Japan

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Don’t Ask, Don’t Act

The military may be having an issue with its notorious”don’t ask, don’t tell” policy, but the economy is having an even bigger problem of its own. Policy makers and media don’t ask how big the problem is. Then, if they discover what’s going on by accident, they don’t act proportionately. Don’t ask, don’t act is not the basis for success in today’s crisis. It is the basis for a goodly dose of Japanese disease, which is something we should all want to avoid like the proverbial plague.

The New York Times, belatedly, has an article describing the ills that have befallen Japan in the decade or so since its economy went through a massive bubble, and then began what appears to be a long term swoon into mediocrity. Long gone are the heady days of “Japan Inc.”. Instead the subtle erosion of deflation has sapped all the vibrancy from the economy and made it entirely dependent on exports for growth. That strategy is now souring as the Chinese continue their assault on world trade. Before long the Japanese look destined for second class status and much diminished lifestyles. If they are not there now.

The story in the NYT is truly saddening. The people interviewed respond with a combination of resignation and confusion. They mourn the lost vitality and the yawning gap between the new prospect and the opportunity, now gone, in the old. A whole generation of Japanese people are growing up in diminished and straitened times.

So what’s new?

Nothing.

Nothing at all.

In fact the problem I have, and it is very disheartening, is that it has taken this long for the media to take Japanese style sclerosis as a serious enough threat to the US that they assign time and energy to reporting it. Up until now the typical American response has been one of arrogant “it can’t happen here” avoidance. Even the NYT falls into that trap by quoting, with obvious approval, several analysts who make the point that the US economy is somehow more flexible and energetic. This will, they suggest, ensure we do not fall into the same hole.

But we already have.

The issue is not the basic flexibility of the economy. Yes the US is structurally more adept that Japan. It is less tied to old fashioned ways. But that is looking more and more like the days of yore and less like the real US we now live in.

Why?

Politics and a deficient elite.

The problems Japan created for itself were sourced in its inability to meet a huge crisis with an equally huge response. Instead it meandered through years of half measures, politically compromised and watered down policies, and weak steps taken but then retracted. It was an epic example of lack of willpower combined with a bureaucratic complacency. The lack of willpower resided in the political leadership – what there was of it – and its unwillingness to describe the situation properly to the voters. The consequence was that the voters had less tolerance for the necessary scale of policy response. This then fed into the bureaucratic malaise which was typified by constant mistaken advice, fear of error, fear of mockery if mistaken, and fear of over reaction. There was always just sufficient evidence to support weaker measures. That evidence was pounced upon with glee by politicians and bureaucrats wanting to avoid strong policy stands. And even when strong policies were introduced, they were withdrawn at the very first sign, however tentative, of an improvement.

The result has been a dithering and deliberate slippage into perpetual deflation and contraction. The people of Japan have been betrayed by the weakness of their leaders.

That anyone can look at this and not see the obvious and exact parallel now being acted out here is beyond me. I see it very differently: we are already well down the same path, and yet we are in denial of the future we are choosing. We have decided to be mediocre.

Why?

Because fighting our way out is both risky and expensive.

It is risky because leaders actually have to bet their reputations, which is not something one does in a corrupt and weak political system like ours. And it is expensive because the banks did a number on us that we have not seen for seven decades. We seem not to grasp how toxic that combination can be.

And that is our central problem. Far too many commentators evaluate the US ability to avoid the Japanese trap through a rosy prism of self reference and self congratulation. They look at the US circa 1960 and think we are still operating with that level of bold decision and skill. We are not. The evidence is the past two years. We dithered in precisely the same way as the Japanese did. Our policies were riddled through with compromise that undermined their efficacy. The prescriptions were calibrated to be the least we could get away with, rather than strong enough for a certain cure. We have constantly misdiagnosed the depths of the problem, and then under prescribed against that misdiagnosis. And our political system is slow, unwieldy, and corrupt. It is time we took off those rose colored glasses and looked reality in the face.

