Downsizing The Global Economy

Reading about AIG bailout number 3, I was struck by the end to a column by BusinessWeek's Diane Brady, who wrote: "The former $100 billion-a-year giant will be smaller, humbler, and less of a force in the marketplace." AIG is in good company - what we are currently seeing is a downsizing of the global economy as a whole. This is not just a temporary phenomenon; the explosion of growth and consumption of the past decade was just as unsustainable from a financing perspective as it was from a climate-change viewpoint.

Here's what I mean: The chief economist of CIBC wrote Monday in a note that the problem with the U.S. carmakers is not that they make the wrong cars, but that they make too many of them. He thinks that in five years time, there will be 25 million fewer cars on the road in the U.S. and that the companies need to shrink to reflect that much smaller market.
Same thing with housing: prices keep declining because there is too much housing stock around, while the pool of people who can and want to buy keeps shrinking. It's similar on a global scale: Chinese textile factories are making too many socks and T-shirts, Swiss watchmakers too many watches, everybody wants more, expects better living standards, more consumption. We have long known that this life style is not sustainable, now we are learning that it isn't financeable either.

Recovery will come when supply and demand find a balance again, but that will be at a much lower level than policymakers appear willing to accept (though planet Earth for one will probably heave a great sigh of relief.) At the moment, all efforts are aimed at restoring what we had before by helping to restart lending. Those trillion-dollar efforts are aimed, particularly in the U.S., at restarting home and consumer lending; at silencing the populist cry that the banks must be fixed so that they can lend again. Credit card companies and shaky auto finance companies turned themselves into bank holding companies and got TARP money - all in the name of restarting lending and helping the economy back on its feet.

These efforts will all be in vain: the grand credit machine of the pre-August 2007 world cannot and should not be resuscitated. It died because it was unsustainable. We should not seek to bring it back to life; the democratization of credit - as one banker once boasted - is nothing but a chimera. The global economy will shrink, and the shrinkage will be led by the developed world, because it was the developed nations that gorged on too much easy credit. Those in the developed world that didn't - the Germans and the Japanese - allowed their addiction to exports to blind them to the necessity of structural reform. Moreoever, much of the developed world's credit addiction was fueled by the surplus funds that other, more frugal countries, had piled up. They too will discover that hoarding reserves cannot replace sustainable domestic development.

Much has been made of the wealth that has been destroyed by the Dow's downward spiral which took the index today back to levels not seen since 1997. We should remember that much of this wealth was not real, but conjured out of the thin air of securitization plus leverage. That funny money is gone, and the world might be better off if it never comes back.