Indeed, anyone old enough to remember first-hand its effects, say, anyone aged 21 in 1929, would be 100 years old today. In other words, there's hardly anyone left.

What was new about this crisis was the global imbalance behind it. For more than a decade, people had been warning that the low savings rate in the US was unsustainable. In 2005, the personal savings rate fell into negative territory at minus 0.5 percent, meaning that Americans not only spent all of their after-tax income, but dipped into previous savings too or increased borrowing.

Mostly it was increased borrowing, through second mortgages on their homes and credit card debt.

Who were they borrowing from? Ultimately, it was those countries with huge net savings: China, Japan, Singapore and the oil exporters. We weren't unhappy, though. We all thought it was a good thing that consumer demand in the United States was robust (though now we call it "frothy"). We tooled up our factories to supply Christmas decorations, knitted clothing, computer peripherals and automotive parts to the booming American market. We built hectares of call centres in Bangalore and Manila to troubleshoot the glitches that all these products inevitably displayed.

An SUV made by General Motors, which is now appealing for government help to save it from bankruptcy

It was a virtuous cycle. The Americans borrowed money from Asia to buy things that Asians made. We lent them money so that they could buy our products, so that we could remain busy.

Oil producers meanwhile pumped more and more oil to power the gas-guzzling sports-utility vehicles (SUV) that the ever heavier American loved. And bought, on easy credit.

* * * * *

 
The other night, I was talking with a friend, someone who's spent his life watching companies, economies and the stock market. "Will the American consumer be the same animal again?" I asked.

He thought for a moment and gave me the answer I expected. Shaking his head slowly, "No," he said.

In that one word, lies the significance of this crisis. We will emerge from this mess, but we will emerge into a different world.

Already, the American savings rate has risen to 2 – 3 percent. It's a far cry from the typical savings rate in many Asian countries of around 40 percent, but it's a reversal of a long trend nonetheless. In circumstances when income is already constrained, e.g. layoffs of 600,000 a month, it tells you how consumer demand has shrunk.

Like how a generation of Americans became risk-averse after the Great Depression, one can expect that after 3 to 5 years of pain, the American after this experience will not be a happy spender. Add to that the demographic shift as baby boomers retire: Typically, retirees have lower consumption patterns than working adults.

The old global economic model with the US market at its centre will pass. The millions of factories and call centres that used to supply tinsel, socks and soothing advice with fake accents will need to be retooled to serve other markets. The relative weight of the US in the global economy will not be the same again.

With export demand evaporating, countries like China realise that to save themselves, they have to rev up domestic demand. The officially-communist regime is now giving out shopping vouchers, following the example of..... Taiwan.

It is this recognition that other economies will need to do more to fill the gap being left by the US that makes the April summit of G20 so important. G20 comprises 19 large economies and the European Union. Not only should they do more, but they need to coordinate their actions and avoid taking protectionist measures against each other.

They will also need to talk about currency volatility and the risk of sovereign defaults by smaller states. Already, Pakistan, Latvia, Hungary and the Ukraine have run to the International Monetary Fund for help.

* * * * *

 
It is uncertainty that is perhaps the biggest devil we face. With no clear timeline out of this mess, with fears that more banks and countries will go belly up, millions upon millions of individual decisions now err on the side of caution. Spending and investment is being held back, with knock-on effects throughout economies.

So see the knock-on effects, take the very first problem that led to this: home mortgages in the US. Till now, it has hardly been dealt with. Banks are still carrying these mortgages as assets on their balance sheets; they have not yet been fully written down, even as house prices have collapsed. The banks know that eventually they will have to make painful write-downs, which may destroy their capital base, and to prepare for that day, they are conserving as much cash as they can, cash that might otherwise be used to make new loans.

At the same time, credit card defaults are piling up, opening another area where banks are unsure how much they will have to write off eventually.

Meanwhile businesses cry out from being starved of finance, which means they can't buy supplies or pay their workers. Or they find their earlier loans being recalled because their sales have plummetted, and the banks have newly decided they are poor credit risks.

Home owners who had taken out loans (mortgages) are either struggling to pay on time, or simply refusing to, further hurting banks' cash flow. Home owners have seen the values of their homes fall well below the dollar value of their loans. And some of them might have lost their jobs too.

Even those who can pay are refusing to pay their installments. The US government has sent signals that resolution of the financial mess should include rewriting the loans to lower the principals to realistic levels. Expecting that the re-writes will favour them, borrowers are dragging their feet with paying their installments, once again hurting banks' cash flow, in turn reducing their ability or willingness to make new loans to businesses.

As you can imagine, the US financial system is in gridlock.

Late 2008, the US Congress passed a US$700 billion Troubled Asset Relief Program (TARP) that was meant to lubricate the stuck financial system. But after spending about US$350 billion, the verdict appears to be that the banks are taking the money to shore up their capital base, and not using it to make new loans. (There are also complaints that the money is being used to pay fat bonuses and other perks.)

Now, an increasingly popular idea is that of nationalising banks instead of just throwing more money at them. Nationalisation allows the government to insist that they renegotiate the mortgage loans with borrowers and actually lend the money they receive from the state, but this idea is highly controversial in free-enterprise America.

Meanwhile, in its first month in office, the Obama administration passed a US$787 billion economic stimulus plan. This is aimed at stimulating demand through tax relief (putting a bit more spending money into people's hands), public works, etc.

But where will this US$700 billion and US$787 billion come from?

To get a sense of proportion, the combined US$1.5 trillion is roughly half the fiscal 2009 US federal budget of US$3.1 trillion put up by the Bush administration last year. Not "half of" the budget. But half more on top of the budget.

Latest estimates are that the US government will be in deficit to the tune of US$1.4 trillion this year. That is 10 percent of the entire US GDP of about US$14 trillion. [1]

Now you understand why Secretary of State Hillary Clinton made her first overseas trip an Asian one with an important stop in Beijing. There, her chief message appeared to be: "Please continue to purchase US treasury bills."

US Secretary of State Hillary Clinton (left) meets with Chinese Premier Wen Jiabao (right), 21 Feb 2009. Photo from Getty Images.
   

However, Chinese Prime Minister Wen Jiabao has already signalled the need to diversify Chinese reserve holdings. In London at the end of January 2009, he said, "In recent years, our foreign reserves have been growing very fast. We are trying to bring more diversification to the holdings of the foreign exchange reserves."

To avoid panic, he quickly added, "Buying U.S. Treasury bonds is a major part of it."

Yes, but, "Whether we will buy more U.S. Treasury bonds, and if so by how much -- we should take that decision in accordance with China's own need and also our aim to keep the security of our foreign reserves and the value of them." [2] 

Ah, the value of them.

Here we enter into another unknown. What is China's appetite for more US debt? If it starts to decline, or if China decides not to accumulate surpluses like before, preferring instead to reinvest domestically to boost its own economy through a bad patch, how will the US fund its budget deficit?

One hope would be the average American's savings rate goes up, and it is his savings that help the federal government bridge its gap. But that would also mean the man-in-street's consumption is reduced even further from the halcyon days pre-crisis. Wouldn't this delay the revival of demand which is the key to crawling out of this economic mess? How capable are other economies in replacing American demand?

And if Obama cannot get a grip on his budget and current account deficits for the next few years, the spectre of a fall in the value of the greenback looms, for the US would be sorely tempted to print money. That fear alone can become a self-fulfilling prophesy. Are we planting the seeds in this crisis of the next one?

© Yawning Bread