Five years on, US fights back as China and India struggle

This weekend it will be five years since the implosion of Wall Street investment bank Lehman Brothers alerted the world to the deepening crisis in the US financial system.

Since then the world has changed - but not in the ways that many commentators predicted in the immediate aftermath of the Lehman collapse.

As Washington was forced to stump up US$1 trillion in public money to fund an emergency bailout of America's banking, insurance, home loan and automobile sectors, pundits around the world were quick to announce the end of US economic primacy.

The crisis exposed the hollowness of the US model, they argued. With its weaknesses revealed, America's sun was now setting, to be eclipsed by the ascendant Asian economic superpowers of China and India.

Five years later, it's clear developments haven't followed their script.

Far from tipping into an irreversible slump, the US is successfully clawing its way out of its post-crisis downturn.

In the financial markets, instead of declining in value since the Lehman failure, the US dollar has strengthened against a broad basket of currencies. And rather than losing its place as the global currency of choice, the greenback has consolidated its position. According to the Bank for International Settlements, the US dollar is now involved in 87 per cent of currency transactions, up from 85.6 per cent before the crisis.

Meanwhile, the US stock market has gained an impressive 35 per cent over the past five years to hit new record highs.

And lest sceptics dismiss those gains as an artificial rally, pumped up solely by Federal Reserve-generated liquidity, it's worth pointing out that US companies are trading at the same valuation today - around 16 times earnings - as they were when Lehman blew up; a testimony to the strength of their profit growth in the meantime.

Away from financial markets, in the real economy the banking sector has rebuilt its balance sheets, while American consumers have slashed their debt burden.

Before the Lehman failure, US households were spending a record 17.5 per cent of their disposable income on servicing their debts. Today that proportion has been cut to around 13.5 per cent, its lowest level since the early 1980s. (see the first chart)

Even better, most of that reduction comes from paying down debt, rather than from lower interest rates. Even if benchmark rates were to climb 5 percentage points back to 2007 levels, US households' debt service ratio would not exceed a sustainable 15 per cent.

The combination of stronger bank balance sheets and lower consumer leverage has helped boost the US property market. Today housing prices - blamed as one of the main causes of the financial crisis - are some 4 per cent higher than they were when Lehman collapsed.

Put all this together, and the result is gross domestic product up more than 5 per cent in real terms since the Lehman collapse. And with the US government having cut its budget deficit from 10 per cent of GDP to 4 per cent in just four years, economic growth is now set to accelerate. With no fiscal drag, US growth should pick up from 1.5 per cent this year to 2.8 per cent in 2014, believes Jörg Krämer, chief economist at Germany's Commerzbank.

Meanwhile Asia's emerging giants are running into trouble. India's growth is stalling and capital is flooding out. And China has only maintained its high growth with an expansion of debt reminiscent of pre-crisis America.

Now, with its competitiveness eroded by a combination of fast-rising wages and currency appreciation, (see the second chart) China is facing a slowdown that threatens to puncture its own credit bubble, further weighing on growth.

All of which just goes to demonstrate the old adage: it's tough to make predictions, especially about the future.

tom.holland@scmp.com