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It should be noted, the U.S. consumed up to $800 billion a year more than produced in the global economy.

Most of the U.S. capital account surpluses were spent by the U.S. government.

Those surpluses should’ve been “refunded” to U.S. consumers in the form of tax cuts, to maintain the virtuous cycle of consumption-employment.

For example, a $5,000 tax cut for each worker in 2009 (or $750 billion for the 150 million workers at the time), would’ve jolted the U.S. economy into a stronger recovery.

Reducing taxes, through massive capital account surpluses, would fuel the U.S. engine of growth and pull the rest of the world’s economies.

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It should be noted, negative net exports subtract from GDP. So, although, the U.S. economy was expanding at a 3% real rate in the mid 2000s, when actual output equaled potential output and the country was at full employment (below 5% unemployment rate), the huge trade deficits added, what was equal to, another 6% a year of GDP to the U.S. economy.

The much smaller U.S. trade deficits over the past few years have made the U.S. “recovery” look stronger, since shrinking trade deficits add to U.S. GDP, in the equation Y = C + I + G + NX. Real GDP growth has been much higher just because the U.S. is consuming less than producing in the global economy, which reflects stagnant living standards at best.

U.S. Real GDP Growth

2010: 2.5%
2011: 1.8%
2012: 2.8%
2013: 1.7% (projected for full year)
2014: 2.5% (projected)

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The U.S. benefited tremendously from Japanese, and then Chinese, imports. Japan and China sold their goods too cheaply and lent their dollars too cheaply to generate a virtuous U.S. cycle of consumption-investment.

In the global economy, the U.S. was able to consume up to $800 billion a year more than produce, in the 2000s (representing 6% of GDP), which raised U.S. living standards substantially.

While U.S. consumers bought foreign goods, foreigners bought U.S. Treasury bonds. The U.S government should’ve “refunded” those dollars to U.S. consumers, in the form of tax cuts, to maintain the virtuous cycle. Instead, the government spent those dollars.

Low prices induce demand. It’s perfectly rational to spend and borrow, rather than save, when prices are low. If those dollars were refunded, household debt would’ve been lower and economic growth higher.

Here’s what James Fallows said about China:

James Fallows studied American history and literature at Harvard, where he was the editor of the daily newspaper, the Harvard Crimson. From 1970 to 1972 Fallows studied economics at Oxford University as a Rhodes scholar.

January/February 2008

Through the quarter-century in which China has been opening to world trade, Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States. This is the real meaning of the vast trade surplus—$1.4 trillion and counting, going up by about $1 billion per day—that the Chinese government has mostly parked in U.S. Treasury notes. In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China.

Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.

Neither government likes to draw attention to this arrangement, because it has been so convenient on both sides. For China, it has helped the regime guide development in the way it would like—and keep the domestic economy’s growth rate from crossing the thin line that separates “unbelievably fast” from “uncontrollably inflationary.” For America, it has meant cheaper iPods, lower interest rates, reduced mortgage payments, a lighter tax burden. The average cash income for workers in a big factory is about $160 per month. On the farm, it’s a small fraction of that. Most people in China feel they are moving up, but from a very low starting point.

This is the bargain China has made—rather, the one its leaders have imposed on its people. They’ll keep creating new factory jobs, and thus reduce China’s own social tensions and create opportunities for its rural poor. The Chinese will live better year by year, though not as well as they could. And they’ll be protected from the risk of potentially catastrophic hyperinflation, which might undo what the nation’s decades of growth have built. In exchange, the government will hold much of the nation’s wealth in paper assets in the United States, thereby preventing a run on the dollar, shoring up relations between China and America, and sluicing enough cash back into Americans’ hands to let the spending go on.

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Ed says: “Why is this recovery “historically weak?””

Basically, the U.S. has a demand problem.

In the long-boom, from 1982-2007, Americans increasingly overconsumed (through up to $800 billion a year trade deficits), built-up debt, and median real income either grew slowly or was stagnant, and then declined after 2000.

Low income workers borrowed too much and high income workers saved too much.

The U.S. needed a massive tax cut in 2009, e.g. $5,000 per worker, or $700 billion for the 140 million workers at the time, to jolt the economy into a self-sustaining cycle of consumption-employment, rather than the small and slow tax cuts we got that just put a floor on consumption.

Also, we needed massive deregulation, e.g. getting rid of or reducing half of the $2 trillion a year in federal regulations, rather than piling on more regulations, which the economy hasn’t been able to absorb.

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