We are no different. In fact we may be worse given our self absorption.

Even Bernanke, who made a reputation lashing into the Japanese government for its constant addiction to half measures, finds himself having to issue watered down statements and commit to weak policies because of the political atmosphere and the willful misinterpretation of our position.

And then there is the economic team. Ugh. Summers, Geithner and the others are petrified of doing anything that might upset the “system”, by which they mean the banks and the credit markets. It is the public’s interest that counts here, not the banks. The notion that we might be handing on to the next generation a much diminished economy, with weaker prospects and stagnant standards of living, should motivate our leaders to face down and eliminate the opposition of the banks. After all, the potential loss of wealth for society as a whole is vastly greater from stagnation than it is from any short term hissy fit the markets might throw.

Which is why I view the so-called financial reform as such a failure. It was a strategic error not to take on Wall Street and cripple its political influence. Not only would such action have been a popular vote winner, it would have been sound economic policy too: for financial instability remains the premier and most often quoted reason to support weak policy. “We mustn’t rock the financial boat”. That would not be on our minds if we had sunk that particular boat – or rather boarded and taken it over -when the time was opportune.

So, looking back over the last two years, I see a constant stream of decisions and policies that mimic the Japanese situation exactly. Of course the two countries are very different, but so far their reactions have been similar. That does not bode well for the US. More to the point: the fact that we have such recent experience as the Japanese malaise to see and educate us, and that we have ignored that possible education, speaks volumes about our own shortcomings. We have spent two years worrying about a surge in inflation that is nowhere to be seen. We have worried endlessly about budget gaps that need to be closed, but yet. We focus on structural problems that have no meaning without the crisis being dealt with first. We quiver at the sound of a bank CEO talking about the foreclosure problems that the banks themselves created. We dither over tax cuts even though we know the impact they will or will not have. We obsess over ratios that are meaningless in our current context. We underestimate the crisis. We overestimate the impact of our tepid response. We run away from the banking industry even though it was the root cause of our problems. We focus on endless political campaigning rather than government. We capitulate to the power of cash in our electioneering. In short: we have become unable to lead or be led.

And, given the malaise we are slipping into, that worries me a whole lot. Because the end of that road is a very poor legacy to hand into the future. Very poor indeed.

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Jobs; Trade; Banks … Ho Hum And Bun Fights

This is getting dull. Really dull. The economy refuses to shift gears. Wall Street twitters on about nothing in particular. Central Bankers are even more confused and surly than usual. Businesses are sitting on piles of cash and complaining that no one cares about them. Banks are in a snit over being asked to play nicely. Consumers have all but disappeared. Government policy makers wring their hands and smile at the same time. The dark clouds of currency wars have rolled into view. And we go nowhere fast.

Welcome to the crisis part 2.

Oh: the very slightly good news is that new claims for unemployment assistance fell again last week. Whoopee. The drop was by 11,000 all the way to 445,000, which, in normal times, would be viewed as hopelessly inadequate, or a mere blip not worth mentioning, but was the reason that Wall Street roared briefly to life this morning. We exist – I won’t dignify our current state by using the word “live” – in such diminished times that even the most modest step in the right direction can be viewed as a triumph of the first order. Our era has so perverted our language that we no longer can use the word “modest” without feeling slightly apologetic. Personally I blame corporate America for its incessant hyperbole that has undermined the value of words that used to mean something.Modest used to mean, well, modest. Now it means a mix of useless and wimpy. Thus when we run into a putrid performance we have and reach for a proper descriptor we are apt to bring pablum out of our bag. This ends up confusing everyone, and allows the incompetent folks who buy and sell stocks for a living to justify anything. Thus today’s new claims data, which can only be described as the greyest of greys, is greeted in the manner once reserved for the returning Caesars of Rome.

My advice: ignore the hoopla. The claims number represents one of a long series of indifferent and indistinguishable data points, none of which tells us much other than that our malaise continues. Allow me to repeat: we need that claims number to be under 400,000. Better yet, we need it to drop to the mid 300,000 range before we reach for the celebratory fireworks.

