Financial Crisis Crushes U.S. Household Consumption and Business Investment: Will Exports to China Provide the Way Out? The gross domestic product (GDP) in the United States, one measure of aggregate demand, is a little over $14 trillion. To understand this figure, one can look from three perspectives: (1) at the comparative size of other big economies like China, Japan, and Germany; (2) at the relative size of the components of U.S. GDP; and (3) at the sheer size of a trillion. The number one trillion (1,000,000,000,000) is 500 times larger than the cash position of a large multinational company such as PepsiCo ($2 billion). It is 1,000 times larger than the one billion people in Mainland China, and 4,000 times larger than the annual budget of a typical college ($250 million). So, 14 trillion is a very large number indeed, and the United States is the world's largest economy. Japan has the second-highest GDP in the world at 455 trillion (T) Japanese yen (JYN) or about $5T U.S. dollars (USD) using the market exchange rate of JPY95/USD in late 2009. China, Germany, and France are the world's third, fourth, and fifth largest economies at $4.4T, $3.7T, and $2.8T, respectively. The Chinese case is especially interesting because the Chinese currency does not trade on freely fluctuating currency markets. Instead, the Chinese government has insisted on an officially sanctioned rate of exchange (CNY6.875/USD) that is allowed to vary over a half of one percent rangea so-called "managed float." It is estimated by the International Monetary Fund (IMF) that if the Chinese allowed their currency to float, it would command approximately 45 percent higher value, and then only 3.875 Chinese yuan would exchange for one U.S. dollar. Using this higher value of the CNY, China would be ranked as $7.8T in size, by far the second largest in the world. The Chinese economy has already been widely recognized as fastest growing throughout the past decade (12-15 percent annually). How the $14 trillion U.S. GDP divides among its various components of C + I + G + Net X is also insightful for thinking about managing exports. Consumption (C) is by far the largest component of U.S. GDP, accounting for about 10T of the 14T in recent years: These U.S. proportions of GDP (71 percent Consumption, 11 percent Investment, 21 percent Government, 10 percent exports, and 13 percent imports) would not characterize the fast-developing economies like China and India nor the export-driven economies like Korea, Japan, and Holland where investment (I) and the import-export sector are much larger. But at 23 percent of GDP, imports plus exports do employ lots of Americans, and this fact was crucial in escaping the 2008-2009 severe recession. The U.S. Federal Reserve kept real interest rates close to zero throughout 2009 not only to stimulate business borrowing and investment but also to keep the U.S. dollar's value low, thereby stimulating U.S. exports. In recent years, export growth contributed the majority of real U.S. GDP growth: +1.5 percent in 2009 from $2 trillion to $2.03 trillion (see above equations) when real GDP declined by 2 percent from $14.4 to $14.1 trillion. Export growth contributed +0.88 percent of the +1.07 percent growth in real GDP in 2008, and +2 percent of the 0.95 percent growth in 2007. As a result, export growth offered one of the only escape routes from the severe 2008-2009 recession. Remember that fully 71 percent of U.S. GDP (domestic consumption C) had gone down by $220B, investment had collapsed by $400B, and fixing everything imaginable in the private investment sector (I) would have addressed only 11 percent of the U.S. economy. As a result, in the near term, export growth along with deficit spending through aggressive government fiscal policy (G) was chosen by the Obama Administration to stem job losses and jumpstart a recovery. What were the symptoms of recession in the United States in 2009 and what challenges did managers face as a result? First, U.S. GDP contracted for four quarters in a row [2.7 percent in 2008 (Q3), 5.4 percent in 2008 (Q4), 6.7 percent in 2009 (Q1), and 1 percent in 2009 (Q2)]. That has never happened since these national income statistics started being collected at the end of World War II. So, the downturn was severe and persistent. Secondly, unemployment skyrocketed above 10 percent by 2009 (Q3) when 4 to 5 percent is "natural" in a fully employed U.S. economy. That too has happened only rarely, just once since 1947 (at the depths of the 1982 recession). Finally, industrial production declined for 17 of 18 months. These business activity declines were not projected by most business planning that companies had undertaken in 2006, 2007, and 2008. A first challenge was to understand the sources of these downturns in consumption, investment, and industrial production. Thereafter, managers had to begin to consider how to respond to the timing of and prospects for recovery. Consumption has collapsed because the majority of American households are now stockholders, and many have retirement account investments with U.S.