Pimco’s El-Erian made a remark a little while ago that is worth a little analysis:
In the last three plus years, central banks have had little choice but to do the unsustainable in order to sustain the unsustainable until others do the sustainable to restore sustainability!
Of course, the problem is that politicians want “recovery.” This implies a return to the previous economic environment. Which unfortunately collapsed because it was – unsustainable. So politicians are also doing the unsustainable to sustain the unsustainable. And yes, we’re getting the same symptoms.
One might well ask, what needs to happen for sustainability? Well, a few things. I’ll focus on the U.S., but the ideas are generally applicable.
- Trade balance. Imports and exports must be in a long term balance. Deficit one year, surplus another is fine, but we can’t run a trade deficit indefinitely as we are presently doing. Our economy must generate tradeable goods and services that other countries will buy in roughly equal value to what we import. The U.S. has exported most of its manufacturing industry, but has failed to offer goods and services to trade for imported manufactured goods.
- Debt. Growing debt faster than GDP is unsustainable. That’s what made things look good during the bubble years, and the consequences of that will show up in a reduced standard of living in years to come. We’re still mortgaging the future – just look at the building boom in universities, funded by student loans. Debt needs to be reduced to a level where interest costs are affordable at interest rates that reflect reasonable time preferences, and then future growth must be tightly controlled. The debt reduction will require a massive reduction in consumption. Deflation, inflation, pick your poison, but the material outcome will be the same.
- Savings. The flip side of debt is savings. Savings is, in essence, a voluntary reduction in consumption which frees up income to be allocated to investment – or, of course, debt reduction. Reducing debt and then building the infrastructure and industry to generate exports will require household and government savings to generate investment. Note that we have to look at business and household savings separately, in essence government and households will have to fund business investment. Business will have to run at negative cash flow as it spends. Right now the reverse is happening.
Financial Reality 