Meanwhile ignore Wall Street. Remember they are the folks who trashed the place in the first place. The one fact we have at present is that they know nothing worth our learning.

In other news we are reading a great deal about the brewing trade and currency wars about to blight the world.

The reason is simple: practically every government facing a domestic crisis has written into its escape plan that it will grow out of crisis by pumping up exports. Those of you with an eye for detail will notice that there is a slight problem with this. Someone has to import. Not everyone can export. Whoops. In the old days the game was extremely simple. Japan, Germany, and China exported. The US and the UK imported. That meant that German, Japanese, and Chinese workers lived below their means while Americans and Brits lived above theirs. A better way to look at this is that the Germans, Japanese and Chinese exported unemployment by deliberately under-consuming goods that they made. The surplus was sent abroad. Further: the spare cash that this generated for those economies was recycled back into the US and UK where it pumped up asset prices. This “surplus” of savings on world markets created by the deliberate under consumption in the exporting nations was a major factor in the real estate bubble. At least that’s one theory doing the rounds. Bernanke is a leader of that train of thought.

Now, in the depths of crisis, the importers need to rebalance their economies and reduce the import inflow. But that implies the exporters have to adjust as well. Therein lies the source of tension. The exporters do not want to change their game. Too many local jobs depend on trade. In the case of China, whole industries depend on it, which means millions of recently displaced agricultural workers do too. That’s a big social problem waiting to burst if exporters have to change course. China’s middle class is insufficient to buy all those goods. At least not yet. So they need to keep on exporting. To us.

Which is why they rig their currency and try to play beggar-thy-neighbor with the rest of the world, and particularly with the US. If China were to allow its currency to float by unfixing its relationship with the dollar, it would be revalued upwards. That would make Chinese goods more expensive in foreign markets like the US and would thus reduce their exports. The displaced goods would have to be sold internally within China or those factories would have to close down. Either way the adjustment could be difficult. It would cramp Chinese growth which has averaged 8% a year for a while now. A slowdown from that pace would – potentially – hit their agricultural and poor workers the most since it would remove their opportunity to earn higher wages. The result? Civil unrest. The entire structure of the Chinese elite would feel the strain. It has already been hit by waves of strikes as workers lobby for better conditions and wages. Add in the loss of export industry jobs and the country gets shaky quickly.

Hence the current stand off.

Of course this scenario is being played out across the globe as countries seek to devalue their currencies to dampen Chinese and other exports and boost their own. It is particularly acute in Europe where the German refusal to rebalance their economy is weighing heavily on places like Spain. Since Spain and Germany use the same currency the poor Spanish cannot devalue. They have only one option which is to throw themselves into massive austerity programs. The Germans meanwhile preach such austerity, apparently oblivious that their failure to boost domestic demand created the excess cash that blew Spanish real estate into its bubble – all those German second homes on the Mediterranean coast, not to mention the tourists and their wads of Euros – and is now exporting unemployment along with those BMW’s.

I won’t mention the dire straits the poor Irish are in. Suffice to say that they make the Icelanders look like amateurs when it comes to self destruction.

So, all of a sudden, attention worldwide is on how to rebalance the flow of trade so that excess cash doesn’t slop about creating bubbles, and the exporting nations don’t foist unemployment on everyone else. The recipe for a full blown trade war is nearly complete. Which is very worrisome, since one of the factors that made the Great Depression truly “great” was the trade war of the 1930’s.

And, finally, on a more comical note: the banks are at it again.

This time they are all in a huff over the new capital regulations introduced by the folks in Basel, which is where the organization that dictates these things is based.

