Time to rebalance

America’s economy is set to shift away from consumption and debt and towards exports and saving. It will be its biggest transformation in decades, says Greg Ip (interviewed here)


STEVE HILTON remembers months of despair after the collapse of Lehman Brothers in 2008. Customers rushed to the sales offices of Meritage Homes, the property firm Mr Hilton runs, not to buy houses but to cancel contracts they had already signed. “I thought for a moment the world was coming to an end,” he recalls.

In the following months Mr Hilton stepped up efforts to save his company. He gave up options to buy thousands of lots that the firm had snapped up across Arizona, Florida, Nevada and California during the boom, taking massive losses. He eventually laid off three-quarters of its 2,300 employees. He also had its houses completely redesigned to cut construction cost almost in half: simpler roofs, standardised window sizes, fewer options. Gone were the 12-foot ceilings, sweeping staircases and granite countertops everyone wanted when money was free. Meritage is now catering to the only customers able to get credit: first-time buyers with federally guaranteed loans. It is clawing its way back to health as a leaner, humbler company.

The same could be said for America. Virtually every industry has shed jobs in the past two years, but those that cater mostly to consumers have suffered most. Employment in residential construction and carmaking is down by almost a third, in retailing and banking by 8%. As the economy recovers, some of those jobs will come back, but many of them will not, because this was no ordinary recession. The bubbly asset prices, ever easier credit and cheap oil that fuelled America’s age of consumerism are not about to return.

Instead, America’s economy will undergo one of its biggest transformations in decades. This macroeconomic shift from debt and consumption to saving and exports will bring microeconomic changes too: different lifestyles, and different jobs in different places. This special report will describe that transformation, and explain why it will be tricky.

The crisis and then the recession put an abrupt end to the old economic model. Despite a small rebound recently, house prices have fallen by 29% and share prices by a similar amount since their peak. Households’ wealth has shrunk by $12 trillion, or 18%, since 2007. As a share of disposable income it is back to its level in 1995. And if consumers feel less rich, they are less inclined to spend. Banks are also less willing to lend: they have tightened loan standards, with a push from regulators who now wish they had taken a dimmer view of exotic mortgages and lax lending during the boom.

Consumer debt rose from an average of less than 80% of disposable income 20 years ago to 129% in 2007. If other crises of the past half-century are any guide, America’s consumers will spend the next six or seven years reducing their debt to more manageable levels, reckons the McKinsey Global Institute. This is already changing the composition of economic activity. Consumer spending and housing rose from 70% of GDP in 1991 to 76% in 2005 (see chart 1). By last year it had fallen back to 73%, still high by international standards.


The effect on the economy of deflated assets, tighter credit and costlier energy are already apparent. Fewer people are buying homes, and the ones they buy tend to be smaller and less opulent. In 2008 the median size of a new home shrank for the first time in 13 years. The number of credit cards in circulation has declined by almost a fifth. American Express is pulling back from credit cards and is now telling customers how to use their charge cards (which are paid off in full every month) to control their spending.

Normally, deep recessions are followed by strong recoveries as pent-up demand reasserts itself. In the recent recession GDP shrank by 3.8%, the worst drop since the second world war. In the recovery the economy might therefore be expected to grow by 6-8% and unemployment to fall steadily, as happened after two earlier recessions of comparable depth, in 1973-75 and 1981-82.

No bounce-back

But this particular recession was triggered by a financial crisis that damaged the financial system’s ability to channel savings to productive investment and left consumers and businesses struggling with surplus buildings, equipment and debt accumulated in the boom. Recovery after that kind of crisis is often slow and weak, and indeed some nine months into the upturn GDP has probably grown at an annual rate of less than 4%. Unemployment is well up throughout the country (see map), though it declined slightly in February.


