Total annualized US domestic savings have fallen from their peak of $2.2 trillion dollars in the third quarter of 2006 to just $1.4 trillion on the latest Fed data. That represents a  drop from 16.2% of GDP to 10.2% in 3 years, and is the lowest level since 1934. I've discussed the ongoing crisis in US infrastructure investment previously, but including all investment, private and public, the current level at 14.7 percent of GDP barely covers depreciation (the calculated rate of capital consumption is 12.9 percent of GDP). Economics 101 teaches spotty faced teenagers that economic growth is a function of the growth in human and physical capital and the productivity of both as enhanced by technical innovation. A growing labor force in the absence of rising per-capita capital formation and of innovation with a broad multiplier effect on productivity results in the 17.5% broad unemployment that the US is now suffering. The contribution of private investment to GDP growth in this decade has been the lowest since the 1930s; on any measure, the US is barely maintaining its capital base.

There is a tendency among investors and financial analysts to apply a microscope to markets rather than zooming out with the telescope that gives crucial perspective. The stagnation of median real US incomes and steadily falling labor force participation rates have been evident thropughout this decade, and their economic  impact on final demand and growth were disguised only by an historic accumulation of debt at all levels of the US economy.  But even doping an economy with ever larger doses of leverage suffers diminishing returns, and indeed the ratio of debt applied to growth generated has risen from just over 2x 30 years ago to over 5x in the recent credit boom. In fact, if we consider that the share of residential construction in US GDP doubled from 3 to 6% during the housing boom (a classic example of the distorting effect of inflation on asset allocation), then the underlying investment picture is even worse. It's hard to argue that colonies of sprawling McMansions added productive capacity to the US economy. A key issue in recent years has been the exponential growth in healthcare costs, now eating up 18% of GDP, or over twice the levels in seen other advanced economies with similar health outcomes, from Canada to France. 

There is only one energy source in the world right now with declining marginal production costs, soaring reserves and extraction rates, and compelling cost competitiveness with crude oil. Unsurprisingly, it has emerged not as the result of subsidized government 'green energy' initiatives, but from a handful of entrepreneurial small US exploration companies whose technical innovation has transformed the US gas market, to the extent that multi-billion dollar LNG import terminals built over the last decade lie unused as surging local supply has supplanted foreign.  Could crude oil follow the fate of LNG imports, as the US moves to energy independence? Conceivably, if Washington stops wasting resources on hopelessly immature alternative energy technologies and focuses on rapidly transforming the country's truck and car fleet to natural gas in compressed form.

Mandated corn ethanol use has been one of the most ludicrous and wasteful policies to ever emanate from Washington, and that takes some doing. Not only is the energy return on investment marginal to negative (i.e. you use more fossil fuel energy in its production that you get back in biofuel energy) but it will act to boost food inflation globally. Solar and wind are not only hopelessly uncompetitive  at much less than $200 oil, but without a revolution in large-scale energy storage and a digital transmission grid, their contribution will be marginal both to cutting carbon emissions and improving energy security. Gas has none of these issues, and its use in both power generation and as a vehicle fuel is based on proven and easily scalable technologies. There is a real urgency to a rational and coherent US energy policy, as non-OPEC production has failed to respond to soaring prices over the last 6 years, as seen in the chart below. Russian production now seems to be peaking, partly because of re-nationalization of key producers like Yukos. This underpins the secular rise in the real cost of oil, with discovery costs alone up from $4 to $24 in a decade, and the marginal production costs of key new discoveries at $70 plus.

