Friday, October 10, 2014

America Estopped


1. INTRODUCTION

Media coverage of the US economy in the 1950s was usually accompanied by footage of things like workers on assembly lines, farmers driving harvesters, buildings under construction et cetera. The situation today is completely different. Current media coverage of the US economy usually includes footage of things like a herd of people making a mad dash at a Wal-Mart sale, people dining out at the Outback Steakhouse, drivers filling-up their tanks at the gas station et cetera. This sea-change in the media-perception of the US economy has led to a fierce debate about its underlying nature.

A) On one hand, we hear some economists and journalists claim that consumption is the driver of the US Economy ('liberal demand-siders'). This side argues that it is consumers who create jobs and not businesses; and they claim to speak for the 'toiling masses' and against the 'handful of privileged oligarchs'. Here are a few examples of this left-tilted view from the current media coverage:

B) On the other hand, we hear some economists and journalists insisting that it is investment that is the driver of all economies, including the US Economy ('conservative supply-siders'). This side argues that it is businesses that create jobs and not consumers; and they claim to speak for the 'hard-working entrepreneurs' and against the ‘lazy welfare-queens'. Here are a few examples of this right-tilted view from the current media coverage:

As is evident from the above-linked survey of the media, much discussion has been generated about the underlying nature of the US economy and its role in the world today. This is certainly an interesting debate with a variety of views professed by a number of worthy participants. Michael Pettis, for one, has suggested that the global imbalances we see today are related to the fact that different countries in the world have different types of economies. Therefore, the investment-driven economy of China and the net-exports driven economy of Germany, for example, tend to be counterbalanced by the consumption-driven economy of the US. His research suggests that even though each of the economies may be individually and separately imbalanced, the situation has continued for as long as it has because they complement each other’s deficiencies on a joint basis. In other words, over-production in one economy meets over-consumption in another economy, thereby keeping prices stable in the global markets. We will dwell no further on these global imbalances here and readers should visit Michael's blog for additional insights into these major issues.

In this article, we will instead focus on a much more specific question: What type of economy does United States really have? Is it a consumption-driven economy? Or is it an investment-driven economy? Or is it something else altogether?

2. DEFINITIONS

Before we examine the data, let us begin with some definitions:

1) Consumption-driven economy
An economy is said to be a consumption-driven economy when consumption-growth is faster than GDP-growth over the period examined. In other words, consumption-share of GDP rises in a secular (but not necessarily monotonous) fashion over that period. In such an economy, GDP-growth may either equal investment-growth or exceed it, implying that investment-share of GDP either remains a constant or falls in a secular fashion over the same period.

2) Investment-driven economy
An economy is said to be an investment-driven economy when investment-growth is faster than GDP-growth over the period examined. In other words, investment-share of GDP rises in a secular (but not necessarily monotonous) fashion over that period. In such an economy, GDP-growth may either equal consumption-growth or exceed it, implying that consumption share of GDP either remains a constant or falls in a secular fashion over the same period.

3) Mix-driven economy
Mix-driven economies are quite rare over extended periods of time, even though most economies do have short-periods of mix-driven growth every now and then. To define it, an economy is said to be a mix-driven economy when either of the following two situations are present:

Type I: GDP-growth is faster than both investment-growth and consumption-growth over the period examined. In such an economy, investment-share of GDP and consumption-share of GDP both fall in secular (but not necessarily monotonous) fashion during that period. The growth actually comes from either an increase in current-account surplus share of GDP or from a reduction in the current-account deficit share of GDP. In the case of the former, it is often called an 'export-driven' economy and in the case of the latter it is called a 'savings-driven' economy over the period examined.

Type II: Investment-growth and consumption-growth are both faster than GDP-growth over the period examined. In such an economy, investment-share of GDP and consumption-share of GDP both rise in a secular (but not necessarily monotonous) fashion during that period. The growth actually comes from either a decrease in current-account surplus share of GDP or from an increase in the current-account deficit share of GDP. Such an economy is called a 'consumption & investment driven' economy over the period examined.

