The U.S. and global economic conundrum

Ghalib Chaudhuri, The Daily Star, Asia News Network, Dhaka

Here are just two of the many economic riddles facing the world today: U.S. as the largest global economy, and de-facto engine of growth for rest of the world, has been pursuing a lax monetary policy through a low interest rate regime since year 2000. This has helped a consumer bonanza based on cheap money that seems to have an interminable life with strangely no effect on price inflation.

And secondly with current account deficit at a high of 5 percent of GDP, the U.S. dollar has curiously managed to maintain most of its value. These are just two of the many puzzling global economic phenomenon that confronts us today. It is at the heart of the imbalance that causes us to think for solution before it turns into a disaster.

World economy is precariously unbalanced, although on the face of it this may not appear to be. The principal worry exist with the U.S. economy; whose consumer keeps the world ticking, as its collective force is singularly responsible for about seventy percent of the U.S. growth; consequently a significant influence on global growth too.

Fortunately for the U.S. and rest of the world, U.S. consumers have been very resilient; other than few months in the summer this year, they have consistently kept an up beat momentum. What is it that keeps them going? A false sense of real wealth is the short answer: The Federal Reserve (U.S. Central Bank) has consistently dropped Federal Funds Rate- the key reference rate since January 2000 till June this year, signaling a looser monetary stance.

Although, rates have begun to rise back since its low of 1percent to a current level of 1.75 percent, which is relatively still pretty low, allowing the American public to continue borrowing at affordable levels and spend away like no tomorrow.

The unprecedented borrowing binge have resulted in raising the debt asset ratio to a historical and unsustainable high of 23 percent, while reducing the saving's ratio to a mere 2 percent. Adding to this predicament is the asset price inflation, particularly property prices, which have gone through the roof, providing another source of false wealth and security.

However what is also curious, that despite the relentless consumer surge, prices in America other than oil, housing and some commodities have remained relatively stable.

The answer to this lies in Asia and more particularly with China who has been extremely successful in keeping down prices by providing consumer goods at lower and lower prices. There are apparently another 200 million additional underemployed workforces ready for deployment, if the world demands it, before there are any perceptible effect on capacity and prices.

So here is one of the conundrums: Artificially stimulated U.S. economy continues with its buying spree causing no pressure on prices, because the world, thanks to China, no longer has an issue with labor supply and capacity.

Just for a moment think what it would be like if the China factor was not there today, and the U.S. is faced with a conventional economic environment. For a starter interest rate would be pushed up further as the fiscal and monetary stimulants would have challenged capacity and consequently driven prices up, prompting the Fed to act in curbing incipient inflationary tendencies. Instead, we have a situation where the existing fault lines are getting bigger and wider for an economic disaster waiting to happen. What will trigger it is the moot question?

The other conundrum revolves round the U.S. dollar. Again, conventional economic theory suggests on the basis of the current account deficit its value should be lot lower than where it is today. However that is not the case, the dollar continues to be resilient after relenting 30 percent of its value against the Euro since its peak. So what is keeping the dollar up?

Once again Asia is the answer and more particularly China and Japan together is helping to shore up the mighty dollar. Both countries are using their bloated reserves to buy U.S. Government Bonds. The objective for both Asian countries is not so much investment returns, but being major exporting nations, wanting to maintain the competitive value of their own currency.

Had it not been for this voracious appetite of these Asian central banks, U.S. would find it difficult to offload its burgeoning debt obligations which is the other deficit that has reached an unsustainable level of about 6 percent of the GDP. The twin deficits of the U.S. have the hallmark of a sinister foreboding.

China largely holds the key to the stability of global economics. To mend the economic fault lines in the U.S., China has to transition and integrate smoothly with rest of the world. Its continued blistering growth around 10 percent, however gives the world the jitters.

The Chinese government is applying the brakes through administrative directives, rather than using the tools of interest rate and currency revaluation. So far it is not really working. Ideally China should slowdown to a pace around 7-8 percent which will help curb the over investment frenzy and reduce the pressure on commodities not least oil. But the crux of the matter is, can China manage a disciplined transition to a modern economy without periodic collapse and sending seismic shock waves around the globe?

The imbalances of the U.S. economy can easily be tipped over by the Chinese, but we feel relatively safe because any detrimental Chinese action can also act as a double-edged sword that could equally harm them too.

Many therefore believe, perhaps naively, that the status quo will be maintained and the desperate need for correction in the U.S. economy will gradually auto correct through graduated policy changes. Hope this view is right, the alternative may just be too catastrophic.

The writer, a former investment banker, is managing partner of an independent consulting practice based in Singapore.