REWINDING "THE GREAT UNWINDING"

David Brooks wrote a nice piece in today's New York Times titled "The Great Unwinding." He wrote of the need for over-leveraged American consumers to tighten their belts and save, and for the American economy to transform itself, with more emphasis on business investment and production. Read his article (click on the link above) and then read my response below:

Nice piece, "The Great Unwinding," generally insightful and accurate. However, you set everything up nicely and then drop the ball on the most critical part of the prescription to cure what ails America.

You say: "The American economy will have to transition from an economy based on consumption and imports to an economy with a greater balance of business investment and production." And then go on to say that "finding a political strategy to accomplish this" is difficult, if not impossible.

You’re missing a critical point. Where's the demand going to come from to fuel U.S. business investment and production?

To move to an "investment economy" requires a source of strong demand. As you properly point out, the U.S. consumer, with too much debt and need to save, will not be a source of demand growth any time soon. The government is attempting to fill in the demand void left by consumers, but can't continue doing so indefinitely for reasons you well understand. Business can't be the source of its own demand without an ultimate purchaser of its product. That would be like business pulling itself up by its bootstraps. Additions to inventory are not long-term sources of demand growth. That leaves U.S. exports as the sole remaining possible source of demand to fuel the transformation you propose. Yet nowhere in your piece do you mention exports.

It was the surfeit of U.S. imports and recycling of surplus dollars into the U.S. economy by our trading partners that got us into this mess. Reversing the process -- deleveraging through exports -- is the way out.

Your sentence should have read: The American economy will have to transition from an economy based on consumption and imports to an economy based on exports and the accompanying build-up in investment and production.

And such an economy requires no political will at all! The market mechanism will do the work, just as it did for the Asians following the "Asian 'Flu" in '97-'98.

Dollars will flow out of the U.S. because Asians, worried about their oversupply of shaky dollar-denominated debt and needing to underwrite stimulus for their flagging domestic economies, will repatriate a chunk of their surplus, driving the value of the dollar down relative to creditor currencies. That will make U.S. exports more competitive, spurring the export sector, and will discourage Americans from buying foreign goods. The resulting U.S. trade surpluses will be a principal source of funds to repay our foreign debt.

Makes sense, doesn't it? When looking for a source of demand, you have to look to those who have money, and right now, Asians and oil exporters are the ones with spendable cash. It is logical, therefore, to look to them to be the new "engines of world economic growth," and not frightened, over-extended American consumers.

Another source of repayment of debt, both foreign and domestic, will be the sale of assets (corporate stock and real estate) to foreign and domestic creditors -- in effect, swapping debt for equity.

Corporate stocks and real estate, already cheap, are very likely to get cheaper if, as I suggest, there is a significant flight from the dollar (which seems to have begun, according to the Treasury's latest TIC reports. That's because interest rates will go up (remember Mexico in '94, Asia in '97-'98), inhibiting domestic economic growth and driving down stock and real estate prices further. So, to foreigners, U.S. assets will be doubly cheap: low prices, low dollar -- an irresistible opportunity to buy control of America's corporate crown jewels and move into some prime U.S. real estate.

All this is market-driven, requiring no political will other than for government to stay out of the markets' way -- i.e. don't follow Larry Kudlow's jingoistic call for "King Dollar," or resort to xenophobic prohibitions of foreign purchases of American stocks or real estate.

If you don't like the idea of a weaker dollar or foreign ownership of U.S. assets, consider this: the only remaining alternative to exports and asset sales as the source of debt repayment is default.

I've written all of this up in a Cassandra Chronicle you can view by clicking on the title: "The Asian Caper Part II, The Golden Trap"

I also have a fascinating Chronicle backing up your call for a consumption tax: "Prohibition's Hangover."

Both well worth your time to read. Please let me know if you do.