The devil is in the details

How a group of macroeconomists brought the world’s largest economy to the brink

THE MACROECONOMIC theories conceived by no less mortals like Nobel laureates during the last three decades now appear like an act without audience in the theatre of the absurd. For the first time since 1917 the US is no longer in the famous-five club along with Britain, Canada, France and Germany with a contracted debt of $14.29 trillion equaling one hundred percent of its GDP. What seemingly was regarded as a balance sheet crisis has distended into an endurance expedition hitherto unknown in economic history. The gravity of disclosures is alarming to the extent that the US is borrowing forty cents per every dollar it spends. Considering that there was a time not too long ago when the prospect of the US defaulting on its debt pledge was unperceivable, the current situation is hugely disturbing especially to those whose currencies are pegged to the US dollar.

If the US lawmakers agree to elevate the $14.29 trillion borrowing parameter, is the cat going to land safely in four feet? Given the element of doubt enfolding the whole affair it appears to be too complicated to be wrapped up too soon.

In its July 16, 2009 issue The Economist wrote, ‘.. Critics argue that economists missed the origins of the crisis; failed to appreciate its worst symptoms; and cannot now agree about the cure. In other words, economists misread the economy on the way up, misread it on the way down and now mistake the right way out.’

Many accuse the former Federal Reserve chairman Alan Greenspan for the 2008 economic crisis attributed to a slipshod monetary policy and exceedingly stumpy interest rates that lead to a display of absurd exuberance of by US financial markets.

However, Greenspan argues that ‘in the developing world, consumption held back by culture and insufficient consumer finance could not keep up with the inundation of income and, as a result, the savings rate of the developing world soared from 24% of nominal GDP in 1999 to 34% by 2007, far outstripping its investment rate.’

If for argument sake Greenspan’s point is accepted then if culture in developing countries is the reason for undue savings, shouldn’t culture be the reason for unwarranted consumption in the West as well?

Purists believe that the early seeds of the present imbroglio were sown during the beginning of the eighties when a new brand of economics (‘Reagonomics’) emerged repositioning ‘supply’ at the centre of the common man’s life style. In order to perpetuate this idea, tax and tariff cuts were executed into play so much so that individuals would find all the money they need to spend in their hands coupled with global access to goods at advantageous rates. More importantly as the final mile of connectivity interest rates were made to scoop to ground level.

All is said to be well that ends well. The economic consumption-oriented models touted as gateways to the Promised Land were immensely appealing if not persuasive. However during the process the fundamental equations that regenerate themselves into full circle (such as, you need to produce to consume; while consuming a fraction from what has been spawned out of production is required to be set aside as savings, which once utilized to invest can again be exploited to produce, ultimately to push the economic cart forward) were ostensibly overlooked. Worse still, the up market conventionalists upset the apple cart by re-engineering Mr. Shane’s Utopia. The misconstrued myth that consumption was all virtue which found its way into the common man’s psyche creating an archetype that is still alive and kicking has planted its feet in a convection column of quick sand rather than in firm ground.

At the same time a reverse paradigm paved the way for the rise of the East Asian behemoths at the far end of the globe. During the next two decades they transformed themselves to be the resources of cheap yet quality goods for the global markets. As a result of the Asian currency crisis this phenomena was further augmented when the Asian states gained access to the global playground by leveraging their weak currencies against the US dollar. The writing on the wall was plain and simple: while Asia exported, US imported. In sum, the balance of trade went on a roll whereby the account deficit of the US became the account surplus of Asian states like China and Asian members of the OPEC.

Nevertheless excesses, be it savings or consumption, are curses. That’s exactly the reason why the Chinese are now finding it not easy to balance their economy. The underlying cause is that it is as much difficult to win over the Chinese commoner to spend as much as it is difficult to persuade the US common man not to spend. As a consequence it may not be surprising to find the Chinese revalue their Yuan in order to keep away from the very same reasons attributed to their own phenomenal growth during the last thirty years.

What they say indeed is true; the devil is in the details.




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