4) Balance-driven economy
An economy is said to be a balance-driven economy, when investment-growth and consumption growth are both equal to the GDP-growth over the period examined. In other words, investment-share of GDP and consumption-share of GDP both remain constant in a secular (but not necessarily in a monotonous) sense over that period. In such an economy, by definition, the current-account surplus or deficit share of GDP also remains constant in a secular sense over the same period as examined. We note that since exactness is rarely found in nature, let alone in an economy, the theoretical words ‘equal’ and ‘constant’ in this paragraph should really be accompanied by the qualifier ‘approximately’ in practice.

Armed with these definitions, we are well-equipped to take a look at the trends in the demand-side component-shares of US economy over the last 30 years, as shown in the graph in figure 1:
FIGURE 1
From a quick observation of the graph, the secular trend of investment-share of GDP over the whole period seems to be downward, even though some local investment-driven periods can be observed as part of a cyclical (i.e. up & down) pattern. In addition, whereas they do seem to be some short-episodes with mix-driven growth, on the whole there is no secular trend that indicates that it was a mix-driven economy over the entire period. The only other clear trend that is immediately visible is that the secular trend of consumption-share of GDP over the whole period seems to be upward. From this, it does appear that the US has been a consumption-driven economy over the last 30 years. Perhaps this is why many economists and journalists refer to the US economy today as a 'consumption-driven economy'.

But is that what the US economy really is? Or does it merely appear so on a prima facie basis, while being something completely different upon closer examination?  To find the answer to this question, we need to separate and analyze the various internal sub-trends that compose and constitute the overall 30-year trend in the US economy. Once we have examined the various bits carefully, we can then put all of them back together to arrive at a better understanding of the state of the US economy over the last generation.

3. ANALYSIS

3.1 Background Equations

Here are the IMF-standard equations that describe the GDP from the demand-side:
GDP = Consumption + Savings --- (I)
Investment = Savings + Current-account Deficit ---- (II)

Using (II) in (I), we get the common form:
GDP = Consumption + Investment - Current-account Deficit ---- (III)

We can re-write (III) symbolically as:

In addition, we can write (IV) in incremental form for any given year as follows:

Still further, what is true on an annual increment basis for any given year in (V) can naturally be summed up over any given period consisting of a number of years as follows:

NOTES on equations (IV), (V) & (VI):

(1) If CAD/GDP is constant and consumption is growing faster than GDP (i.e. C/GDP is rising), then it follows that I/GDP must be falling, implying that GDP must be growing faster than Investment. This would be an example of consumption-driven growth.

(2) If CAD/GDP is constant and investment is growing faster than GDP (i.e. I/GDP is rising), then it follows that C/GDP must be falling, implying that GDP must be growing faster than consumption. This would be an example of investment-driven growth.

(3) If GDP is growing faster than both consumption & investment (i.e. C/GDP & I/GDP are both falling), then it follows that CAD/GDP must also be falling, implying that GDP must be growing faster than the CAD as well. This would be an example of Type-I mix-driven growth.

(4) If consumption & investment are both growing faster than GDP (i.e. C/GDP & I/GDP are both rising), then it follows that CAD/GDP must also be rising, implying that CAD must be growing faster than GDP as well. This would be an example of Type-II mix-driven growth.

(5) If consumption & investment are both growing at the same pace as GDP (i.e. C/GDP & I/GDP are both constant), then it follows that CAD/GDP must also be a constant, implying that the CAD must be growing at the same pace as GDP as well. This would be an example of balance-driven growth.