A bearish frenzy has developed in the US dollar, and is probably the strongest consensus I've seen since the bullish stampede in oil futures crashed last Summer. With publicity hungry commentators from historian Niall Ferguson to journalists spinning lurid Chinese/Arab conspiracy theories weighing in with their economic insights, and hedge funds leveraging up aggressively again on the global carry trade using the dollar as a 'free' funding currency, it's time for a reality check. There is no alternative to the dollar as the global reserve currency for the foreseeable future; while the dollar's share of CB reserves has declined from 72% to just over 62% this decade, this is the result of the Euro's emergence, with the Yen still a paltry 3% of global forex holdings. Total dollar holdings have steadily risen, and even this year, China has continued to accumulate dollar assets, while grumbling about US economic policy. It will be at least a decade before Yuan convertibility is a real prospect, and only then if China can radically overhaul its financial markets in the meantime, developing deep capital markets and hedging mechanisms and gradually opening its capital account. At the moment, even in Hong Kong, less than 2% of trade is conducted in Yuan. As for those complex IMF special drawing rights, which dollar bears offer as a real alternative global currency, call me when a Colombian drug smuggler is caught with a suitcase full of the things.

The structural nature of America's trade deficit has been demonstrated this year by the fact it still remained at 3% of GDP in Q2, in the depths of the recession (from 7% at the peak of the boom in 2007, when its funding was soaking up 70% of global excess reserves). In fact, the US hasn't run a trade surplus since the early 1990's recession, and that constant funding requirement places ongoing pressure on the dollar. I've commented at length on the dangers of current Fed policy, which does little to alleviate deflation in real assets while stoking hyperinflation in financial ones, and to the extent it is spiking commodity prices, undermining a real recovery. If it was down to me, I'd immediately place the $870bn in excess commercial bank reserves at the Fed at a negative interest rate (ie charge them for the privilege of parking their cash, as the Swedes have already done) and simultanously hike rates by 50bps. This would correct the current dangerous distortion of the monetary base. Those reserves, applying the typical 7-8x deposit to loan multiplier over the last couple of decades, would translate into a credit surge equivalent to 40-50% of US GDP, underwriting a cyclical recovery, and closing the divergence between the Fed's $1.2trn of quantitative easing and the $110bn rise in M2 money supply as stymied by commercial bank capital hoarding. By hiking rates now, you offset the inflationary implications on expectations, while underpinning the dollar and supporting foreign capital flows while the US economy rebalances after a decade of excess consumption and underinvestment.

I wrote several times in 2008 on Japan's secular economic decline, determined by the developed world's worst demographic outlook. Over the next 20 years, the workforce will decline by 20%. Five years ago, the population was 127.7 million, today it marginally lower, but  the composition has changed radically.  In 2004, the population below the age of 15 was 17.7 million, the population aged 15 to 64 was 85.1 million and the population aged 65 and over was 24.9 million. Now, the population below the age of 15 has dropped 3.5% to 17.1 million, the population between 15 and 64 has dropped 4% to 81.6 million, while the number of people older than 65 has increased 16% to 28.9 million. This devastating trend is set to accelerate over the next decade, with the working age population declining by 0.9% a year, implying a major drawdown of Japan's savings mountain, with adverse implications for global markets reliant on Japanese excess saving as well as for the Yen and JGB yields. The household savings rate as a % of disposable income has fallen to 2% from 14% in the early 1990's at the beginning of Japan's long decline, while government debt will probably hit 200% of GDP by next year.

It is increasingly unclear how the country can fund its rising dependency ratio (see chart below). The country's birthrate has plummeted since the 1950s and has been below replacement level (2.1 births per woman in developed countries) for decades. Today it is at a mere 1.2 births. As a result, Japan now has the highest proportion of residents over the age of 65 (20 percent) in the world, and the health ministry estimates the country's population will decline by 25 percent by 2050 despite risisng life spans; (Russia will be similarly depopulated over that period).