The banks argue, rightly, that higher capital implies less credit available. This is correct because capital is held in proportion to assets. So if that proportion is forced higher, the banks have two choices: they can raise more capital and not deploy it as loans; or they can keep their current capital, and reduce the amount of loans from where they now are. Either way the level of lending will drop. The entirely neutral analysts at Goldman Sachs tell us that the drop could cut about 1% off of GDP over the next few years. Conveniently we are not told how much GDP was destroyed by the excess lending of the last few years – that would mess up the story. In any case, the bleating from the banks is now very loud. Fewer loans means lower profits. And we all know what that means: lower bonuses. So I think we can ignore the warnings of lower GDP and cut straight to the one thing we know they care about: that fifth New York apartment. Or: how awful that they might have to forgo the Hamptons home and the Aspen retreat. How mean spirited of us to force such choices on the poor dears. Now this is a true national policy issue.

Not really.

A cursory review of Hyman Minsky and his financial instability hypothesis tells us that less lending is a very good thing. It reduces long run volatility because more of the economy’s wealth relies on equity funding and not debt. That makes it less susceptible to the swings of interest rates and thus more stable. This is good. Very good. The cost for getting this stability is that we will generate less wealth on paper. GDP will, indeed, grow less quickly. But, as we recently learned, wealth that relies on debt is often an illusion – just as illusory as Lehman’s asset values were.

Frankly we could do with less illusion and more reality. Hence we should gird ourselves to ignore the weeping and wailing of Wall Street, even if they have a technically correct point. After all our economy is not theirs to play with. It’s ours.

Not only that, but we want it back.

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GDP: Good News

Everyone – well almost everyone – predicted that the second quarter GDP figures would show an improvement over the miserable performance of the last six months. That much was not hard to do, after all businesses will eventually run out of stuff to cut, slash, burn or otherwise eliminate. Once we reach that point even the most radical cost cutter has to turn his or her attention to growth. Rebuilding inventories, replacing worn out machinery, and generally fixing things then becomes the norm and GDP consequently sinks no further.

So this morning’s report that GDP fell only 1% during the second quarter came as a surprise only so far as the decline was so small. After having dropped by 5.9% over the past six months the economy’s free fall has finally started to slow down a bit. And after four straight quarters of contraction we can look forward, tentatively, to a slight upturn in the third quarter. Those four quarters of decline make this the longest recession since the Great Depression, although between then and now we have seen some sharper, but much shorter, declines.

The story within the numbers supports the notion that businesses are past the deepest part of retrenchment. Business investment declined ‘only’ 8.9% during the second quarter, which is a sad state of affairs until we realize it dropped at a 39.2% rate in the first quarter. After that appalling decline earlier in the year it was not too difficult to forecast an improvement!

The change in business spending – or rather the slowing down of the reduction in spending – contrasts with personal consumption: in the first quarter it grew very slightly – by 0.6% – while in the second it dropped by 1.2%. This turn for the worse was driven mainly by a sharp reduction in durable goods spending – stuff like cars and refrigerators – which fell 7.1% in the second quarter after having grown well, by 3.9% earlier in the year.

For those of you who need more evidence of the stimulus working: government spending kicked into gear nicely – it grew buy a heady 10.9% during the quarter; and even our beleaguered state governments managed to grow their spending 2.4 %.

Finally trade also contributed to the turn about. Both exports and imports declined less rapidly than before, with exports declining ‘only’ 7.0% and imports by 15.1%, compared with 29.9% and 36.4% respectively in the first quarter.

What do we make of this?

Obviously things are turning around. As I mentioned, this was inevitable given the depth of the retrenchment that businesses went through. The much harder question concerns the next few quarters and the shape of the recovery. There, I think, is not much evidence of enduring strength. At least not yet. That drop in consumption last quarter concerns me somewhat, especially when we couple it with the downturn in consumer sentiment of recent months. The other aspect of today’ report that suggests a sluggish recovery is, ironically the savings rate, which perked up some more from 4.0% in the first quarter to 5.2% in the second.

It is this steady accumulation of savings by American consumers that will turn out to be the most important single issue for the entire world economy over the next year or so.

