The following article is not of any great consequence for my projected book, and the sentiments it contains will change (and probably intensify) over the coming year or two. However, in view of the generally optimistic views that bodies such as the IMF, World Bank and individual finance ministers of countries are habitually wont to give (at least until recently), the current view of the Bank for International Settlements (as quoted below) is another indication that something much more worriesome and, indeed, mysterious, is going on now.

Yes, there are fairly well understood reasons why Japan has stalled completely, Europe is on the verge of it, and America may well be following suit before the end of the year, yet there seems to be a deeper reason why western consumers are not responding as economists, business and finance ministers would like them to. I am beginning to think that what I'm calling the 'initiatory' consumer or trend-setter (the middle class which responds most quickly to innovatory products) is (unconsciously) giving a sophisticated message to the powers-that-be -- "Stop the World! Let's sort out our present problems before we resume economic growth. (And I want more leisure and community, too!)"

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THE WORLD ECONOMY ADJUSTS TO A DISAPPOINTING DECADE

Martin Wolf

Last week the Federal Reserve cut its short-term interest rate to 1 per cent. What was the reaction to a level of rates not seen for four decades? In a word, disappointment. The US is not the only advanced economy whose policies are failing to satisfy the critics. The Bank of Japan is widely thought to have done too little, even though interest rates have been close to zero for years. The European Central Bank has just given Germany an interest rate not seen since the time of Bismarck. But that, too, is condemned by many as too little, too late. Why then are these policymakers proving so disappointing? Because their economies are, is the answer.

This year's annual report from the Bank for International Settlements -- as always an exceptionally thoughtful analysis -- underlines the point "The last year or so has been marked by economic disappointments . . . this was surprising to many given the high degree of policy stimulus being applied in large parts of the world. In fact, such a pattern of unrealised expectations has been the norm for at least the last couple of years".* The scale of these disappointments is shown by the development of consensus forecasts for 2001, 2002 and 2003, respectively. Early forecasts for 2001 and 2002 proved far too optimistic. So far, 2003 is following the same pattern.

These disappointments have usually been blamed on a host of unanticipated events corporate scandals, the outrage of September 11 2001, the Argentine crisis, the Iraq war, severe acute respiratory syndrome and so forth. But this litany of excuses looks increasingly desperate. Something far more powerful is at work. The Anglo-Saxon economies, above all the US, whose demand was the motor of the world economy in the 1990s, have run out of fuel. But other big economies have not taken their place.

As Wynne Godley and Alex Izuretia of Cambridge university note, between 1992 and the 2000s, the financial balance of the US private sector shifted from a surplus of income over expenditure of about 5 per cent of gross domestic product to a deficit of much the same size.** In other words, private spending rose in relation to income by some 10 percentage points of GDP. This will not happen again this decade, perhaps for many decades, since it has left the US private sector - both corporate and personal - with unprecedented debt in relation to income.

These financial deficits have started to reverse, initially in the corporate sector. By early 2003, the balance was already down to about minus 1 per cent of GDP. This post-bubble adjustment has rendered US private demand chronically weak. If the adjustment is now complete, private demand will rise from now on in line with incomes. A more realistic view is that private spending will rise more slowly than incomes. Either way, the US private sector will no longer add stimulus to global demand. If the sober view proves right, it will subtract from it.

It is almost impossible to understate the significance of this turnround in the behaviour of the US private sector for the world economy. What, after all, might be the offsetting forces?

One is the US government. So far, the shift in the US private sector deficit towards balance has been offset by the rising US fiscal deficit. One consequence, as the BIS notes, has been that US gross national savings was down to 13.8 per cent of GDP last year. A quarter of the investment of the world's biggest and richest economy was financed from abroad.

The second offsetting force is a reduction in the net foreign lending that finances so much of US investment. The foreign private sector does, indeed, want to lend less. Last year, the US basic balance of payments - the account plus net long-term capital flows - was minus $218bn (£131bn). Net direct investment, plus equity flows, were also minus $58bn. The private financing of the deficit came in the form of $343bn in net purchases of US bonds. But since that was nowhere near enough to cover the deficit, the balance came through massive government purchases of US liabilities.

At constant exchange rates, net increases in the dollar-denominated reserves of foreign governments amounted to $220bn last year, while total reserve accumulations were $351bn, 67 per cent of them by Asian governments. Asian mercantilists are sustaining the yawning US current account deficit in order to maintain their own export-dependent growth.

Unfortunately, the role of foreign governments in sustaining the US demand engine in this way creates two huge difficulties.

The first is that so long as these governments prop up the dollar, US domestic demand must grow at least as fast as trend output and probably still faster if output itself is to grow at least in line with trend. This means at best a stable current account deficit, and more likely a rising one and so increasing net external claims on the US economy. Moreover, given the debt-imposed constraints on the growth of private demand, this probably also means a continuing rise in the US fiscal deficit.

The second difficulty is that if the US dollar falls, nonetheless, it can only do so against currencies that are free to move. Much the most important of those is the euro. It follows that to the extent that there is an adjustment of the US current account it will be suffered largely by the eurozone, which will be forced into continuing stagnation, or worse. While that could force needed policy changes, it will do so by first creating disappointment that borders on desperation.

So "how can imbalances in growth and external accounts across the major regions be resolved while maintaining robust global growth overall," as the BIS asks? The answer is brutally clear on current trends, they cannot be. If the world is to grow while the US private sector and external imbalances adjust, as they must, the rest of the world must generate a period of demand growth well above that of their own potential GDP. Alas, this essential change is, at present, being doubly thwarted, first, by governments preventing the needed movement in exchange rates and, second, by policymakers failing to promote domestic demand. If this picture does not change, a disappointing few years could easily become a dismal decade.

Financial Times; 2 July 2003