Back in the golden days of 2004, American consumers were the fuel for a historic expansion of the world economy.
Ringing up sales of everything from GPS navigators to gasoline, they drove US imports to a record level. The United States devoured $500 billion more in imports than it exported – single-handedly enabling booming trade surpluses for countries from China to Japan to Germany. For several years, the world economy clicked along at 5 percent growth, as Americans paid for this consumption binge partly by pulling unprecedented amounts of equity out of their homes.
You know how the story ends. A financial crisis and a deep recession curbed home-equity borrowing and erased any notion that US consumers will provide the chief path to global growth anytime soon.
That means the search is on for a new, more sustainable model for world economic growth – one that avoids the pitfalls of what policymakers now call "global imbalances."
Already, the imbalances have been partially corrected by the harsh hand of recession. American consumers can no longer soak up extra output from Asian factories the way they did earlier this decade.
But this leaves two big questions related to rebalancing the world economy:
Who or what will fill the hole left as US consumers retrench? And how can nations – especially the US and China – avoid a repeat of the kinds of imbalances that set the stage for the great recession?
These urgent questions have an important subtext: a longer-term shift in economic power from advanced nations to the emerging countries.
For the US, this doesn't necessarily portend a period of decline, policy experts say. But challenges lie ahead. Belt-tightening for government, restraint by consumers, strategies that revive exports, the need for artful financial diplomacy – these could become themes in a new economic chapter for America.
The recession has become a catalyst for the world to focus on imbalances and the ongoing shift in economic power, but these aren't the kinds of issues that can be resolved at a single summit. Still, important signs have emerged in recent weeks:
• US Treasury Secretary Timothy Geithner has been working hard on the pivotal US-China relationship – both to nudge changes by Beijing and to reassure China, a major creditor, that the US will get its own house in order. After a US-China economic dialogue two months ago, Mr. Geithner summed up the outcome: "China will rebalance toward domestic demand-led growth," he said. "President Obama has committed to lowering federal deficits to sustainable levels once recovery is firmly established." For both nations, such achievements will be a tall order.
• At a Pittsburgh summit of the Group of 20 nations last month, a wider pool of leaders rallied around the idea of working together on "global rebalancing." The process lacks an enforcement mechanism, but the group asked the International Monetary Fund (IMF) to assess how individual nations do.
• At the G-20 meeting, the world's economic old guard agreed that major emerging nations should get formal seats at the table when big policy issues arise. In effect they said goodbye to the old Group of Eight and made the enlarged G-20 pool the primary forum for big-country discussions in the future.
• In early October, IMF forecasters gave an upward bump to their outlook. In part, this stems from stabilization in advanced economies. But the recession has amplified the importance of emerging economies. China and Brazil, to name two, appear to be recovering faster than expected. The IMF forecasts 5.1 percent growth in emerging nations next year, and just 1.3 in the advanced economies.
"The current numbers should not fool governments into thinking that the crisis is over," IMF chief economist Olivier Blanchard has warned. Sustainable growth for the world will depend, he said, on solving the problem of big imbalances.
The biggest of these, perhaps, is the US trade deficit. It reached $840 billion last year. That's how much America imported, over and above the value of its exports.
Since 2002, as China's exports ramped up, the US trade gap has surged into what some economists see as a danger zone – a size greater than 5 percent of America's gross domestic product. That's way beyond where it was in the 1980s and '90s.
One cause for the trade gap is US financial habits. High federal budget deficits and consumer debt mean that America is forcing itself to borrow overseas – and in effect that means imports must outrun exports. The danger is that other nations will become wary of lending so much, and a messy collapse of the dollar or a spike in US interest rates could result. That would be bad news for the US – and for the rest of the world.
But another cause stems from policies outside the US. Asian nations manage their currency values to promote exports, economists say.
The trade deficit has eased this year, as recession curtails Americans' appetite for Chinese electronics and other goods. But the trade gap could widen again – or at least fail to keep shrinking – absent additional actions by policymakers, economists say.
Beyond the gigantic trade deficit, some economists worry most that the overseas migration of America's manufacturing base is reaching a crisis level.
The US is now running trade deficits in advanced-technology products such as computers – a trend that began in 2002. In a few years, Chinese firms expect to export cars to the US. Even America's longstanding leadership in aerospace and semiconductors is at risk, says economist Charles McMillion of MBG Information Services, in a new report for the US-China Economic and Security Review Commission.
Beyond any single product category, the weakening of America's broad supply chain overall "is the most urgent challenge to US economic and military security," he writes in the report. The need is not just to reduce imbalances but to do it in a way that allows both advanced and emerging nations to grow. US consumer spending is expected to rise in 2010 at barely half the pace typical in some recent expansion years, many forecasters say.
Americans faced worries about economic decline before, a quarter-century ago. One big difference today: US government debt has ballooned, is on pace to keep growing, and is held in large part by foreign governments and investors.
"The US then was the world's banker, and now we're the world's debtor," Mr. McMillion says.
A degree of debt is not a problem, but many economists see current trends as unsustainable.
Still, with the right policies, America can prosper and remain a world leader, they say.
So how does the US adjust the imbalances and retain its vigor? Here's a checklist of economists' top ideas:
Currency adjustments. If the value of Asian currencies were to rise and the value of the dollar to fall, US exports would be more competitive. Some researchers warn that currency changes are at best only part of the fix. But since 2002, a dollar decline has made US factories more competitive. So far, the dollar has adjusted mainly against European currencies, with the euro now looking unrealistically strong to many analysts.
Trade rules. The US-China Commission's 2008 report to Congress urged tougher efforts to prevent violations of World Trade Organization treaties (along with currency changes and other steps). The trick is to balance enforcement with pursuit of trade openness, which has buoyed global growth, economists say.
Industrial policy. A revival of US manufacturing might be aided by federal policies to promote jobs in leading-edge industries. One recent initiative will make sure the US gives China a run for its money in automotive batteries. Anything that reduces reliance on fossil fuels could be a double win - helping the environment and reducing dependence on oil imports.
Human capital. Strengthening education – and enticing more high-skilled foreign students to stay after studying in the US – can help America remain the leader in innovation and entrepreneurship. Economists also urge better support for displaced workers to train for new careers.
Consumer behavior. Greater saving by US consumers would reduce the need to borrow from abroad. Personal savings rates have already jumped, a welcome move although it was prompted by recession.
Federal deficits. It's hard for the US to rebalance while the government is borrowing huge sums from abroad. This looks to be a long-term battle centered on healthcare costs, although any dollar or interest-rate crisis could force tough decisions on Congress. When Wall Street went haywire last year, the dollar actually rose, because it's the world's haven currency. But "looking forward, there will increasingly be other options to the dollar," World Bank President Robert Zoellick said recently.