out his argument as to why the US economy was in desperate need of aid.

Fiscal stimulus is appropriate as insurance because it is the fastest and most reliable way of encouraging short-run economic growth at a time when a serious recession downturn would pressure American families, exacerbate financial strains, raise protectionist pressures and hurt the global economy.

Like a drunk in a bar ordering another round because he’s heard that, since a glass of red wine a day has some purported health benefits, it’s logical to assume that a whole bottle of 120-proof Scotch must have even more, the Congress heard this wisdom, raised a glass to the fine Dr Summers, toasting, "I’ll drink to that". Summers' prescription was for a stimulus package in the neighborhood of $50-75 billion; if the drunk stumbling out of the bar gets stopped by the authorities and is discovered to have a blood alcohol reading three times the legal limit, well, he, as well as the Congress, can always claim that he just got caught up in the overall heady intoxicating spirit of the procedure.

For most of this decade, at the global economic symposiums where, you know, only the right sort of drip-dry international economic bureaucrat and shiny-trophy-wife-festooned corporate tycoon were in attendance, as the lobster cracked-crab cocktail and Bollinger Blanc got wolfed down like hot dogs and Budweiser at a ball game, the talk that forever pervaded these events was of the dangers of what is called "global imbalances."

From the traveling annual bacchanals of bucks sponsored by the World Bank, the International Monetary Fund (IMF) , and the Bank for International Settlements (BIS), to the annual winter carnival of cash of the World Economic Forum at Davos, Switzerland, the "global imbalances" that raise so much concern centered around the huge budget, trade and, especially, the massive current account deficits of the United States.

Rising from about $385 billion in 2001, about 3.75% of gross domestic product, to over $800 billion, over 6% of GDP in 2006, the current account deficit, at its moist basic level, measures just how much more the country is consuming over what it is producing.

The mirror image of the US current account deficit is, of course, the current account surpluses of the countries doing the exporting to the United States, currently primarily the oil exporting countries, Germany, and especially, the new world factory floor and export powerhouse of China.

Standard economic theory of the floating exchange rate regime that has governed the world economy since 1973 states that countries with current account deficits should see their national currencies depreciate, and countries with current account surpluses should see their currencies rise in value; like water levels in the locks of canals equalizing when the locks open, eventually, the deficits and the surpluses would more or less even out.

That has not happened with today’s "global imbalances", primarily because the US dollar has not depreciated sufficiently to make purchases of foreign goods so expensive as to make them out of reach to American consumers. A major factor keeping the US dollar artificially high has been the tendency of the surplus countries to recycle their export earnings back into US Treasury securities, rather than letting them be converted back into their home currencies.

This system, called Bretton Woods II (after the 1944 Bretton Woods, New Hampshire conference at which the World War II allies put forth their plans for the postwar US dollar-centered international monetary order) by economists Nouriel Roubini and Brad Setzer, is the primary reason why the global imbalances have not equalized and have continued to grow until they have reached a level many observers think threatens the continued health of the global economy. (For financing of the US current account deficit, see US living on borrowed time - and money Asia Times Online, March 24, 2006.)

In a February, 2005 speech at Columbia University in New York, Rodrigo de Rato, then managing director of the IMF, raised the concern over global imbalances and what could happen if they continued to be left unaddressed:

When we speak of 'global imbalances' in the international economic system, we are referring to the large current account deficit of the United States and the corresponding large surpluses in a few countries, mainly in emerging Asia. Related to this, the lop-sided pattern of economic growth in recent years also springs to mind. Global growth has been, and remains, unduly dependent on the United States and China. The euro area and Japan - which together account for nearly one-quarter of global output - continue to under-perform. If this trend persists, it will widen existing imbalances further, and increase the risks of drastic disruptions to global growth.

