I’ve been particularly bearish on the economy in my last couple posts, calling this the equivalent of a depression and a crisis that risks civilizational failure. However, there are signs that we can avoid the worst. The news came out today that Consumer debt fell by 7.4%, or nearly $1 trillion dollars in the last two years. Though the pace of repaying that debt is declining, it means that our total consumer debt now stands at $11.6 trillion. There are also fewer credit cards, and in general it appears that at least the American public has come to grips with the fact that the wild consumerism of the 00’s cannot continue.
So, a piece of good news hits, and my first reaction is to rethink my position about this crisis. Is it possible that I’m far too bearish and concerned, under estimating the capacity of a country as large and rich as ours to bounce back and recover from the long debt-driven party of the last thirty years?
Some signs of sanity are real: people are paying down mortgage debt, delinquencies in consumer loans are down, as are home foreclosures. Families across the country are starting to put their household finances back in order, adapting to the uncertainties of the recession. Home lending practices have been tightened, as has credit access to the sub-prime market. In fact, this is how a recession should look — the economy is slow as we recover from a credit binge.
A best case scenario would involve a gradual increase in economic growth, and a tightening in what to me is still the most important statistic: the current account. In the second quarter of 2009 the current account deficit hit a ten year low, at $84.4 billion. However, the latest figure (released in September, Q2) is $123.3 billion, the fourth quarterly increase in a row. The current annual GDP is $14.73 trillion. The current account deficit now is at about 3.4% of GDP, up from 2009, but still a sustainable number compared to the 7% of GDP hit back in 2006. We’re still consuming more than we produce, but not to the extremes of a few years ago.
Ultimately I think the US needs to see this number stabilize closer to 0. Treasury Secretary Timothy Geithner recently proposed that the G-20 set targets capping current account surpluses at 4%. The argument the US is making is that China bears some fault for the current global crisis by how it has kept its currency under valued while running constant trade surpluses. One could even accuse China of engineering a mass transfer of wealth from the US to China, using our belief in free trade to flood the market with cheap consumables we’d go into debt to keep acquiring. They were, however, simply playing by our rules (and we’ve been willing consumers).
Yet the US can’t play hardball with China because we do still need them to buy our bonds, and if they got really made and started dumping bonds, stocks, and US currency, they could do severe damage to the US economy. Arguably they could weather such a storm better than we could. So what does the US do? Quantitative easing.
To do this the Federal Reserve board created $600 billion out of thin air, put them on their accounting sheet, and then used that money to purchase US bonds. That, of course, has the impact of driving down the interest rates on those bonds, which negatively impacts countries like China who holds them. China originally complained about this, but apparently in exchange for Geithner to quiet down on current account surplus targets, they’ve also muted their criticism. This also isn’t the first time the Fed did this; since the crisis began nearly $2 trillion have been “created” in that manner.
Colloquially “quantitative easing” is simply “printing money.” The risk, of course, is inflation and even hyperinflation. It is a form of stimulating the economy that is often used when lower interest rates fail to generate more economic activity. In the US that and a fiscal stimulus have so far failed to generate growth. That’s seen as bad, though given the rate in which consumers have been paying down debt, one wonders what would be happening to the economy without the stimulus! Quantitative easing was used by Japan a decade ago, but didn’t work to stop Japanese deflation. Indeed, Japan’s high government debt, low interest rates and then quantitative easing should have risked inflation. It hasn’t because low unemployment means there is not a reserve of new workers ready to go into the system and generate income.
Japan has maintained its industrial base (unlike the US), has vast foreign capital reserves, and has had a current account in surplus (meaning it invests in the rest of the world). The relative “comfort” of Japanese deflation — it remains a wealthy low unemployment country — isn’t cause for comfort here. The key for us remains to increase production. Without increasing production the only way out of the recession is through consumption of foreign goods, and that would require more debt. In other words, the problem would intensify and set up another crisis.
Paying down the debt is an important step — and private debt is perhaps even more important than worrying about government debt at this point. My fear would be that quantitative easing could induce more consumption of foreign goods, thereby increasing the risk to the dollar moving forward. My hope would be that somehow we find ways to increase production at home so that ‘new’ money is spent improving America’s productive capacity rather than just causing more consumption.
Ultimately, I don’t see any way that can happen without a decline in the value of the dollar.
A falling dollar would mean foreign goods would get more expensive, and we’d consume less of them. American goods would get relatively cheaper, and there would be incentives to produce more of them. More Americans and even people abroad might find it cheap to “buy American.” This would produce problems in emerging markets, many of which rely on the US to buy their goods. This also would wreck havoc with the bond markets and the US ability to sustain debt and deficits. The result could be such global uncertainty that a call for a “new Bretton Woods” would be quite persuasive.
The Bretton Woods system is the monetary and institutional system of free trade and fixed exchange rates created after WWII, named for the location in New Hampshire of a July 1944 meeting setting the framework for the post-war system. Bretton Woods II is often used to discuss the changed nature of the system after the end of the fixed exchange rate system in 1973. Robert Zoellick of the world bank has talked opaquely about an internationalization of capital accounts, perhaps a “Bretton Woods III,” that could even reintroduce gold as a benchmark against which currencies are measured. Though this is not necessarily a call for a new ‘gold standard,’ it does reflect growing concern about the ability of humans to successfully handle fiat currencies. To me this signals recognition that currency instability is likely in our future; a dollar crisis may be the next phase of this global slowdown.
So yes, Americans paying down the debt is a good thing. But we also have to increase production and stop growing the current account deficit. I doubt that can happen without a weaker dollar — perhaps substantially weaker. Now that it’s clear that the Euro is not in existential crisis, I would not be surprised to see the dollar start to decline in value. How hard and how far the fall is uncertain. Whether or not the global system can handle all this in a stable manner may determine how deep this global economic crisis ultimately becomes.