3.2 Data Collation

With the caveat that there are really only 2 degrees of freedom (see equations (I) & (IV)) in the data-field, here is a basic table of IMF-data that indicates the shares (expressed as % of GDP) of consumption, investment, CAD & savings. We note that the IMF data in this table are identical to the IMF data plotted in figure 1:

In addition, here is the corresponding table that displays the cumulative annual-increments (see equation (VI)) in the component-shares from 1984 (reference point) to 2012, expressed as percentage-points (PP) of GDP:

We need to begin with a visualization of the data in order to start the analysis. Therefore, we begin with a plot of the cumulative annual-increments (see equation (VI)) of component-shares from 1984-2012, exactly as shown in Table II:
FIGURE 2
It is obvious from figure 2 that there are a variety of growth-drivers during the long period from 1984 (reference year) to 2012. Clearly, we have numerous short-spells of investment-driven growth, mix-driven growth, balance-driven growth and consumption-driven growth, respectively. In addition, we know that there were three Keynesian actions (1989-91, 2000-03 & 2007-09) by the US government during the whole 1984-2012 period.

3.3 Types of Sub-Periods

(1) Consumption-driven growth (1984-1987)
As seen in figure 3, consumption-share of GDP increased during this sub-period, while investment-share of GDP fell. From the definitions provided above, we conclude that this sub-period had consumption-driven growth. The consumption-share growth in this sub-period was probably triggered by: (a) lowering of general income-tax rates, (b) elimination of specific consumption-taxes that were imposed during the 70s to contain demand & hence inflation, (c) proliferation of consumer-debt due to the rising CAD, and (d) lowering of real interest rates that aided the rise of this consumptive debt. 
FIGURE 3

(2) Mix-driven growth (1987-1989)
As seen in figure 4, consumption-share & investment-share of GDP both fell during this sub-period, implying that GDP was growing faster than both consumption & investment. According the definitions provided, we conclude that this sub-period had Type I mix-driven growth. The growth in this sub-period naturally came from a reduction in the current-account deficit share of GDP. This implies that savings alone grew faster than GDP during this time, and hence the economy could be said to have been 'savings-driven' over this sub-period.
FIGURE 4

(3) Keynesian-Estoppel (1989-1992)
This first Keynesian-Estoppel* sub-period began with the stock-market crash of 1989 and continued up to the recession of 1991. As seen in figures 5 (a) & (b), government-action forcibly drove-up the consumption-share GDP, even as the bust drove-down the investment-share of GDP. This is a special case and cannot be considered as standard ‘consumption-driven growth’, because natural consumption follows the decrease in investment and tends to also decline as fearful consumers attempt to increase their savings during the bust. It is government-action that borrows the ‘excess’ savings of these fearful consumers and forcibly converts it into consumption in order to prevent the economy from going into a free-fall decline. Therefore, this sub-period was an example of a state-diktat driven economy, in which US government action maintained consumption levels even as investment levels actually declined during 1989-92.

*Word-Definition: The word 'estoppel' is used here to mean an action by which the government prevents (or stops) the economy from taking a course it would otherwise have taken, in order to prevent a socially-painful or socially-unacceptable outcome. The word ‘stimulus’ has not been used here because a stimulus is applied as a temporary push to a slow or stagnant situation. On the other hand, when the economy is in free-fall and the government wishes to stop it from collapsing further, the action required is no longer called a ‘stimulus’, but rather more aptly described as an ‘estoppel’.
FIGURE 5(a)
FIGURE 5(b)

(4) Investment-driven growth (1992-1997)
As seen in figure 6, investment-share of GDP increased during this sub-period, while consumption-share of GDP fell. From the definitions provided above, we conclude that this sub-period had investment-driven growth. The investment-share growth in this sub-period was probably triggered by a general reduction in government-consumption levels made possible by the end of the Cold War.  The additional savings made available by the reduction of the government fiscal deficit (i.e. reverse of ‘crowding out’) during this period was recycled into investment, thereby leading to a strong spell of investment-led growth.
FIGURE 6

(5) Mix-driven growth (1997-2000)
As seen in figure 7, consumption-share & investment-share of GDP both increased during this sub-period, implying that consumption & investment were both growing faster than GDP. According the definitions provided, we conclude that this sub-period had Type II mix-driven growth. The growth in this sub-period naturally came from an escalation in the current-account deficit share of GDP. This implies that deficit-fueled consumer-debt must have been rising very quickly during this time, and hence the economy could be said to have been driven by rising ‘deficit-fueled investment & consumption’ over this sub-period.
FIGURE 7