So if America is to avoid the stagnation that afflicted Japan after its bubbles burst, where is the demand going to come from? In the short term the federal government has stepped up its borrowing—to 10% of GDP this year—to counteract the drop in private consumption and investment. Over the next few years this stimulus will be withdrawn. Barack Obama wants the deficit to come down to around 3% of GDP by the middle of this decade, though it is not clear how that will be achieved. Indeed, if the rest of the economy remains moribund, the government may be reluctant to withdraw the stimulus for fear of pushing the economy back into recession.

Tighter credit and lower consumer borrowing are not the only drivers of economic restructuring. A less noticed but significant push comes from higher energy prices. A strengthening dollar and ample supply kept oil cheap for most of the 1990s, feeding America’s addiction to imports. That began to change a few years before the crisis as the dollar fell and emerging markets’ growing appetite put pressure on global production capacity.

A fourfold increase in oil prices since the 1990s has rearranged both consumer and producer incentives. Sport-utility vehicles are losing popularity, policies to boost conservation and renewable energy have become bolder, and producers have found a lot more oil below America’s soil and coastal seabed. Imports of the stuff have dropped by 10% since 2006 and are likely to come down further. When natural-gas prices followed the rise in oil earlier this decade, exploration companies used new methods to get at gas trapped in shale formations from Texas to Pennsylvania. Abundant domestic shale gas should radically reduce America’s gas imports.

America’s economic geography will change too. Cheap petrol and ample credit encouraged millions of Americans to flock to southern states and to distant suburbs (“exurbs”) in search of big houses with lots of land. Now the housing bust has tied them to homes they cannot sell. Population growth in the suburbs has slowed. For the present the rise of knowledge-intensive global industries favours centres rich in infrastructure and specialised skills. Some are traditional urban cores such as New York and some are suburban edge cities that offer jobs along with affordable houses and short commutes.

A burst of productivity could lift incomes and profits. That would enable consumers to repay some of their debt yet continue to spend. The change in the mix of growth should help: productivity in construction remains low, whereas in exports the most productive companies often do best. But the hobbled financial system will make it hard for cash-hungry start-ups to get financing, so innovation will suffer.

The outlook for business investment depends on whether it is for equipment or buildings. Spending on equipment is expected to be fairly strong, having largely avoided excess in the boom period, and indeed in the fourth quarter of 2009 it raced ahead at an annual rate of 19%. In February John Chambers, the boss of Cisco Systems, a maker of networking gear, called it “one of the most robust, positive turnarounds I’ve seen in my career”. Demand for new buildings is far lower: empty shops and offices attest to ample unused capacity. And business investment typically accounts for only 10-12% of GDP, so it will never be a full substitute for consumer spending.

The road to salvation

As consumers rebuild their savings, American firms must increasingly look abroad for sales. They have a lot of ground to make up. Competition from low-wage countries, mostly China, has increasingly taken over the markets of domestic industries such as furniture, clothing or consumer electronics. Yet shifts in the pattern of global growth and the dollar are laying the groundwork for a boom in exports. “There’s a world view that the United States is the consumer of the world and emerging markets are the producer,” says Bruce Kasman, chief economist at JPMorgan Chase. “That has changed.” He reckons that America will account for just 27% of global consumption this year against emerging markets’ 34%, roughly the reverse of their shares eight years ago.

The cheaper dollar will resuscitate some industries in commoditised markets, but the main beneficiaries of the export boom will be companies that are already formidable exporters. These companies reflect America’s strengths in high-end services and highly skilled manufacturing such as medical devices, pharmaceuticals, software and engineering, as well as creative services like film, architecture and advertising. Thanks to cheap digital technology, South Korea and India now knock out the sort of low-budget films that compete with standard American fare. But only Hollywood combines the creativity, expertise and market savvy to make something like “Avatar” which has earned $2.6 billion so far, some 70% of which came from abroad. That adds up to several jumbo jets.

Exports are a classic route to recovery after a crisis. Sweden and Finland in the early 1990s and Thailand, Malaysia and South Korea in the late 1990s bounced back from recession by moving from trade deficit to surplus or expanding their surplus. But given its size and the sickly state of most other rich countries’ economies, America will find it much harder. It has been exporting more to emerging markets than to developed ones for several years, but if other countries, particularly China, do not sufficiently boost domestic demand, “the unwinding of the global imbalances could reverse quite quickly in 2010,” says an IMF staff paper.

