US has been the main culprit behind the destabilising global imbalances of
recent years. America's massive current account deficit absorbs about 75 per
cent of the world's surplus saving. Most believe that a weaker US dollar is the
best cure for these imbalances. Yet a broad measure of the US dollar has dropped
23 per cent since February 2002 in real terms, with only minimal impact on
America's gaping external imbalance. Dollar bears argue that more currency
depreciation is needed. Protectionists insist that China – which has the largest
bilateral trade imbalance with the US – should bear a disproportionate share of
the next downleg in the US dollar.
There is good reason to doubt this view. America's current account deficit is
due more to bubbles in asset prices than to a misaligned dollar. A resolution
will require more of a correction in asset prices than a further depreciation of
the dollar. At the core of the problem is one of the most insidious
characteristics of an asset-dependent economy – a chronic shortfall in domestic
saving. With America's net national saving averaging a mere 1.4 per cent of
national income over the past five years, the US has had to import surplus
saving from abroad to keep growing. That means it must run massive current
account and trade deficits to attract the foreign capital.
America's aversion toward saving did not appear out of thin air. Waves of
asset appreciation – first equities and, more recently, residential property –
convinced citizens that a new era was at hand. Reinforced by a monstrous bubble
of cheap credit, there was little perceived need to save the old-fashioned way –
out of income. Assets became the preferred vehicle of choice.
With one bubble begetting another, America's imbalances rose to epic
proportions. Despite generally subpar income generation, private consumption
soared to a record 72 per cent of real gross domestic product in 2007. Household
debt hit a record 133 per cent of disposable personal income. And income-based
measures of personal saving moved back into negative territory in late 2007.
None of these trends is sustainable. It is only a question of when they give
way and what it takes to spark a long overdue rebalancing. A sharp decline in
asset prices is necessary to rebalance the US economy. It is the only realistic
hope to shift the mix of saving away from asset appreciation back to that
supported by income generation. That could entail as much as a 20-30 per cent
decline in overall US housing prices and a related deflating of the bubble of
cheap and easy credit.
Those trends now appear to be under way. Reflecting an outsize imbalance
between supply and demand for new homes, residential property prices fell 6 per
cent in the year ending October 2007 for 20 major metropolitan areas in the US,
according to the S&
Case-Shiller Index. Most likely, this foretells a
broader downturn in nationwide home prices in 2008 that could continue into
2009. Meanwhile, courtesy of the subprime crisis, the credit bubble has popped –
ending the cut-rate funding that fuelled the housing bubble.
As home prices move into a protracted period of decline, consumers will
finally recognise the perils of bubble-distorted saving strategies. Financially
battered households will respond by rebuilding income-based saving balances.
That means the consumption share of gross domestic product will fall and the US
economy will most likely tumble into recession.
America's shift back to income- supported saving will be a pivotal
development for the rest of the world. As consumption slows and household saving
rises in the US, the need to import surplus saving from abroad will diminish.
Demand for foreign capital will recede – leading to a reduction of both the US
current-account and trade deficits. The global economy will emerge bruised, but
much better balanced.
Washington policymakers and politicians need to stand back and let this
adjustment play out. Yet the US body politic is panicking in response –
underwriting massive liquidity injections that produce another asset bubble and
proposing fiscal pump-priming that would depress domestic saving even further.
Such actions can only compound the problems that got America into this mess in
the first place.
China-bashers in the US Congress also need to stand down. America does not
have a China problem – it has a multilateral trade deficit with over 40
countries. The China bilateral imbalance may be the biggest contributor to the
overall US trade imbalance but, in large part, this is a result of supply-chain
decisions by US multinationals.
By focusing incorrectly on the dollar and putting pressure on the Chinese
currency, Congress would only shift China's portion of the US trade deficit
elsewhere – most likely to a higher-cost producer. That would be the same as a
tax hike on American workers. If the US returns to income-based saving in the
aftermath of the bursting of housing and credit bubbles, its multilateral trade
deficit will narrow and the Chinese bilateral imbalance will shrink.
It is going to be a very painful process to break the addiction to asset-led
behaviour. No one wants recessions, asset deflation and rising unemployment. But
this has always been the potential endgame of a bubble-prone US economy. The
longer America puts off this reckoning, the steeper the ultimate price of
adjustment. Tough as it is, the only sensible way out is to let markets lead the
way. That is what the long overdue bursting of America's asset and credit
bubbles is all about.
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