Imbalance Whac-a-mole

US inflation: The 1.1% drop in March US retail sales suggests consumers are filling their piggybanks. The savings rate was 4.2% in February and should show further rises for March and April as “stimulus” tax cuts kick in. Some economic imbalances are disappearing at last. Pity about the new ones.

For several years the US suffered from two unsustainable economic imbalances. Its balance of payments deficit was $800bn annually, or 6% of GDP. Its citizens’ savings rate was zero, far below the average 8% of the previous three decades. Both imbalances were unsustainable but their elimination was bound to involve economic suffering.

Now Americans are feeling the pain, but at least the imbalances have diminished. February’s trade deficit was $26bn, an annual rate of little over $300bn. February’s savings rate was 4.2%, halfway back to 8%. Better still, March’s decline in retail sales (despite bringing more immediate pain) and the consumer tax cuts in the Obama stimulus package, which kicked in with April’s pay packets, should have pushed the savings rate above 5%. Just a few more months of such progress, and the twin imbalances will have been eliminated, so economic growth can resume, right?

Unfortunately not. First, broad M2 money supply has grown at 15% since September, so once the economy stabilises, inflation will become a real threat. The March producer price index decline was entirely caused by falling energy prices, which have since rebounded somewhat; “core” producer prices are still rising at a steady rate. Deflation has not merely been postponed, it is now unlikely, as economic “bottoming out” will probably be accompanied by faster price rises.

Second, the federal budget deficit in 2009 is likely to be $1.8 trillion, or 12% of GDP – twice the peak balance of payments deficit. This imbalance too must be corrected. Because of its size, reducing the deficit will involve choices that are both highly painful and economically restrictive, hampering a healthy recovery.

The recession may be close to bottoming out, but real recovery requires eliminating the new imbalances, which are larger and more dangerous than the old ones.