America’s current-account deficit, the broadest measure of its trade and payments with the rest of the world, shrank from 6% of GDP in 2006 to 3% last year (see chart 2). Could it come down to zero? It nearly did in 1991 after five years of booming exports. This time the deficit started out a lot larger and the rest of the world is weaker. Still, even stabilisation around 3% would be a blessed relief because it would slow the growth in America’s indebtedness to foreigners.


America’s imbalances were years in the making and will not be undone overnight. But the elements of a rebalanced economy are already visible a 40-minute drive to the south of Mr Hilton’s offices in Scottsdale, Arizona. Around the same time that Mr Hilton was watching sales of his homes dry up, Brian Krzanich, head of global manufacturing at Intel, was finalising plans to spend $3 billion retooling his company’s massive semiconductor factories in nearby Chandler. Mr Krzanich knew perfectly well there was a recession going on. Intel’s sales were down and 3% of the staff at the factories had been laid off. But he also knew that once global demand rebounded, Intel would have to be ready to produce a new generation of cheaper, smaller and more efficient chips. “Unless you think your business is going to shrink for an extended period, like seven years, it always pays to make that investment,” he says. In the last quarter of 2009 Intel, helped by resurgent demand for technology, enjoyed record profit margins, and Mr Krzanich was approving overtime.

Mr Hilton, for his part, runs his company on the assumption that the days of easy money and exuberant consumers are gone for ever. In his office he has a yellowed copy of the Wall Street Journal from September 18th 2008, the week when Lehman failed and American International Group was bailed out. “Worst crisis since the 30s with no end in sight”, reads one headline. “I wish I’d had that article in 2005,” says Mr Hilton. He keeps it around as an antidote any time he is “feeling all happy and slappy”.

Eating their words

Néstor Kirchner, the country’s then president, oversaw a deal to restructure some $82 billion in bonds on which the country had defaulted four years earlier.  The government offered new bonds worth only about 35% of the old ones.  The government managed to sell bonds worth $8.5 billion in the local market and $7.6 billion to Venezuela, despite in some cases at high interest rates.  Through this process, the government tried to make peace with international capital markets.  Kirchner's wife, Cristina Fernandez, who succeeded him in 2007, wants to make peace with the bondholders. At her request, Congress lifted the ban on reopening the debt restructuring.  It will be interesting to see how the situation works out by 2011, Fernandez's last year of the term.

Coming out of the Recession

There were 162000 jobs added in March which was the highest month since March of 2007. There has been an increases in growth of jobs in 3 of the last 6 months. This is a great sign considering the weather issues in the two previous months. Even though the job increase has not reduced the unemployment rate these numbers are very encouraging considering last year at this time the country was losing hundreds of thousands jobs every month.

March jobs report shows growth

According to the government report, the U.S. economy gained more jobs in March than any other month in the last three years. This sounds very encouraging, and it's definitely a good news for everyone!

However, more jobs does not mean less unemployment rate right away. Although more jobs have been created, it will take some time for the unemployment rate to drop. Moreover, some economists had feared that most of March's gain would be due solely to Census hiring.

Looks like there is still a long way to go before the unemployment rate falls to normal, but this is definitely moving in the right direction.

The inflation solution

According to the analysis of this article, inflation could be a solution of the recession. Different from prosperous phases, policy makers usually advises that the inflation rate should be controlled in a moderate degree. It said that a relative higher growth rate of inflation will help alleviate the debt burden of people, and, therefore, stimulate investment. Moreover, the growth of inflation could avoid the decrease of nominal wages, which often arouse complaint from workers. That is, it might be that the real wage is decreased without an awareness of the majority of workers.

