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US response to downturn worrying

Instead of addressing the cause, policymakers are addressing the symptoms – the collapse of credit quality

THOSE Asian allies and trade partners of the United States who can raise their gaze above stock market gyrations look with concern at the US response to its economic difficulties.

They note a continuing unwillingness to face realities and fear that the medium-term result will be both an enfeebled America and a sharp rise in protectionist sentiment. US policies are dominated by the twin objectives of propping up asset prices and consumer spending. Interest rates have been slashed in a panicky response to Wall Street, and the administration (and all the presidential candidates) favours US$150 billion or so of tax cuts to boost spending (and the budget deficit).

The short-sighted view in Asia is that this is good for the region because interest rates will support market sentiment and stock prices, and consumer spending boosts will help sustain Asian exports. The violent swings of Asian markets over the past few days testify to the extraordinary influence of Wall Street on the world as well as on US policies.

But step back just a little from these daily events. Why should we be so concerned with stock price falls? Even now, the Standard & Poor’s 500 is down only 7 per cent from a year ago and up 50 per cent over five years. Several markets are up 500 per cent or more over that period! Every market in Asia, with the exception of Japan, is still above year-ago levels – in the case of India and China, by a very large margin. Much froth remains to be removed before prices can be considered sustainable. Ironically, Japan has been the exception despite having the lowest interest rates, lowest inflation and a strong trade balance.

In all the talk in the United States about falling asset prices and recession fears, the issue of the savings rate and the trade balance has been forgotten. Yet it is in those issues that the crux of the US problem lies.

In November, according to the Bureau of Economic Analysis, the personal savings rate in the United States was a negative 0.5 per cent. It has been declining steadily since a double-digit level in the early 1980s, a decline that has been in part driven by rising asset prices, which masked the need for saving out of income rather than relying on credit-driven boosts to apparent wealth.

But instead of encouraging savings, the Fed is hell-bent on bailing out Wall Street by reducing its lending rate to 3.5 per cent, barely above the (well-massaged) rate of consumer price inflation. The resulting US dollar weakness will help entrench inflation. Meanwhile, if the attempt to stimulate consumer demand succeeds, the US import bill will remain around current levels. The current account deficit will gradually decline as exports rise, but will probably remain above US$500 billion a year (compared with around US$700 billion in 2007).

This will have two very damaging effects. Firstly, it will enable Asian governments to continue to put off domestic stimulus to offset what should be declining US import demand. Secondly, the continued generation of vast surpluses by Asian and oil exporting countries will lead to a backlash against their sovereign wealth funds. These will be on the prowl for US assets other than low-yielding Treasuries or the dubious financial institutions that have already caused them massive sub-prime losses. Bailing out Citi may be welcome, but will China be allowed to buy 3M and Coca-Cola?

There is already a growing sense in the United States, and elsewhere in the West, that whatever the theoretical benefits of freer trade may be, it is partly responsible for the increased income differentials against which democratic societies eventually tend to rebel. Anti-trade sentiment will be further fuelled by foreign acquisition of US icons on a scale far in excess of the Japanese purchases in the late 1980s.

US profligacy has also spilled over into unsustainable credit booms in China and India originating in the massive global oversupply of US dollars and hence of the monetary base and foreign reserves of these countries. When the dancing ends, there may also be a rethink of market-driven economics in those countries too.

There is a direct connection between easy credit in the United States, Wall Street irresponsibility, consumer excesses, unsustainable trade imbalances, the return of global inflation and the worldwide asset price boom. Yet instead of addressing the cause, US policymakers are addressing the symptoms – the collapse of credit quality, which had been going on for years but was masked by the creation of new and poorly understood new credit instruments. Instead of addressing the savings imbalance, the government proposes to make it worse by substituting government debt for any reduction in consumer debt.

One can only hope that Fed and Washington policies fail and the American consumer adjusts on his own to his true situation, returning the US to a sustainable path and forcing its Asian trade partners to respond appropriately.


Source: NYT (Business Times 25 Jun 08)


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