De Rato expanded on these concerns in a November, 2005 speech in Seville, Spain, and then, with the bravado easily available only to an international economic bureaucrat who does not need to face the voters in November, suggested some remedies that never had any chance of adoption:

Today's global payments imbalances, and more broadly, the current geographical patterns of growth, saving, and investment in the world economy, should be a major concern to policy makers. Indeed, communiques of finance ministers' meetings show that they are a major concern. Put simply, they are unsustainable. Higher net savings - private and public - are needed in the United States, and lower net savings are needed in a number of other key countries.

If the US current account deficit remained at present levels it would mean ever-growing US external indebtedness, and it is difficult to see this being accepted by private investors or central banks of countries that would need to hold the US assets. I do not share the view of some policy makers that correction of global imbalances can be entirely left to the market. I think the risks are too great ... If global growth is to be sustained, many countries will need to share the work of reducing global imbalances. It is particularly important, and increasingly urgent, that the United States tackle its current account deficit by increasing domestic saving, and this means mainly reducing its fiscal deficit … So I believe that actions on the revenue side, preferably through reforms to broaden and simplify the tax base, are also needed.

In this, de Rato goes to what is believed to be the core driver of the world’s global imbalances, the United States federal government budget deficit. As the greatest single unified consumer of goods and services in the American economy, when the federal government spends more than it takes in, as it has been doing for most of the past 40 years with the exception of the last two years of Bill Clinton’s presidency, it quickly gets reflected in a trade deficit with the rest of the world, and that, along with the financing of that trade deficit, is what makes up the current account deficit.

A rising stock market pumps revenue into the US Federal Government, as investors pay capital gains taxes on appreciated stock sales. Therefore, it is not surprising that the US budget deficit has recently been on a declining trend. According to the non-partisan Congressional Budget Office, and not including the costs of the wars in Iraq and Afghanistan, (which, in a bizarre bipartisan conspiracy to make bad numbers look better, are not included in the budgetary sums) the federal budget deficit has declined from $413 billion in fiscal year 2004 to $162 billion in 2007. In response, the global imbalances of the current account deficit have also declined, albeit much less dramatically. From an average of $202 billion a quarter in 2006, the comparable average current account deficit for the first three quarters of 2007 fell to a paltry $188 billion.

These statistics prove that, although the Federal Budget deficit makes up the core of the current account deficit, private spending by US consumers also represents a significant part of the problem. With the offshoring of much of America’s manufacturing base this decade US consumer spending is now essentially synonymous with the US trade deficit, especially since Americans spend as if their dollars burn holes in their pants pocket.

The national savings rate has fallen from 2.9% early in 2000, to under 0.5% for most of late 2007; in November of last year the savings rate actually went negative - Americans spent every penny in their pockets and then went on to see if there was any spendable value in their pockets’ linen linings.

Therefore, it is obvious that increased savings, by both the federal government through a lower budget deficit, and by US consumers through less spending, is the key to bringing the "global imbalances" to a more manageable level.

First off, Americans must spend less. How can this be accomplished? Probably not through more Sunday morning sermons evangelizing the world of God over that of Mammon; Americans live in the most religion-saturated society on earth, but as soon as they rise blessed from the pews its off to the malls, bibles put down, Sunday sales circulars taken up.

One thing that works in making Americans more circumspect in fast drawing for their credit cards like gunfighters in an old west shoot-em-up is the prospect of economic uncertainty. It was during the recession of the early 90’s that America last ran a current account surplus, falling from a deficit of over $40 billion a quarter late in 1987 to a surplus of almost $10 billion in early 1991. This decline in the current account deficit was totally resultant from consumers pulling back; over the same time period, the government fiscal deficit rose from $145 billion to $212 billion.

So now, here Americans are, facing another economic slowdown, much like in the early 1990’s, one wholly originating from the credit quality issues of an over-leveraged real estate sector. Should America just let this happen? After all, the phenomenon of a nation, just like that of a family, living beyond its means could not be expected to last forever. To paraphrase Samuel Johnson’s famous quote about the prospect of a hanging at dawn working to focus the mind, for millions of financially over-extended Americans, the prospect of a foreclosure might just focus the mind away from mindlessly extravagant consumer spending.

