"Stop behaving as whiner of first resort"

A comment by Ricardo Hausmann in today’s Financial Times takes US policymakers to task for trying to prop up demand and stave off a recession.

We’ve pointed out repeatedly, as have various economists quoted here, that consumption as a percentage of US GDP is unsustainably high and saving correspondingly too low. It can only continue with massive foreign borrowing, and there are limits to how long friendly central bankers will keep bailing us out. If the US does not reduce consumption and increase savings, it will eventually and even more painfully be foisted on us when our creditors start cutting the debt supply.

Lower consumption means lower domestic demand. At a minimum, that translates to lower growth, and give how far our savings rate has plunged, probably a recession.

The US has repeatedly given that sort of tough-medicine advice to developing nations, and many readers have commented on the hypocrisy of the US deciding that it is a special case, exempt from normal good economic practice.

Hausmann gives a more economically rigorous and detailed treatment of this general theme. From the Financial Times:

The same voices that supported tough macroeconomic policies to deal with the excesses of spending and borrowing in east Asia, Russia and Latin America are today pushing for a significant relaxation in the US to deal with the so-called subprime crisis. Interest rates should be slashed quickly and $150bn put into taxpayers’ pockets by April at the latest, they say. The Fed cut by another half-point on Wednesday.

The goal seems to be to avoid a 2008 recession at all costs. As Larry Summers, former Treasury secretary, put it, failure to act would make Main Street pay for the sins of Wall Street.

It is easy to lose sight of the overall picture. Main Street consumers have overspent and over-borrowed and are unable to meet their obligations. The fact that households may have so behaved because they were enticed by “teaser loans” does not change the facts; it only assigns blame. Consumption has been above sustainable levels and needs to adjust down, whatever view one has about the responsibility of adults over their financial decisions.

The adjustment of private consumption to sustainable levels is necessary, but is likely to have a negative influence in the short run on the growth of aggregate demand, of which it represents more than 70 per cent. It is hard for this adjustment to take place without bringing down the rate of growth of gross domestic product, possibly to negative numbers.

It will also lower the US external deficit and put downward pressure on world growth. That is a consequence of the imbalances accumulated over five years of unprecedented world growth. Returning to a sustainable path is good for the US and the world economy over any horizon that assigns some value to what happens after 2008. Sustainable growth is not the consequence of an unsustain­able consumption boom but of the progress and diffusion of science, technology and innovation – which show no sign of slowing down.

An efficient adjustment to the US over-consumption imbalance (and Chin ese under-consumption) in a way that does not hurt longer-term growth should be based on compensating for the decline of US consumption with an increase in domestic investment and in consumption abroad. It should not be based on giving the US consumer more rope with which to hang himself.

Hence, macroeconomic policy should not be based on a panicky attempt to avoid a 2008 recession at all costs but on a forward-looking strategy that achieves the needed reduction in consumption at the lowest cost in terms of the stable growth. This is not achieved by giving US households a $1,000 cheque by April, a trick that no macro economic textbook would argue is particularly effective. If there is fiscal room – a big if, given the weak structural position of the US government and its likely cyclical worsening – it would be better spent in accelerating investments in plant and equipment via accelerated depreciation schemes, to improve the capacity of the economy to keep on growing after the crisis.

The logic behind monetary easing is also suspect. Much of it is automatic, as central banks pump in money just to keep interest rates steady. It is understandable that politicians facing a November election and bankers with a lot of their money at stake should feel that this is the worst crisis ever and have an obvious interest in exaggerating the consequences for Main Street.

They all assume that if banks lose capital, they will stop lending. This is what happens in developing countries because of incomplete financial markets, but is not what one would expect in the world’s most sophisticated capital market. In fact, bank capital has already been lost and the solution is not to put more air into the bubble but to put more capital into banks. This is already happening: Citibank, UBS, Merrill Lynch and Morgan Stanley have raised more than $100bn from foreign investors and sovereign wealth funds. Authorities might use their moral suasion to accelerate this process.

The US should face its need for adjustment with courage and reason, not fear. It should stop behaving as the whiner of first resort, ready to waste all its dry powder on a short-sighted attempt to prevent a 2008 recession. Many poorer countries with weaker markets and institutions have survived and benefited from an adjustment that involves a year of negative growth. Faster bank recapitalisation, fiscal investment stimulus and international co-ordination should be first on the ­policy agenda.

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  1. Jojo

    Hear, hear! What’s good for the goose is good for the gander, right? Hold your nose and take your medicine, as your mother ordered.

    But this is a presidential election year, so our politicians will do everything possible to try and convince the electorate that they have everything under control. NOT!

  2. Anonymous

    It is, of course, possible that a sizeable chunk of the stimulus package will be available for investment in capacity. How?

    Well, do the math with regard to the whatever hundreds of dollars that go to individuals vis tax rebates, unemployment checks, etc:

    If, say, 40 million households are in debt (mortgage, credit, car loan, etc), then some percentage of the money they receive will go to pay off interest. How much will go to that as opposed to further consumption? I don’t know. But, it probably relates to the percentage of consumers who have sensed ‘the party is over for now’.

    This money, then, goes through hands of consumers straight to corporations.

    What will corporations do with it?

    That answer will determine how much of the stimulus goes into the kind of investment that can help put the economy on a firmer foundation.

    Of course a cynic who looked to how much corporations have concerned themselves with ‘the greater good’ would have to conclude: Not much.

    And, if that’s accurate, then the stimulus package is really just one more shell game to prop up corporate profits.

  3. NC Jim

    Repeat after me:

    Cannot have a recession going into an election. All incumbants will be blamed.

    Kick the can up the road as long as you can and let the next President deal with the consequences.


  4. Lune

    To play the devil’s advocate, allow me to assert that the U.S. is indeed a special case. It prints the world’s reserve currency. Until that changes (a process which has started), the prescriptions for the U.S. will be different because practically speaking, the stick the rest of the world wields towards the U.S. is very different.

    No country, be it first world / third world, East / West, whatever, takes its financial medicine until it’s pushed to the very verge of bankruptcy and mass social upheaval. A bunch of pointy-headed economists with their cushy jobs and tenure for life (to use a stereotype that I’m sure none of your readers exemplify :-) talking dryly about the need for financial pain is no match for the millions of voters and potentially violent protesters that politicians who implement such measures will be facing. Appealing to rationality when talking about people losing their jobs and homes is naive.

    So that said, what levers does the rest of the world have to force the U.S. to take its medicine? Even China, potentially the largest lever, can’t decide whether it should sell its dollar holdings, revalue the renminbi, or continue its current policies and hope for the best.

    Until the U.S. finds itself forced to borrow Euro/Yen/Yuan to fund its account deficits, I suspect the world, much less FT columnists, won’t really have a way to make the U.S. cry uncle…

  5. Yves Smith


    Sadly you are probably right, but there was a time long ago when Americans did make sacrifices (rationing in WWII) and could take tough medicine (Volcker’s interest rate increases).

    There is an appalling lack of appreciation of the advantages we gain by having the dollar as the reserve currency, and worse among people who should know better.

  6. CrocodileChuck


    Hayek said that recessions are beneficial: “like a cold douche” (shower).

    Schumpeter’s definition of capitalism: ‘creative destruction’. My question: where is the second part of the above?


    ps Paul Keating, then Treasurer of the Labour party said of Australia’s ’90/’91 downturn: “The recession we had to have”.

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