Where Will Growth Come From?

White House economist (CEA Chairwoman) Romer today said the economy inthe future will see business investment and exports filling the holeleft by consumer spending (and fiscal stimulus) as households savemore.

White House economist (CEA Chairwoman) Romer today said the economy in the future will see business investment and exports filling the hole left by consumer spending (and fiscal stimulus) as households save more. The economy, Romer said, would be less dependent on consumption as the savings rate reverts to the 1990’s level at 66% down from 70% currently. She also said households would no longer tap home equity to finance current consumption to the extent of the last decade. Government is filling this hole now with mainly fiscal policy and some aspects of monetary policy – more like drop in the bucket that private consumption filled until last September.

She probably is right in the long run, as in anything is possible the more years one allows for something to happen like exports and business investment to pick up the slack from reduced household demand.

But this is not possible for the next several years at least. Not even China can direct its economy from savings to consumption overnight and its government holds all the marbles. If China can’t transition to a demand-led economy how can the US export its way to prosperity ahead? Germany and the Euro Zone will go American? This is a world of lessons learned and if there is any lesson learned it is don’t count on leverage to buy ones way to happiness. Having a savings for a rainy day is wise, not cheap. Europe for the most part (excluding the UK which did behave very American-like in the last decade) does not need to learn a lesson it already knows…the wisdom of saving.

US high tech exports have a world marketplace to sell into but quasi adversarial states like China mean only some tech exports ever make it to China. Europe has adequate domestic tech substitutes in hardware and software and outside things like video games, higher education and Hollywood movies, there is not much else Europe wants that is American – in time maybe golf clubs and fishing rods when China discovers leisure and respects as well as enforces property rights.

Sadly the $787bln fiscal stimulus and $1.8trln projected budget deficit for FY2009-2010 will not fill the hole left by a household in mean reversion and in a world where net wealth has collapsed. What has helped fill the hole indirectly has been the massive provision of liquidity by the Fed via conventional and unconventional means and we all agree this is unsustainable without a Zimbabwe-like ending.

And with the US consuming much of what the world makes, when this stops happening as it has, the rest of the world does not have the income to support the level of imports that high levels of exports helps support.

Global output gap is enormous as happens in world recessions. And a world recession brought on by a sudden collapse in credit flow does not allow for more typical business cycle adjustments. Instead it is feast and famine overnight leaving firms heavily exposed to excess inventory (or employment if service-based firms). What business wants to expand capacity? Well surely there are some like those in green technology, but this part of the economy is still insignificant and not a major factor in growth, and not even with government incentives.

Business investment is likely to remain depressed as long as or longer than household savings rates rise.

I think today’s US trade report shows just how badly global trade is hurt when US consumption collapses. Looking at the table below I have highlighted the change in bilateral US trade deficits with major regions using Q1 2009 data compared with Q1 2008 data (note bilateral data are seasonally unadjusted and hence year-over-year comparisons are more meaningful than month-over-month comparisons). Only the bilateral deficit with China is holding up relative to the rest of key trading partners (down 8% Q12009/Q12008) suggesting massive substitute effect – Chinese made goods for rest of the world made goods (and a stronger case for yuan appreciation). Mexico and Canada have seen their surpluses with the US implode. So has the EU. And Japan as well. Auto demand (lack thereof) is surely a key driver in the reduced imports into the US from major auto producing nations. And OPEC has seen its oil exports hit by reduced consumption and lower prices compared with a year ago.


My point is Romer may be right in some distant point in time, but not in the next decade at least. Which means the private sector will not come roaring back on the coattails of exports and business investment. And as government finds it can’t keep throwing borrowed dollars at the problem (just as Japan did in the lost decade), outside of the Fed generated money creation, there is not much in the cards that will drive US growth much above flat to 1.5% when the recession ends (well into 2010 at the earliest).

My question is how long can export-led economies hold out when global trade is under such intense pressure? Protectionism is inevitable and there are signs of it already. When Germany, Spain and Italy adopt cash for clunkers and auto sales surge, the US will follow (bill already in works in Congress), this is a form of protectionism if indirectly.

China may be in fine shape to throw resources at its slowdown. But China can’t afford to throw money at China at the rate that will trickle down to the developed world and restore world trade.

We may be seeing green shoots on the macro landscape. But green shoots in a draught will not bear flowers or fruit.

Where does growth come from ahead? The government until it finds it can’t keep it up and then it is a hobbled private sector (earnings starved firms, income/wealth starved households in need of deleveraging and banks filling own holes and recalibrating leverage) that yields a US version of Japan’s lost decade.

David Gilmore