(6) Keynesian-Estoppel (2000-2003)
This second Keynesian-Estoppel sub-period began with the bursting of the internet-bubble in 2000 and continued up to the recessionary conditions of 2003. As seen in figures 8 (a) & (b), government-action once again forcibly drove-up the consumption-share GDP, even as the bust drove-down the investment-share of GDP. The government borrowed the ‘excess’ savings by running fiscal deficit much larger than the one seen during the first Keynesian-Estoppel. It then forcibly converted this ‘excess’ savings into consumption by massive increases in government-consumption in order to prevent unemployment from rising. Therefore, this sub-period was another example of a state-diktat driven economy, in which US government action maintained consumption levels even as investment levels considerably declined during 2000-2002.
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FIGURE 8(a)
FIGURE 8(b)

(7) Investment-driven growth (2003-2007)
As seen in figure 9, investment-share of GDP increased during this sub-period, while consumption-share of GDP stayed approximately constant. From the definitions provided above, we conclude that this sub-period had investment-driven growth. The investment-share growth in this sub-period was obviously related to the growing of the housing-bubble, which triggered a general construction-boom. Given that consumption-share of GDP stayed approximately constant, as seen in the same figure, it is obvious that the housing-bubble was fueled by the rising CAD-share of GDP. In other words, investment & the CAD both grew faster than GDP, while consumption-growth trailed GDP-growth during this sub-period. This was clearly a deficit-fueled investment boom.
FIGURE 9

(8) Keynesian-Estoppel (2007-2009)
This third Keynesian-Estoppel sub-period began with the bursting of the housing-bubble in 2007, was amplified by the resulting financial-crisis of 2008, and continued up to the recessionary conditions of 2009. As seen in figures 10 (a) & (b), government-action once again forcibly drove-up the consumption-share GDP, even as the construction-bust drove-down the investment-share of GDP and sent unemployment sky-rocketing to levels unseen in a generation. The government again borrowed the ‘excess’ savings by running a fiscal deficit even larger than the one seen during the second Keynesian-Estoppel. It then forcibly converted this ‘excess’ savings into consumption by massive increases in government-consumption in order to prevent unemployment from rising. Therefore, this sub-period was another example of a state-diktat driven economy, in which US government action maintained consumption levels even as investment levels radically declined during 2007-2009.
FIGURE 10(a)
FIGURE 10(b)

(9) Investment-driven growth (2009-2012)
As seen in figure 11, investment-share of GDP increased during this sub-period, while consumption-share of GDP declined. The additional savings made available by the reduction of the government fiscal deficit (i.e. reverse of ‘crowding out’) during this period was recycled into investment, thereby leading to a spell of investment-led growth. Given that the CAD was approximately a constant during this period, we can conclude that this investment-driven sub-period was structurally more similar to the one during 1992-1997 (I-1) than to the one during 2003-2007 (I-2), and was therefore more ‘sustainable’
FIGURE 11

(10) Final re-assembly of all sub-periods (1984-2012)
In figures 12 (a), (b) & (c) below, all the various sub-periods described above have been compiled together in correct sequence to indicate the fluctuating patterns of the US economy’s growth-drivers.
FIGURE 12(a)
FIGURE 12(b)
FIGURE 12(c)

In addition, Table III (a) indicates the increases in component-share seen in each of the sub-periods.

Finally, Table III (b) sorts all similar growth sub-periods by type and provides increases in component-share across that particular type of growth-driver.

Note: As seen in Tables III (a) & (b), the average time-proportion spent in Keynesian-Estoppels over the last generation was a high 29%. This implies that the US spent, on average, 3 years in every 10 year-period in a state of crisis, with the government desperately trying to prevent economic collapse. This is an extreme result. In addition, contrary to the common-perception, the US spent only 11% of the time over the last generation in consumption-driven growth periods, while investment-driven growth periods predominated by occurring 43% of the time. 