Or maybe not. Recent payment statistics indicate that many at-risk American homeowners are paying off their credit cards before their mortgages - the logic there apparently being that you can always find another place to live, but if the plastic maxes out what on earth will you do on the weekends?

In a debate conducted on Justin Fox’s Curious Capitalist blog on the Time.com website, Gilles Saint-Paul of the Universite des Sciences Sociales de Toulouse presents his argument why an economic recession, while harsh and bitter tasting, might just be the strong medicine that the American economy needs.

The US economy does not 'need’ a recession but it needs to cut consumption by several percentage points to restore its trade balance. I also think it needs to avoid bailing out those who gambled on risky loans and overpriced houses. Otherwise, it will have another round of financial bubble, which may again sustain excess consumption because market participants will reinforce their presumption that buying the bubble is a one-way bet since they will be bailed out if things turn sour. And along with the bubble comes an imbalance in the composition of investment (for example, a housing bubble may lead to too much construction). It would be nice to have these needed corrections without a recession, but I doubt it can be avoided. Default on loans will worsen the balance sheet of financial institutions and reduce the supply of credit to the economy. A fall in consumption will reduce aggregated demand because it takes time for nominal prices to adjust and for the composition of demand to be redirected to the external sector [exports], as it should.

In the Financial Times, Willem Buiter of the London School of Economics expands on the recession as strong medicine theme.

The kind of sustained increase in the national saving rate (by at least 3% of GDP to restore external sustainability, and by at least 6% of GDP to give US citizens hope of a dignified retirement) cannot in practice be achieved without passing through a slowdown, and possibly a recession. Higher saving means lower consumption or higher income without a commensurate increase in consumption. I am sufficiently Keynesian to believe that a reduction in consumption will lead to (at least) a temporary slowdown in activity. The kind of supply-side miracle that would produce an increase in income without an equal increase in private and public consumption is hard to visualize for the US. It's hardly China, after all. For the past couple of decades, the US consumer has been saved from the consequences of undersaving by capital gains. Unfortunately these capital gains were to a significant extent bubble-manufactured and have now imploded. After the tech bubble and bust and the housing boom and bust, I cannot see another asset bubble coming to the rescue of the improvident US consumer. So save you must.

In a January 31 opinion piece in the Financial Times briskly entitled "Stop behaving as whiner of first resort", Ricardo Hausmann, the director of Harvard University's Center for International Development, tells Americans to suck in their guts and take the recession like a man.

The adjustment of private consumption to sustainable levels is necessary, but is likely to have a negative influence in the short run on the growth of aggregate demand, of which it represents more than 70%. It is hard for this adjustment to take place without bringing down the rate of growth of gross domestic product, possibly to negative numbers … The US should face its need for adjustment with courage and reason, not fear. It should stop behaving as the whiner of first resort, ready to waste all its dry powder on a short-sighted attempt to prevent a 2008 recession. Many poorer countries with weaker markets and institutions have survived and benefited from an adjustment that involves a year of negative growth.

It is interesting that none of these voices advocating a cut in America’s profligate consumption comes from a native-born American; Hausmann of Harvard (which many Americans don’t consider part of America anyway) was previously the Minister of Planning in Venezuela. Almost as if they were arguing that the high school football team trade in their shoulder pads and cleats for pink tutus, or that the national pastime of baseball be replaced with the girly commie ballet russe of chess, is advocating that Americans consume less in the short term for the benefit of their long-term national interest now seen as so inherently unpatriotic and subversive that no informed observer, at least no informed observer without the thick shield of sturdy university tenure, can even whisper the very prospect?