In this article, it gives an example of the Britain who probably agrees with the idea of increasing the inflation rate. Britain might use inflation as a tool to transfer wealth from savers to debtors which may help boost the spending. Nevertheless, it points out that although a higher inflation rate will probably solve the problems of recession, policy makers should also pay attention on how much the inflation rate should be increased, since it would have a certain impact on the interest rate of Britain.

Lenders Loosen Reins on Jumbo Mortgages

This article is about the sudden increase in jumbo loans that are being approved and the decreasing rates on these loans of $729,750 or more. Current conditions for borrowing in these high amounts are early indicators of improvement in the mortgage market. Mortgage industry executives are very optimistic about overall conditions as indicated by the improvement in conditions for the high end of this market. In this article Frederick Wohlfarth, the president of a real estate broker in Manhattan known as Wohlfarth & Associates, said he has already seen a 40 percent rise in sales requiring jumbo loans over last year. This article also notes that credit scores of 700 or more are still the most important factor that determines approval for these jumbo loans.

U.S. Easter Spending Will Increase for First Time Since 2007

U.S. consumers plan to spend as much as $14 billion on candy-filled baskets, lamb dinners, and coloured eggs for the Easter holiday weekend. The projected 1.8% growth would be the first increase in Easter holiday spending in three years. According to IBISWorld, a Los Angeles based research firm, spending for the same period fell 8.3% in 2009 and 1% in 2008, which attributes the increase with food, candy, and clothing sales leading the way, which provides a sign of the U.S. consumer that non-essential purchases are rebounding. George Van Horn, a senior analyst at IBISWorld, "Consumers are still favouring need versus want, but volume is up as people become more confident." The Conference Board's index of U.S. consumer confidence rose to 52.5 in March, an increase from 46.4 in February.

The increase in spending by the general public during the Easter holiday shows two signs of recovery of the American consumer. As U.S. consumer confidence rose to 52.5 from 46.4 in one month, it shows that the average consumer is feeling more confident and thus spending more. Similarly, as consumer confidence has risen amid the recent recession, the growth in Easter holiday weekend spending in recent years suggest that the U.S. consumer is spending more of their disposable income in non-essential goods. Does this growth in the Easter holiday period suggest that consumer confidence is on the rise to what was deemed normal in the past?

Manufacturing grows at fastest rate since 2004

It is reported that the manufacturing growth rate reaches the fastest one since 2004. According to the news, the index of Tempe Ariz.-based Institute for Supply Management’s (ISM) manufacturing rose to 59.6 in March from the February reading of 56.5. This is driven by significant growth in new orders and production and a larger inventories, which grew for the first time in 46 months. The new orders rose to 61.5 from 59.5 the month before; the production component increased to 61.1 from 58.4; and the inventories inched higher to 55.3, which is the first time that components has posted above the 50 tipping point in 46 months. Additionally, however, some economists regard this report as a subjective and overrated survey.

U.S. to Delay Chinese Currency Report

The article mainly talks about the fact that US would delay the decision on whether to declare China a currency manipulator. But the Obama administration also vowed to raise the issue at a series of forums, including the annual Strategic and Economic Dialogue between US and China and a meeting of G20 leaders. According to this article, American experts believe that China has artificially undervalued Renminbi. China had allowed Renminbi to appreciate during 2005-2008, but then resumed the practices to pegging its currency to a nearly fixed rate to bolster its export-oriented economy during the financial crisis. The economists claim that China can stimulate domestic demand and reduce reliance on export by letting Renminbi appreciate. Appreciation of Renminbi can also stimulate American private saving by making imports more expensive and exports less expensive.

Job Market Picks Up, but Slowly

This article talks about the recent resurgence in the job market. The resurgence is not much of one, March jobs hirings were higher then the previous months because of the government hiring 48,000 temporary workers for the census. Other job increase was just from a change in the weather, in February jobs were down because of all of the snow storms throughout the country. Even with the improving economy companies are still reluctant to hire until they see steady progress in the market. Economists say that we should expect to see unemployment where it is for a while, and the job outlook should take a long time to improve.