4. DISCUSSION

4.1 Keynesian Imbalances in America

During the bust, as seen in figures 13 (a), (b) & (c), when investment collapses and panicked consumers attempt to increase saving, thereby sending the economy into free-fall, the government borrows the excess savings (i.e. increased savings - decreased investment) and converts it by force of state-will into consumption. This growth in government-consumption prevents the economy from contracting excessively and so buys time for imbalances (of debt, overcapacity etc.) to correct themselves in an orderly fashion. This is the Keynesian-Estoppel.
FIGURE 13(a)
FIGURE 13(b)
FIGURE 13(c)
Once the panic has subsided and confidence returns, the government must reverse this action during the next boom. It must reduce government-consumption share of GDP during the boom just as it has increased government-consumption share of GDP during the bust. In other words, as seen in figure 13 (b), government-consumption growth must significantly trail GDP-growth during the boom, in order to compensate for its leading of GDP-growth during the bust. This is known as the ‘Keynesian-Recharge’. If this ‘recharge’ is done correctly, total consumption-share of GDP returns to the level at which it was before the bust, and the system is then once again ready to perform another Estoppel at some future crisis.

The first Keynesian-Estoppel of the bust of 1989-92 was correctly ‘recharged’ during the subsequent investment boom of 1992-97. As seen in figure 6, consumption-share of GDP by 1997 had returned to the level at which it was in 1989. This implies that the first Estoppel was properly compensated and the system adequately ‘recharged’ for next use during the bursting of the internet-bubble in 2000.

However, the second Estoppel of the bust of 2000-03 was not ‘recharged’ during the subsequent housing-bubble investment-boom of 2003-06. As seen in figure 9, consumption-share of GDP by 2007 had still not returned to the level at which it was in 2000. This implies that the second Estoppel was not properly compensated and the system was not adequately ‘recharged’ before it was forced into use yet again in response to the bursting of the housing-bubble in 2007.

The third Keynesian-Estoppel of the bust of 2007-09 simply added to the uncorrected imbalance left over by the second Keynesian-Estoppel and sent consumption-share of GDP to even higher levels. As seen in figure 11, consumption-share of GDP by 2012 had still not returned to the level at which it was either in 2000 or even in 2007. This implies that the last-two Keynesian Estoppels have still not been properly compensated and the system is currently out of balance.

In summary, then, consumption-share of GDP has been sent too high by repeatedly applying Keynesian-Estoppels to the system during the busts, without implementing the corresponding Keynesian-Recharge during the intervening boom. It is clear that these frequent and large Keynesian Estoppels have ‘drained the batteries’ of the system. Unless it is recharged by completing the second part of the Keynesian prescription, it is possible that the Estoppel might fail during the next bust and send the economy into irreversible decline.

4.2 The Problem of the Current-account Deficit

The US current-account deficit (CAD) has been the subject of much vigorous debate. At first glance, it appears strange that a rich country like the US, which should ordinarily have no need to augment domestic-savings by running a CAD, should find itself in a situation in which it has been running a large, growing and sustained CAD over the last 30 years. In addition, since running a CAD implies, by definition, that the US is exporting aggregate demand, it has been argued that the CAD is damaging to the US because it is effectively importing unemployment from the surplus countries.

So why does the US continue to run the CAD? As it turns out, the US, as the provider of the global reserve currency, runs the CAD as the principal mechanism by which it provides dollars to meet the genuine reserve requirements of other countries in the world.  A genuine reserve requirement for a country is often said to be equal to 2 months of imports, or 6 months of deficits, or 100-200% of short-term external-debt of that country. Such reserves allow other countries to dampen currency-volatility (spread out any sudden-changes over time) and also provide 'insurance' against any sudden exogenously-triggered liquidity withdrawals, thereby enhancing market-stability in those countries. Given the importance of the dollar to lubricate global trade, as well as the genuine need of other countries to hold modest levels of reserves, therefore, the US cannot eliminate its CAD or try to run a surplus. Such an action on part of the US would damage the world by enhancing market-uncertainty and increasing friction ('de-lubricate') in international trade settlements. Obviously, damaging the world would automatically damage the United States itself.

