Keeping America afloat

In late 1998, during one of the crises plaguing emerging markets during the 1990s, Abby Joseph Cohen - the (then) highly esteemed strategist at Goldman Sachs, coined the phrase "aircraft carrier" to describe the American economy. She argued that the crisis in emerging markets wouldn't deflect the great ship America from its course.

More than a decade since, the aircraft carrier is listing badly. It seems the image she created won't live on much longer.

We all like similes and metaphors. They add color and vitality to otherwise dry-as-dust economic analyses so mind-numbingly full of numbers and facts. But if a simile or metaphor proves to be wrong, we have to find a new one. Allow me to make my meager, unworthy suggestion for an addition to the economic lexicon. The American economy is no longer a juggernaut of a boat cruising the great global oceans in unqualified safety, so what other mode of transport might we suggest? A hot-air balloon comes to mind.

Like a hot-air balloon, from time to time the U.S. economy needs a shot of hot air to keep it inflated, lest it crash to earth. Like a hot-air balloon, it can be kept by its pilots at a roughly given height, but it can't be navigated with any precision. The direction of the American economy will be governed by external forces greater than itself.

The hot gas that Americans have been pumping into the balloon to keep it from crashing to the hard ground of reality is actually a mix of liquidity, low interest rates, huge budget spending and tax cuts. In the short run, this mix creates the hot air that keeps the balloon afloat. Unhappily, frequent administration of this mix just winds up strengthening the gravitational force pulling the airship groundward because of the mushrooming weight that in economic circles is called mounting debt.

Let's see how many "hot air events" we can count in just the last decade. In 1997-1998 there were several crises around the world: Russia, the collapse of Long-Term Capital Management and the Asian currencies crisis. In all these cases, America reacted the same way: injections of hot air. The hot air, and cheap money, had the effect of inflating the technology bubble that peaked in 1999.

Immediately thereafter came the terror of the Y2K bug (remember those funny forecasts that the world as we knew it would come to an end a second after December 31, 1999, because computers would think the year 2000 was actually 1900, and entire global systems would crash, causing mass panic and starvation? The forecasts were wrong.) America handled the bug fear fest by pumping in more hot air.

A couple of years later Nasdaq crashed - more hot air. September 11, 2001 - hot-air dosage. Housing bubble explodes? Bring on the hot air. Financial meltdown? Huff and puff and inject hot air. Detroit crashes? You guessed it, hot air.

In short, the American hot-air balloon needs hot-air injections at an increasing frequency. One has to ask, how much hot air can the balloon's leaders manufacture?

There is no clear-cut answer to that. But it seems the supply is running short. If it turns out that the incentive plans of 2008 and 2009, with all the accompanying deficits and injections, can't keep the bubble afloat, and that the second the hot-interest-rate pump is disconnected, the hot-air balloon begins to lose height, that will probably mark the end of that strategy.

Very probably, the last hot-air injections really will be the last because the price - the cost to future generations - is becoming intolerably heavy.

I think that's actually good news. A hot-air balloon may be a pretty mode of transportation as it gently drifts through the wild blue yonder, but other modes of transportation are a lot more practical. The sooner America's economic leaders digest the news that they have to abandon hot-air balloon economics in favor of another, more stable platform, even at the price of a crash landing on the rocks of reality - the better.

The problem is that it's very hard for Americans to come to terms with the fact that they can't go on this way. We humans apparently have a bug in our programming: We only accept reality after it has bitten us hard.

Change in the American system depends on one fundamental insight: The period of prosperity driven by consumer spending, mainly on imported goods using borrowed money, is over. Efforts to revive the corpse by artificial means are doomed. Maybe there will be one or two more stabs at driving consumer spending, but it can't go on - the resources are running out.

And in its wake, America is left with one great gaping hole.

The hot-air model is dead. America needs a new model, in which investment in infrastructure, production and jobs replaces consumer spending.

Many Americans may cavil that their standard of living will drop. They won't like the change. But it isn't up to them anymore. The forces pulling in that direction were set in motion years ago. They are stronger than the will of the American people.

Now for some good news for America, and bad for the rest of the world, mainly China. There's a saying that during a famine, the fat people lose weight, but the thin people die.

The United States has built up gigantic financial deficits and debts. China, on the other hand, has a surplus of financial assets. Many a pundit says the trend will continue until China supplants the United States as the financial superpower.

But surpluses versus deficits aren't the whole story. People and countries have economic assets that you won't find in balance sheets. China has a vast sea of hard-working, disciplined laborers accustomed to low pay and settling for little. You could see them as China's No. 1 export. China exploits this advantage and has accrued great wealth, some of which is spent on acquiring essentials such as food for its giant population and raw materials for industry.

When an American buys a Chinese product, he's buying a raw material from Australia or Brazil that was processed in China. Some of the dollars the American paid therefore wind up in Australia or Brazil and some stay in China to be used to buy more food or raw materials.

The United States is "poor" in cheap manpower that will work for a pittance, but it doesn't have a gigantic population that needs feeding. The United States has a great deal of natural resources and enough food to take care of itself and export, too.

Other than oil, regarding which the United States could certainly economize, most of its basic needs can be supplied by America's own resources.

The day may be nearing when America , the world's favorite client, abandons its hot-air balloon strategy and replaces some of its excessive consumer spending with savings and investments. And then its suppliers, including China, will themselves experience a sharp slowdown, possibly even a crisis.

Is that a likely scenario? Hard to say. On the one hand, massive increases in debt, the systematic implosion of the dollar and the increases in commodity prices can't go on forever. Many people think America can't diet, so the dollar is doomed. If the dollar weakens, commodity prices will climb further and manpower-rich countries such as China will become the place to invest.

But life can surprise. If America, willingly or by force, starts dieting rather than pumping more and more hot air into its balloon, the opposite will happen. The dollar will strengthen. Commodity prices will drop. Countries whose economies are based on making cheap consumer goods for export to America will hurt, very badly.

The writer is the chief executive of Compass Investments, a member of the Psagot group.