Here’s why:

  1. It was ‘over spending’ by Americans that enabled growth in the exporting countries like China, Japan, and Germany over the past few years. Americans lived way beyond their mean and went deeply into debt.
  2. That indebtedness led America into a very fragile position where a collapse in banking became inevitable. Sloppy credit standards became the norm, which led to an accumulation of bad debts.
  3. That is now being unwound.
  4. This unwinding or ‘de-leveraging’ implies less consumption – by definition – and thus much more sluggish growth here in America, but also in countries who relied on selling goods here.
  5. It also affects the world’s capital markets: because some countries, notably China, Japan, and Germany saved rather than consumed the world became awash with spare capital for investment: these countries ‘saved too much’. That capital found its way to America via our trade imbalance, and fueled our binge of debt.
  6. So a slower US economy means that those countries either grow more slowly or they increase consumption/investment at home.
  7. The other hidden story here is that the US dependence on foreigners for money is decreasing, so the proportion of the Federal Deficit that we finance by borrowing from China etc will drop sharply – in fact it already has. We know this because our trade deficit has dropped sharply during the recession and the trade deficit is a measure of how much foreign capital we are importing to support our indebtedness.

So, for all these reason the US drop in consumption is about to be the big story.

It means we will see much slower growth than we are used to for a while. It will mean the recovery in employment will be slow. And it will mean that our dependence on foreign debt will diminish.

In other words we will start to deal with our underlying economic imbalances at last. It’s about time the illusion of the Reagan/Bush era was stripped away and we got back to basics rather than living in a pretend world where we imagined that our competitive position was that of the 1950’s.

Adjusting to the new reality and then rebuilding will be difficult and will require a great deal of discipline across the board – our Federal deficit will have to be reduced significantly and that means extra taxes, or painful cuts in things like defense spending – but reality is preferable to silly illusions like shining cities built in the clouds.

And it is also why things like health care reform and banking reform should be seen as part of an overall economic strategy: we need to re-allocate our resources towards future sources of wealth and away from either frivolous or ephemeral short term things.

But all that lies ahead. Right now all we can say is that we are not falling as badly as before.

And that’s really good news.

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The Outlook: Part 2

Following up on my short post yesterday about the Federal Reserve Board’s outlook for the economy, today I received the Congressional Budget Office [‘CBO’] forecast which takes the form of a briefing to Congress. The story is pretty much the same. But there are small differences we ought to be aware of.

The CBO takes a dimmer view of the outlook for unemployment. The Fed predicts the unemployment rate topping out at between 9.5% and 9.75%. The CBO expects it to go beyond 10.0%. The news this morning that jobless claims moderated very slightly seems to indicate that the job situation is settling down a little. The key statistic to watch is not the week to week data because that can easily be distorted by a single and unrepresentative event: last week’s figures was much higher because it included a rash of Chrysler lay-offs. Instead we should pay attention to a moving average stretching back a month or two. This allows us to remove distortions like the one caused by Chrysler and thus get a better reading on trends. When we do this the ‘bottoming out’ effect is more noticeable. It is clear that job losses are still very high, but that there is no discernible worsening. There’s a hint of stabilization. And I mean only a hint.

Nevertheless given the continued high level of job losses, and the very high degree of difficulty workers are encountering as they try to find new jobs – which is also embedded in this morning’s data release because continuing, as opposed to new, claims for unemployment benefits are still at record highs – I expect the CBO prediction to be more accurate. Plus I have a feeling the Fed deliberately erred on the optimistic side when talking about the job outlook because it wanted to use unemployment in its bank stress tests, and as you know, I think they wanted to soften those test for political reasons.

So unemployment will be a very significant drag on the economy right through the next year or two.

Having said that the CBO still predicts that the recession will end later this year and that we will see very slow growth during the third and fourth quarters of 2009 followed by a slightly better outlook in 2010. Currently the CBO is predicting GDP to grow by about 2.9%, adjusted for inflation, next year. There are two ways of looking at that. One is that it is quite low given that ‘normal’ recoveries usually get off to a flying start and then settle down later. The second is that it is quite good given the huge hole we are climbing out of and the ongoing risks we still have to overcome. I am in the second school.