So then is the US, as the provider of the de facto international reserve currency, doomed to suffer from loss of demand and possibly higher-unemployment because it has no choice but to run a CAD for the sake of the world?

Before we mount our crosses in martyrdom, let us use equation (VI) to examine whether it is really the CAD itself that is harmful, or whether it is the temporal derivative of the CAD-share (i.e. the rising of the CAD as % of GDP) that represents the real danger to the US. Let us examine the two cases separately as follows:

CASE I: Constant CAD-share of GDP

As seen in equation (VI), if the CAD-share of GDP were a constant, then any increase in I/GDP would automatically lead to a decrease in C/GDP. The decrease in C/GDP would gradually lead to evolving excess-capacity and hence puts a lid on any excessive investment-overhang. Conversely, any increase in C/GDP would automatically lead to a decrease in I/GDP. The decrease in I/GDP would gradually lead to inflation by virtue of evolving under-capacity and hence put a cap on any excessive consumption-overhang via raising of interest rates. An economy in a state like this would see normal business-cycles with small progressions, small recessions and small Keynesian Estoppels. In other words, a small, steady CAD would get 'adjusted' into the US economy and would cause no special damage, either in terms of unemployment or in terms of imbalance-formation & instability-magnification.

Case II: Rising CAD-share of GDP

A rising CAD-share of GDP, on the other hand, tends to amplify the underlying business cycles and thus leads to massive boom & bust phenomena. For example, as seen in equation (VI), if I/GDP is rising, a rising CAD/GDP may allow C/GDP to also rise simultaneously (see sub-period M-2 during 1997-2000 in figure 7). Alternately, it could prevent the C/GDP from falling, even as it simultaneously adds more fuel to the rise of I/GDP (see sub-period I-2 during 2003-2006 in figure 9). The natural constraint of over-capacity that was seen in Case-I would be severely weakened. Therefore, the resulting boom proceeds much farther (i.e. the imbalance grows much larger) than would have been otherwise possible, leading to the creation of a massive investment-bubble. In the end, the unwinding of this super-charged investment-cycle leads to a serious and painful bust.

Similarly, if C/GDP is rising, a rising CAD/GDP may allow I/GDP to also rise simultaneously (see sub-period M-2 during 1997-2000 in figure 7). Alternately, it could prevent I/GDP from falling, even as it simultaneously adds more fuel to the rise of C/GDP. The natural constraint from inflation (and hence raising of interest rates) due to evolving under-capacity that was seen in Case-I would be severely weakened. Therefore, once again, the resulting boom proceeds much farther (i.e. the imbalance grows much larger) than would have been possible, leading to the creation of a massive consumption-bubble. In the end, the unwinding of this super-charged consumption-cycle also leads to a serious and painful bust.  

Clearly, it was the rising of CAD/GDP in the US (from 2% in 1997 to 6% in 2006) that was responsible for amplifying the internet-bubble (1997-2000) and the housing-bubble (2003-2006) into super-massive boom & bust phenomena. This is clearly evident in sub-periods M-1 (1997-2000) and I-2 (2003-2006) indicated in the graphs. In light of this, researchers should move their focus away from the CAD itself and instead examine the large-amplitude cycles of the CAD, which tend to magnify the boom and the bust phases of the US Economy and hence require ever-larger and ever more-frequent Keynesian Estoppels.

QUESTION: What would the US economy have been like, had it hypothetically managed to maintain a constant CAD/GDP during 1984-2012?

Here are the approximate counter-factual trends that would have been seen had the US managed (hypothetically) to maintain a constant CAD of 2% of GDP over the last 30 years:
FIGURE 14(a)
FIGURE 14(b)
As seen in figures 14 (a) & (b), the C/GDP & I/GDP would have had no obvious secular-trend as both would have been largely cyclical. Sometimes we would have seen investment-driven growth, sometimes consumption-driven growth, and balance-driven growth would have occurred for the rest of the time. We note that 'mix-driven growth’, by definition, is not possible in an economy with a constant CAD/GDP ratio. As also seen in the graph, we would still have seen the usual business-cycles, but the high consumption-levels that we see today would not have developed, because the Keynesian-Estoppels would have been much smaller in magnitude and more easily recharged in each cycle.

