Is the planned US stimulus strategy wrongheaded and, if so, what is the correct US policy response? Increase capacity? And what are the consequences of the planned US response? Does China simply keep over-producing and the US keep over-consuming with just a new source of financing (i.e., the US govt)? How does that end?

So what is the adjustment the US should make? Do I understand correctly that (ideally at least) the US should support a gradual decrease in demand/increase in consumption over 4-5 years while China undertakes the opposite? What are the consequences of the less-than-ideal US response we’re likely to get (besides a trade war)?

China aluminium cash cost: $2500-$2800 USD
LME Spot: $1500ish
World 1st quartile cash cost cutoff: $1600

Now, check how much capacity China has cut off. Hint: its a lot less than 100%. They are also still producing their own bauxite from crappy deposits and smelting with high cost power. I doubt Obama is going to let Alcoa and Rio’s Alcan go belly up because Chalco is unwilling/under pressure to not fire workers.

I’m still confused about a couple of issues. First is the issue of short-term employment numbers in the States. With the vast majority of Americans employed by in service industries of which consumer retail is a big part, is it materially relevant to discriminate whether these distributors are selling foreign or domestic goods? In other words, even if we are to have a complete leakage of the fiscal stimulus going towards the purchase of foreign goods, wouldn’t that still help jobs numbers, especially in retail and banking?

Regarding the point about the US being able to finance its own spending, would Americans save that much seeing how the US monetary authorities are drawing massively on global savings to finance American credit? We are seeing indications of lower mortgages already with the purchase of agency-issued MBS and there are also signs that the government may invest in consumer credit loans as well.

More importantly from the standpoint of domestic politics and public policy, will it be sustainable or desirable to rely on domestic credit to fund $50 trillion worth of unfunded government liabilities over the next 75 years? Even if it is fully possible to fund that amount, which is mostly composed of entitlement spending on Medicare, would it advisable to take such a course given the ramifications of the ‘crowding-out’ effect?

I find your blog informative and insightful. Thanks for sharing your thoughts.

There are a couple of areas that I perceive to be inconsistencies:

1). The notion that the US will dramatically decrease foreign trade doesn’t quite fit with the actions of US monetary and fiscal authorities. The US has a huge fiscal stimulus looming on the horizon and the Fed is very close to monetizing consumer credit by directly purchasing securitized consumer loans. If we are to judge the likelihood of protectionism based on the bureaucrats’ perceived political imperatives at the moment, it seems to me that protectionism is as likely to appear (or in this case unlikely) as politicians allowing a plunge in consumer spending to continue.

2). The extent to which US fiscal authorities are able to implement any spending programs in the next few years is directly dependent on the availability of foreign credit. Without foreign trade, how do you see the US gov’t funding domestic services such as health care?

By the way, do you guys realize that twofish is GOD? When everybody else speaks their opinions, he speaks the TRUTH.

I don’t think they are, but what people get wrong is that cultural impediments to consumption are highly generational and can be explained by a “rational expectations” model. Germany is more of an inflation hawk than England is because of the hyperinflation of the 1920′s.

Michael: The same thing was said about Asian countries until the early 1990s, after when changes in domestic monetary and exchange policies suddenly resulted in such an explosion of imports.

But a person arguing for a cultural explanation would argue that 1) this also corresponded to a generational shift and 2) monetary and exchange policies would be influenced by culture.

Michael: All Roads, to try to respond, I don’t think the US and Europe can continue consuming when the financing of consumption has been cut by the banking crisis.

But if consumption in the US and Europe is constrained by financial factors, won’t these financial factors also constrain China? One thing I don’t get is that I hear a lot of people talk about China encouraging consumption as if there were this big button in Hu Jintao can press saying “CONSUME”. I haven’t heard very much about actual policies intended to encourage consumption.

Also encouraging consumption seems to assume that the Chinese banking system is sound. If the Chinese banking system is really a mess (and I don’t think it is) then China can’t safely increase consumption without first cleaning out that problem, because in that situation increasing consumption will cause latent problems to appear causing an even bigger mess.

Michael: As for timing, I think the problem needs to be resolved very quickly, perhaps in the next six months, and I think the solution will require major economies to agree to boost demand fiscally to give China three or four years to bring overcapacity down.

If there is overcapacity, then the thing to do is to boost demand by any means possible. If the US won’t buy Chinese goods, then if you can’t think of anything better to do, the Chinese government can buy these goods and then dump them into the ocean (which is what I think is going to end up more or less happening with cars built by GM.)

Maybe China does have more steel mills than it needs, but are you arguing that the solution to too much steel is to dynamite the steel plants, rather than write off the cost of building the plant, and think of things to do with cheap steel? When an industrial firm undergoes bankruptcy, the point is not to reduce industrial capacity but rather to restructure the finances to preserve as much wealth as possible.