The Need for a New Economic Model. Gennaio 2009

• Let’s start from the accounting identity. In the case of the US we have had in the last years a growth led by consumption (C). Investment (I) has been weak and below the companies’ current cash flow. Public Deficit (G-T) has been around 3%, not too much. The foreign trade balance has been negative, as the US imported a lot of foreign produced goods. (To have an idea, the estimated 2009 US trade deficit is around 250 B$ with China, 150$ with Europe, and 100B$ with the Oil Countries).

• Two questions immediately arise: how to consume a lot, i.e. the consumption’s rate of growth becomes higher than the rate of growth of income, and how to pay for the foreign goods.

• In the consumer goods domain we have had deflation. The price of goods either collapsed or stayed very stable, taking account for the quality increase. Example: Electronics and cars. In services we have had a stable and low inflation. If something can be internationally traded, it comes under price pressure, otherwise no. Example: I (if I were economically rational) don’t take an expensive plane to go to a barbershop in China, because of the low cost of an haircut. Globalisation does not affect the western coiffeur but it hurts the unskilled western blue collar. Symmetrically, globalisation does not support the eastern coiffeur and it helps the unskilled eastern blue collar.

• At the end, the rate of inflation has been low, and even more important, stable. Stability means that the average inflation has been 2,5%, with an upper band of 3%, and a lower one of 2%. Inflation rate has been low and, even more relevant, predictable. The risk premium on bonds (more on the technical matter) went down. Therefore the real absolute level of the bond yield dropped down (more on the technical matter). In the US, the private bond market is the market for the debt of households. The financial industry supplied bonds (backed by mortgages and credit cards) to the US (and world) savers at decreasing interest rates. At the end, money was picked up cheaply and lent to the households (the borrowers of last resort) for consumption.

• Summing up, Chinese production pushed down the prices of manufactured goods. Chinese purchases of US bonds pushed down the rate of interest on bonds (whose technical name is yield). The Anglo-Saxon consumer became able to buy more goods, both because of lower prices, and the low cost of debt. (The propensity to increase the debt is high amongst the Anglo-Saxons, but is very low in Europe. An hypothesis: everybody wants to show here and now, even through a high debt, how hard and successfully he has worked, in a world where the legacies of the class of origin have disappeared).

• Chinese companies earn dollars from their exports, but they have to pay both the wages to the manpower and the suppliers. They need yuan. The central bank changes their dollars at a fixed rate into yuan. The central bank invests these dollars into the US public debt. So the US received dollars from China in order to import from China. The US accumulates debt and China credits.

• In the last decades several hundred million people in Asia became for the first time well off, meanwhile the Anglo-Saxon consumers stuffed themselves with plasma TV and SUV. That was the world till 2007.