This leads us to an astonishing conclusion: A steady CAD of 2% of GDP would cause less harm than a cyclical variation of the CAD between 0% and 4% of GDP, even if the average CAD across the cycles were to be at the same at 2% of GDP level. This is because the former would get 'absorbed' into the natural ebb & flow on the US economy, while the latter would naturally tend to magnify or amplify its internal boom & bust cycles.

4.3 The Leaking-Demand Problem

During the bust, the Government props up demand by borrowing the excess savings (i.e. difference between savings and the falling investment) and spending it to prevent consumption-growth from collapsing along with investment-growth. Given that the CAD is merely an expression of inadequate savings (i.e. a CAD implies that investment needs are greater than domestic savings present), it follows that the CAD should ideally vanish during the bust. In practice, of course, the CAD does not completely disappear, but the CAD-share of GDP usually decreases during the bust, as seen in figures 5 and 10.

Since the decrease in the CAD-share of GDP ‘assists’ the government in propping-up domestic-demand, we can perform a comparative study of ‘load-sharing’ to determine how much of demand increase came from additional government-spending and how much from the reduction of the CAD-share, as shown in Charts 1 (a) & 1 (b):
CHART 1(a)
CHART 1(b)
From Chart 1(b), it appears that during the first Keynesian Estoppel (1989-92), government spending did ~62% of the work and the reduction in the CAD-share did ~38% of the work of increasing domestic demand to offset the falling investment during the bust.

Similarly, during the third Keynesian Estoppel (2007-09), government spending did ~54% of the work and the reduction in the CAD-share did ~46% of the work, implying that it was slightly more efficient than the first case in which more of the demand ‘leaked out’.

The same chart indicates, however, that during the second Keynesian Estoppel (2000-03), the government spending did ~125% of the work and the reduction in the CAD did ~ -25% of the work of increasing domestic demand to offset the falling investment of the bust. This is a shocking and disturbing result. As seen in figure 8, even as the government was desperately trying to shore-up demand during the 2000-03 bust, the CAD was actually increasing over that period. This makes no sense whatsoever; it is almost schizophrenic in character. While on one hand increased government deficit-spending is indicating that an excess of domestic savings exists in the economy, on the other hand the CAD-share is increasing, indicating a deficiency of domestic savings in the economy. This leaves the observer confused; it cannot simultaneously be both, so which is it? Clearly, we can see that the rising CAD once again made a bad situation much worse.

5. CONCLUSIONS

5.1 Managed Moderation

The US must set a deficit-target within a range of 2-3%. If the world needs US Dollars for use outside of US trade, the world can certainly have US Dollars via a reasonable, manageable and managed deficit. A discussion & consensus will be needed between the US and the East-Asian and Germanic countries so that this target can be maintained. For example, if the US deficit rises above 3%, the East-Asian and Germanic countries will have to agree to take action (reduce wage-repression, financial-repression, adjust currency-pegs etc.) to reduce their surpluses. Conversely, if the US deficit falls below 2% and a global-shortage of dollars appears for genuine reserve needs, the resulting dollar-demand would naturally strengthen the dollar and move the deficit back into the targeted range. Once the US CAD is stabilized, the business cycles within the US will stabilize and the extraordinary magnitude of the amplified boom and bust sequences we have seen over the last 20 years will become a thing of the past.

