Happy Days Unlikely to be Here Again for Some Time

Earlier this week Martin Woolf posted this graphic in a FT article. His argument was that the world has run out of willing private sector borrowers, and that governments will have to take their place - but that this can't go on for ever. There will come a point when no one trusts 'government paper' any more. The countries on the left of the graph - those with huge surpluses - have to expand domestic demand to absorb these surpluses. In doing so they will export demand to the deficit countries - who almost certainly face further, perhaps dramatic, currency depreciation - and pull the global economy away from the abyss and a general move towards protectionism.

In the subsequent discussion various pointy-heads make the point that both Germany and Japan are set up as export focused economies and that shifting this is not going to be easy. Similarly John Ross has already noted that,

"..[if] China’s balance of payments surplus were to fall by half under the impact of pressure on exporters and cheaper imports due to the higher exchange rate, while its savings level remained the same, this would required $175-$200 billion extra a year investment in China’s domestic economy. While there is no financial constraint on this, due to the high savings rate, the task of physically gearing up the economy for such a scale of extra-investment programmes is gigantic."

& this is not even to attempt to think about what 'increasing domestic demand' might mean for the countries holding the largest trade surpluses of all - the oil exporters. For many of them, their entire economy is based on pumping the stuff out of the ground and shipping it overseas: for the Gulf States and Saudi there is a real question as to where they actually have enough people to stimulate purely domestic demand to the level required. Here's a thought: after you have given each of, say, the one million Bahrainis free university education, a rent free mansion and two gold plated limos what else can you do ? After all, 60% of their exports and 30%of the GDP comes from oil - Saudi Arabia has 27 million people, but their oil dependence is even more striking: 90% of exports and 45% of GDP. 'stimulating domestic demand' to this sort of level surely just ain't possible.

Meanwhile, Woolf makes the point that the German surplus more or less keeps the Eurozone afloat and in balance, despite the massive French, Spanish and Italian deficits. So we still have the old 'German horse and French rider' model of how the EU works - but this must surely break down eventually. I'd certainly try to avoid attracting attention at the next EU summit if I were José Luis Rodríguez-Zapatero: it is not immediately clear to me why a German Christian Democrat, even a Keynesian influenced one, should pay for social democratic programmes in Iberia.

So who does that leave most exposed? Well, the States of course. But Empires don't collapse through one shock. They will manage their declined gradually, though not without considerable political and no doubt psychic pain as it becomes apparent that their days as top dog are perhaps numbered.

Oh: and Britain, Turkey and Australia. If Woolf is right we, more than anyone else, have to become poorer, work harder and put more of our savings into productive enterprise, not housing and other consumption goods.

The thing is, if I understand Woolf correctly, this is the happy scenario. If it doesn't happen we have a return to protectionism and the 1930s.