There are huge imbalances still to be reduced. Consumer debt reduction will cramp consumption and business investment still looks very weak. And exports simply will not be a factor. The collapse in world trade has hammered economies that rely on exports: Japan’s economy dropped like a stone in the first quarter this year – it fell at an annualized rate of 15.2% from January through March which is astonishing by any standard – so it is extraordinarily unlikely that the US economy will be lifted by trade. That leaves government spending as the lynchpin of growth for a while to come. The Federal Deficit is the essential fuel we need until consumption adjusts to the new less indebted world of the future.

The problem with that is the glut of US government bonds that are now out on the world markets. There are signs that our ability to fund the debt will run into difficulty if the rate of deficit spending is not curtailed soon. Already recent bond auctions – the Treasury sells its debt through an auction process – have been less than enthusiastically received and there are even rumblings that the US may lose its AAA bond rating later this year. For those who doubt this I point to the UK as exhibit ‘A’: their bond rating was lowered by Standard and Poor’s just today. Rumors of a US downgrade are picking up steam. While not a catastrophe a downgrade would signify a historic moment for the US economy and would not just raise the interest rates the government has to pay, but, because so much domestic US debt is priced at spreads from Treasuries, it would cause the entire nation’s interest rate structure to shift upwards also. Plus, historians may well look back on such a downgrade as the defining moment in America’s transition from world economic dominance to mere parity with China or the European Union.

Who would benefit from higher rates?

The banks.

The CBO report documents that the credit markets have climbed back from the edge of doom: the apocalyptic spreads we saw in the immediate aftermath of the Lehmann debacle have fallen away to being merely high. Confidence is evidently flowing back into the world’s financial system -as it should given all the taxpayer money that we have thrown at it. Nonetheless as banks start to look forwards at earnings trends over the next few years their ability to grow profits will depend heavily on the nature of the yield curve – the difference between short and long term rates. Without a resurgence of inflation I expect the Fed to keep short term rates quite low for years ahead in order to help growth. The potential of higher US bond rates will tend to drive longer term rates upward and thus widen the yield curve. Why will this help banks? Because the essence of banking is to borrow short and lend long: their cost of funds lies at the lower end of the curve and the prices they charge on loans lies at the higher end. So the steeper the yield curve, the more profitable banking becomes.

This will make Tim Geithner smile since he is relying on the banks to ‘earn they way’ back out of their capital malaise. But it will tend to press down on borrowers, both consumers and businesses, and will thus slow the recovery.

Finally the CBO highlights an essential conundrum we should all be aware of: there is a massive conflict between the near term requirements of fiscal policy and the longer term requirements.

Near term we need to run huge deficits. That is the only way we know to stop the economy falling into a depression. It is testimony to the efforts that have been necessary so far to avoid total collapse that the US budget outlook over the near term is, frankly, terrible. The Federal Deficit has shot up as a result of things like TARP and the stimulus package. This is as it should be and follows the prescription of Keynesian economics perfectly. But: fiscal policy cannot remain that loose. At some point we will have to start work on reducing all this debt we are now issuing.

I have said before that our task has been made much worse by the Reagan/Bush legacy. We ran horribly lax fiscal policies through both the 1980’s and the 2000’s. The result is the world is awash with our bonds just as we need to flood the market even more. Hence the glut I mentioned above. Instead of running fiscally conservative policies both Reagan and Bush ran incredibly irresponsible ones. It was Cheney who famously said that ‘deficits don’t matter’. Well they always did. And they matter very much right now.

There is no doubt that fiscal policy will have to revert to very tight standards in a couple of years. That implies both higher taxes and less spending.

Once again this will put a lid on consumption.