With the rapid-rise of Asian economies, it is reasonable to assume that the US economy will keep becoming an ever-smaller share of the global economy. If the US then implements bounds on its CAD, then it will naturally reduce the ability of fast-growing large-countries like China to keep running large surpluses. The only solution to this problem is for large, planned-deficit countries like India to also grow fast and so provide additional sinks for the global surpluses.
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5.2 Uncle Sam's Meddling

It is true that government meddling in trade and/or in the economy generally leads to inefficiency, and is hence usually undesirable and sometimes even dangerous. However, we note that the term 'government-meddling in the US economy’ is often incorrectly used to imply only the interference of the US government. Even if the US government does not meddle in the US economy, it is obvious that the German, Chinese and Saudi governments, for example, are already meddling with it. In a globalized, free-trade system, the meddling of foreign governments in their own economies automatically affects the US economy via trade-imbalancing and capital-distortions. Therefore, interventionist foreign-governments effectively end-up meddling in the US economy, regardless of whether that is their intention or not. In light of this, the ideological opposition to US government interference in trade (or the economy) -- while historically and rationally valid-- is no longer justified in the context of the global trade system we have today. The ideologues of this anti-government variety, who often refer to Keynesian-Estoppels as 'Voodoo Economics', and who have so far been insisting that the US Government stays out of the economy, will have to choose between following three options in the near future:
(a) Get all foreign governments to stop meddling with their own economies, or,
(b) Stop trading with the world and turn the US into an isolationist country, or,
(c) Accept that the US government with have to take counter-actions as needed.

5.3 The Nature of the US Economy

Even though the US Economy appeared to be consumption-driven from a quick inspection of figure 1 at the top of this article, a more detailed analysis (see Table III (b)) has now revealed that:
(a) The US economy spent only 11% of the time during the last 28 years in consumption-driven growth mode, with consumption-share of GDP rising.
(b) Mix-driven growth occurred 18% of the time, with the increasing consumption-share sub-type (i.e. Type II mix-driven growth) occurring only 10% of the time.
(c) Investment-driven growth, with consumption-share of GDP falling, predominated during the last 28 years by occurring 43% of the time.
(d) The economy spent 28% of the time over the last 28 years in Keynesian-Estoppel mode, with government-diktat guiding the economy in order to prevent collapse.

In light of the above, a more nuanced descriptor is clearly needed for the US Economy. As seen in Table III (b), the total increase in consumption-share over the last generation has been 6.5 percentage-points of GDP. We could divide this 6.5 PP increase into three parts as follows:

PART 1) As seen in the last 4-rows of Table III (a), an increase in consumption-share of 3.2 percentage-points of GDP over the last 12-14 years is directly attributable to the two un-recharged Keynesian Estoppels. Once they are adequately compensated, this increase will simply vanish and the US economy will rebalance. In fact, as it turns out, this is exactly what the IMF projects will happen over the next few years, as seen in figures 15 (a) & (b).
FIGURE 15(a)
FIGURE 15(b)
PART 2) An increase in consumption-share of ~ 2.8 percentage-points of GDP over the last 28 years may be simply attributed to the increase in the old-age dependency ratio in America. Even though the US may not be aging as fast as Japan & Germany, the baby-boomer retirement wave implies that a larger section of the population has been retiring to consume without producing. This automatically leads to a slowly-rising consumption-share of GDP and is a natural phenomenon unconnected to deliberate consumer-behavior.

PART 3) This finally leaves a tiny and almost statistically-irrelevant increase in consumption-share of ~ 0.5 percentage-points of GDP over the last 28 years to be attributed to the ‘frivolous, bling-loving, shopaholic’ American Consumer.

In final summary, therefore, the US economy is not naturally the 'consumption-driven' economy that it appears to be on prima facie examination. In its natural state, it is a balanced economy that simply alternates between investment-driven and consumption-driven cycles, with some pure balance-driven periods and Keynesian-Estoppels thrown in. The primary reason why it superficially appears to be a consumer-driven economy is because of the imbalances created by uncompensated large Keynesian-Estoppels, which were themselves the consequence of a large & rising CAD. The secondary reason why it superficially appears to be a consumer-driven economy is because the retirement-pattern naturally causes consumption to rise slightly faster than production as part of a classical aging-demographic pattern. Once we correctly account for these two factors, the myth of cultural consumer-excess in the US is automatically shattered.


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