Hamish McRae: The new President has a huge challenge ahead of him

It makes no sense to use loans from China to fill shopping malls with cheap tat
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The Independent Online

It is a devastating inheritance. The 44th president of the United States takes over an economy that has almost certainly fallen into recession, and coping with that will surely dominate the first part of his term of office. But there is something even bigger stalking the US economy and that is its longer-term dependence on foreign investors being prepared to carry on financing it – in effect, buying up America. To wean the country off such dependence will be even harder than shepherding it through the downturn. Cyclical problems eventually solve themselves; structural ones don't.

Still, this cycle is starting to look much nastier, with prospects suddenly deteriorating in the past few weeks, even days. Until September the US seemed to be coming through the global downturn in somewhat better shape than Europe or the UK. But now the US economy seems to have hit a wall. Consumers are cutting back radically; house prices are still falling; companies are finding it hard to borrow and hence slashing investment; unemployment is rising; and, a practical issue for the new president, the government deficit is ballooning. The Federal Reserve has cut its overnight interest rate to 1 per cent but so far that has had little effect, and obviously at that level has no more ammunition left. If a rate of 1 per cent does not help the economy, why should half a per cent or even zero?

As a result of these darkening economic conditions, Americans have become both angry and frightened: angry because of the excesses and stupidities of Wall Street and frightened because as the malaise has spread beyond the financial community to the real economy they have begun to suffer directly. That fear shows in a catastrophic loss of consumer confidence. In October car sales were down 31 per cent on the previous year, the worst month for the industry since 1991. Allow for population growth and it was arguably the worst month for sales since the 1950s.

So the first challenge for the new president will be to help Americans recover their sense of optimism. Franklin D Roosevelt had to combat that when he took over in the very much worse economic conditions of 1933. Those famous words in his Inaugural Address are worth quoting in full: "So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself – nameless, unreasoning, unjustified terror which paralyses needed efforts to convert retreat into advance."

It is thanks in part to the folk memory of the catastrophic policies that deepened the 1930s depression that the US authorities, indeed the world's monetary authorities, have sprung into action, rescuing banks so that depositors don't lose any money and pumping liquidity into the system so that the banks can continue lending. But if the financial institutions are probably past the very worst of the crisis, their recovery has hardly begun. Meanwhile the real economy is still heading downhill and at an increasing speed.

There is no wand that the new president can wave to magic this situation away. We are where we are. One of the problems he faces will be the expectation that a new Administration can make a swift and material difference to the country's economic prospects. Policies can be helpful or perverse and had the US banking system been allowed to collapse that would have been profoundly perverse – the one serious error of policy this summer that we can now identify was allowing Lehman Brothers to go bust. But even helpful policies take time to have effect.

Fortunately, however, economies are self-healing. While 2009 does look very difficult for the US economy, with most predictions suggesting it will shrink overall, there are reasonably solid hopes for a recovery in 2010. At some stage US house prices will bottom out and start to rise again, and at some stage the banks will be recapitalised and confident to resume lending. There will be a recovery and it will take place during the life of the incoming Administration.

But there is something else. For the past 15 or so years, but most particularly during the past five, the US economy has increasingly lived beyond its means. This shows up in the huge current account deficit, the largest proportionately and of course absolutely, of any large economy. It shows up too in a large fiscal deficit, larger proportionately even than our own. It shows up in very low US household savings, which are at or close to zero.

The US has been able to run the "borrow and borrow big" policy because other countries have been prepared to lend to it. Rationally it is bizarre that the world's biggest economy, and the one with just about the highest standard of living, should have to borrow to keep itself going. Strategically it has been unwise to borrow so much from economic rivals such as China and somewhat unstable partners in the Middle East, because sooner or later these loans have to be paid back.

Besides, it makes no long-term sense to use loans from China to fill the shopping malls with cheap tat. The US consumer ends up with rubbishy consumer products and the US as a country ends up with huge obligations, giving China the opportunity to buy up real assets – land, office blocks, companies and so on – that had previously been owned by Americans.

If the country as a whole has been unwise so too have many individuals within it. One of the startling revelations of the past few months is the way in which Americans with no income, no assets and no credit record have been able to borrow money from the banking system. Those loans are now going sour and you can argue whether this was principally the fault of the borrower or the lender. You cannot however argue that it is a great idea for families not to have any savings.

You can talk about this in terms of economic numbers, that in the US the proportion of GDP that is consumed rather than invested is too high at 70 per cent. But it is not just an economic issue; it is a social issue. It is a question of whether you depend on others or do you depend on yourself.

So the challenge facing the 44th president is to explain to Americans that the country needs to become less dependent on others for physical resources, most notably oil, but more importantly less dependent on the rest of the world for financial resources. It needs to get saving again both at a national and family level. The US economy remains huge, flexible and powerful. But it has undermined its own strength by its self-indulgence and those of us who like and admire the US, as I do, would feel more comfortable were the new president to start nudging the country towards a more sustainable future.

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