The nation’s leaders seem to think so. The core of the "stimulus package" is to have government tax rebate checks of at least $600 sent out to most Americans, probably as early as April. The express intent of these windfalls is that they should be spent - and fast; happy days will certainly be here again for Wal-Mart’s suppliers at the factories of the Yangtze River valley outside Shanghai. Besides forestalling even the very thought of less consumer spending bringing down the US current account deficit, the stimulus package, along with increased government spending on unemployment benefits and other countercyclical spending programs that rise in times of economic hardship, will also once again bloat up the US federal budget deficit. The non-partisan Congressional Budget Office predicts that the budget deficit will more than double in fiscal year 2008, to over $400 billion.

It is important to note that many countries do not accept that you have to make a choice between economic growth and being in current account balance. Germany, which derives its economic growth overwhelmingly through high-quality high value exports, and where the current economic concern is still centered around fears of inflation arising from out of its too fast economic growth, last year registered a current account surplus of 162 billion euros, about $235 billion at the current rate of exchange. German economic officials are not worried about an economic slowdown; they’re the ones keeping euro interest rates high in hopes of engineering a mild one.

But in the United States, the right to enjoy continuing and uninterrupted high levels of domestic consumption is so sacrosanct that, applied to the private consumption of housing, it forms the core definition of what is called the "American dream." The country can worry about paying for it later - preferably much later.

Hausmann brings up another point that must be obvious in most of the countries of the developing world. When it comes to dealing with economic crises, America’s attitude is definitely do as I say, not as I do.

The same voices that supported tough macroeconomic policies to deal with the excesses of spending and borrowing in east Asia, Russia and Latin America are today pushing for a significant relaxation in the US to deal with the so-called subprime crisis. Interest rates should be slashed quickly and $150bn put into taxpayers' pockets by April at the latest, they say.

Following upon the fall of the Soviet Union came a new American attitude as to how developing nations in economic distress should be handled. During the Cold War, these countries were treated gingerly, for the fear was that if these societies were pushed into deep penury they might be tempted to "flip" over to the side of the Communists. With the end of the Communist threat, that fear disappeared, as did the velvet glove. Out came the iron fist.

For about 20 years now, poorer nations in economic distress seeking assistance have had the misfortune to have been subject to what is called the "Washington Consensus."

The core mandate of the Washington Consensus demanded that the supplicant nations severely cut their government social welfare spending in order to generate budget surpluses. Also, the depreciation of these countries’ national currencies, and the Washington Consensus demand that the governments stop subsidizing prices of necessities such as imported food and medicine meant that the less fortunate in these societies were subject to substantial hardship in meeting their needs for the daily necessities of life.

Hausmann’s quip about the "same voices" advocating the stimulus package for America is a particularly pointed jab at Summers who, as Treasury Secretary, was the hanging judge who sentenced the poor unfortunate nations caught up in the East Asian financial crisis of 1997-98 to the Washington Consensus.

At its core, what is the entire subprime economic meltdown but yet another crisis of American overconsumption, in this case, the overconsumption and resulting misallocation of housing finance capital? The names and the faces may change, but, at its core, the song remains the same. The basic financial mendacity that displayed itself in the loans to the less-developed world in the early 1980’s, in the Savings and Loan fiasco in the late 1980’s, in the Long Term Credit Management hedge fund collapse in 1998, in the bursting of the dot-com bubble in 2000-01, is now being displayed again in the subprime sector.

Like an obese man not willing to change his lifestyle but still expecting his physician to heal him, unless America shows itself willing to address its real, core underlying problem, its never-ending desire to consume more than it produces, in another 10 years or so the country should expect to be precisely back where it is now.

Fiscal prudence and fiscal discipline may be all well and good for the wogs and gooks carrying the crosses of the Washington Consensus, but as for applying the same dour principles and policy prescriptives to the namesake nation of the Washington Consensus.

Well, American Protestant fundamentalists consider their country to be uniquely blessed and chosen by God, a gleaming city on a hill, a shining light onto all the nations. Good deal, if you never have any intention of paying the light bill.

Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at juliandelasantellis@yahoo.com.