So for all these reasons: debt reduction, the collapse of trade; higher cost of debt; and the need for higher taxes, I just cannot see a return to strong GDP growth for a while.

In fact that 2.9% GDP forecast by the CBO looks ambitious to me.

Let’s hope they’re right.

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Our Trade Problem

Today’s trade release by the Commerce Department is interesting from a number of angles. Let’s get the hard data out of the way first: the US trade deficit widened in March, which is the month for which we have the latest information. The gap between exports and imports rose to $27.6 billion, up from $26.1 billion in February. The short term significance of this change is that the February number had been the smallest trade deficit for nine years and was the last of eight consecutive months during which the gap narrowed. The dramatic shrinkage in the trade gap since the middle of last year has been a fairly important factor in holding GDP higher than it would have been otherwise: net exports are counted as a component of GDP with exports adding and imports subtracting from the total. So the steady drop in imports implied that a higher percentage of our demand was being met from domestic production.

Or at least that’s the way it appears under normal circumstances.

In reality the drop had more to do with the collapse of world trade, the drop in US consumption, and the equally dramatic fall in world commodity prices. The fall in US domestic demand, which is the root problem we are trying to deal with, obviously resulted in less demand for imported goods. At the same time the worldwide recession caused prices of things such as oil to fall from their peaks and so imports cost less. So not only were we importing fewer things, they were costing less as well. That should have been a boost to our well being except that a large part of the gain was offset by the loss of export markets as foreign consumers cut back on their purchases of American made goods and services.

So not only was the gain in net trade smaller than it might have been, it was somewhat of an illusion. I have no doubt that once our economy regains momentum the trade deficit will start to widen again.

And therein lies the rub.

As we re-engineer our economy so it relies less on debt fueled consumption, which will be one of greatest challenges over the next decade, we will be faced with a conundrum: what will replace consumption as the engine of the economy?

I am not suggesting that consumption will ever be replaced as the major driver of growth. My point is that as we shift away from debt towards a more balanced approach to spending, and as savings chew up a larger portion of incomes, consumption will have to back away from being closer to 70% of GDP which is what is has been recently. I expect it will settle somewhere lower and contribute between 60% and 65% of GDP each year. That decline from 70% to 60% will need filling if we are to see GDP grow.

And that’s the dilemma policy makers must face.

Where will that needed addition to the economy come from?

Countries that have previously experienced the kind of severe downturns we going through have typically turned to trade as a primary source of that addition. Japan, whose experience in the late 1990’s we have all talked about so much recently, was able to mitigate its drop in domestic demand by boosting its exports with its Asian trade partners in particular. The boom in China nicely coincided with Japan’s need to find a way to support itself and so exports to China helped mask Japan’s population from their dramatic drop in consumption. Without the trade boom Japan saw at that time its economic woes would have been far more severe and had much more impact on its consumers.

I doubt we will be so lucky.

The recession is worldwide. America plunged down first, so it is likely it will re-emerge first also. That means most, if not all, our trade partners will be still battling the downturn just as we are looking for trade opportunities.

So just when we need trade the most to help offset our own lost demand, and to assist us restructure our economy, the chance of opening up trade will be severely limited.

This is why I think growth is likely to be well below historical averages for quite some time, even after the recovery is well established. In fact I think the adjustment period of slow growth could easily be as long as five years.

People who expect us to rebound back to a typical growth rate either underestimate the difficulty represented by this trade dilemma, or are expecting Americans to go back to their bad debt habits.

My own view is that ‘de-leveraging’ – the cutting back on debt – by both households and businesses will be a dominant theme for years to come. In fact I think the government too will be engaged in debt reduction.

Eventually the Chinese and other emerging markets represent our best hope of re-establishing a more healthy and balanced economy here in the US. Their drive towards higher living standards offers us the chance to export and meet some of their demand. But until those economies get back on track ours will be held back as well.

So trade is another cause of caution concerning the future.

Those trade gains we have seen since the middle of last year need to be made permanent.

Only this time for the right reasons.

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