-based mutual funds. American mutual fund assets lost $2.4 trillion in value during 2008. So, U.S. households suffered a massive reduction in wealth equivalent to the cash position of 1,200 PepsiCo corporations. Not surprisingly, durable goods consumption (autos, appliances) was again down by 7 percent in 2009 (Q2) after plummeting 40 percent in 2008. Non-durable consumption also declined 3 percent after falling by 11 percent in 2008. Investment collapsed by another 20 percent in mid2009 after declining by 51 percent in 2009 (Q1) and 41 percent in 2008. Inventory purchases particularly were slashed. Why? Three reasons seem apparent in the National Trends economic data from the Federal Reserve Bank St Louis: (1) demand traffic has declined to a trickle in many durables such as home appliances, suggesting that anticipated unit sales should be forecasted at very low levels in the near term, (2) energy costs spiked in mid-2008, raising the producer price index by 10 percent, (3) export demand from some of the United States' largest trading partners (Japan and the EU) declined by half, reflecting a worldwide recession that measured out to 2 percent of world GDP. The only bright spot in mid-2009 was China, where rapid growth continued. As to the timing of recovery, J.P. Morgan's global purchasing managers' index swung sharply upward in the first quarter of 2009. After expanding in 2002- 2007 and contracting throughout 2008, the purchasing spending plans moved back to neutral. The extraordinarily tight inventory position of many companies was surely responsible, but to whom could these supply chain officers have been planning to sell? The answer is China. Chinese GNP grew in 2009 at 9 percent, and Chinese retail sales grew at 17 percent when much of the rest of the world was slowing to a near stop. In an important sense, China is not simply an export machine. Investment is 41 percent of GDP and consumption is just 36 percent, reflecting much infrastructure building. In 2008-2010, steel use in China totaled 440 million, 515 million, and 540 million metric tons40 percent larger than the tonnage of India, the United States, and the EU combined. Household demand is just starting to accelerate as China changes from developing to developed-country living standards. As a result, U.S. exports to China have continued to grow right through the severe worldwide recession of 2008-2009. The ways out of the current recession are therefore probably at this juncture limited to expansionary fiscal policy and an expansion of exports. Massive deficit spending by federal governments on infrastructure and productivity-enhancing training and facilities is more attractive than several other alternatives. Federal tax rebates are unlikely to shake households free of their newfound fascination with savings and reduced consumption. In 2007, federal tax rebates led households to pay down credit card debt rather than go out and replace an appliance that was wearing out. Ironically, credit card companies then flagged those households as greater credit risks and promptly cut their credit limits. Such a sequence of events of course increased the households' desire to save for security since they could no longer expect to live on credit cards should their breadwinner suffer a layoff. John Maynard Keynes described this situation as a classic liquidity trap where consumption spiraled downward despite tax policy designed to accentuate household liquidity. Monetizing federal deficits by printing money is almost always a mistake because of the risk that approach poses for renewed inflation if industrial production does not quickly increase. As a result, independent central bankers in Europe, Japan, and to a lesser extent the United States will resist any attempt to monetize these swollen federal deficits. More traditional monetary policy of purchasing short-term federal debt (e.g., T-bills) and replacing those assets circulating in the capital markets with an infusion of cash in the economy will normally (if done carefully and in moderation) not trigger inflation but will lower short-term interest rates. Since lower borrowing costs enhance the ability of businesses to fund their working capital requirements, expansionary monetary policy can in principle be transmitted into increased real activity in the economy. Unfortunately for the United States and Japan, short-term interest rates are already near zero (0.1 to 0.4 percent), so traditional monetary policy really has no room left to stimulate these two largest economies. Ingenious credit policy initiatives have been tried but are proving largely unsuccessful in breaking loose more bank lending. Bankers have proven stubborn about extending credit to small and medium-sized businesses that survive on such loans from one stage of the business cycle or of seasonal sales to the next. Having been burned by overextending credit 2004-2007, bankers and bank regulators are overreacting by under-lending. As a result, business credit conditions have tightened precisely when companies need to begin to build inventories to trigger new sales from returning customers. In this scenario, only deficit spending on G and greater exports especially to India and China hold the prospect of restarting an economic expansion. Companies should poise themselves to take advantage of the extraordinary federal spending implied and to develop further their export sales to China. QUESTIONS: Which part of the global economy is growing? How do $1.47 trillion German exports in 2008, $1.43 trillion Chinese exports, and $1.48 trillion U.S. exports compare to the sizes of GDP in those countries? Why is the export sector so crucial to the recovery from the 2008-2009 severe recession? What U.S. companies are likely to profit first from increased exports