By 2050, 40 percent of the population would be over 65. Where Japan has led, the rest of the developed world will soon follow with a steep drop in the global birthrate since the 1970's that has resulted in a rapidly aging population and workforce in Europe, Japan, and soon too in the US (which has been spared by Latin immigration). Not only does this have direct economic implications on household formation, demand for durable goods etc, but it has a cultural impact too, making a society more conservative and averse to risk-taking. It's a phenomenon that strikes me whenever I travel from youthful and dynamic London to cities in Europe like Vienna or Munich with a much older population on average, which are impressively prosperous but also stultifying. Globally, the world's birthrate looks set to drop below replacement level between 2040-50, although population will still rise for some time after as longevity extends

Don't expect to be crushed underfoot in the rush; while rate cuts were tightly co-ordinated to stem last year's systemic panic, their reversal will be piecemeal and grudging. The decision by the RBA to raise rates by 25bp, while hardly unexpected, underlines the resilience of the Australian economy throughout the credit crisis. I've long favoured the Australian and Canadian dollars as both countries enjoy growing resource wealth per-capita, a well regulated banking system, relatively strong fiscal balances, and substantial exposure to Asia, which has led the global rebound. Both have this week hit new one-year highs against the US dollar, reflecting not only anticipation of a widening yield premium (and yield differentials are now firmly back on the agenda for currency traders, as a period of unsustainably low global interest rates brought about by central bank efforts to offset the impact of the financial crisis starts to slowly reverse) but the huge carry trade now developing in the US currency. It's likely that Canada and Australia will be the fastest growing developed economies in 2010.

With Hilary Clinton as Eva Peron singing 'Don't cry for me Obama'? One of the most remarkable economic reversals over the last decade has been the impressive macroeconomic discipline shown by leading emerging markets from Brazil to India, while developed nations such as the UK and US have become increasingly reckless and profligate. While the former have been steadily re-rated by investors leading to a huge secular bull market in emerging market equities and bonds, the latter have yet to pay the price for their growing fiscal irresponsability. Argentina's troubled history in recent decades leads many to forget just how prosperous and advanced the country was a century ago; in fact, it was one of the ten richest countries in the world on a per capita basis until the 1930's. Any analysis of the country's stunning decline into inflation and dictatorship a few decades later must begin with the role of an entrenched economic elite who pursued their narrow interests regardless of the national cost. Rather than investment bankers, Argentina had an elite of a few thousand landowners who equally dominated the economy via agricultural exports. Their pursuit of naked self-interest led to an increasingly unbalanced economy that underinvested in education and infrastructure and was dominated by inefficient monopolies protected by political patrons. That effort to protect the status quo at all costs via a captive political system led to the failure of attempts to modernize the economy  and income inequalities growing to a destabilizing extreme. Sound even vaguely familiar?

Early this year, I advocated building exposure to long-term inflation hedges such as TIPS and resource equities, because they were radically mispriced as investors fled in fear of a sustained deflationary environment. That strategy played out well, and TIPS are now implying around 2% CPI inflation over the next decade, or broadly in line with experience in the last. We face a tug of war between inflationary and deflationary forces in coming years, and key to the outcome will be the scale of excess liquidity (ie a rising money-to- GDP ratio) and how swiftly it is drained from the system in a recovery. Currently, the huge expansion of central bank balance sheets hasn't translated into higher credit via the banking system and therefore a broadening of money. In other words, the velocity of money remains very subdued as banks focus on deleveraging (with the exception of China). This can be seen by the remarkable 6% of GDP parked at the Fed as reserves by US commercial banks, and similar bank risk aversion is evident in the UK and Europe.

Monetary policy has been astonishingly loose for most of the past decade, in response to a series of financial panics starting with the 1998 LTCM/Russia meltdown, proceeding via the IT bubble bursting in 2000, and now the systemic banking crisis of 2008. Ironically, like a doctor feeding an addict's drug habit with ever higher dosage, the response to each crisis has precipitated the next. Between 1996 and 2009, nominal GDP in USD for the top five global economies grew 60%, but narrow money grew 230% and broad money 210%. Much of the excess leaked into a fast sequence of speculative bubbles from Internet stocks to oil futures. You can picture the current monetary situation like a dam, with a lake of fresh money rising even higher, held back only by weak supply (and indeed demand) for credit. When that dam breaks, and credit growth resumes, even at much lower levels than seen in recent years, the inflationary risks become substantial. When looking at inflation, it is a mistake to consider it simply in terms of narrow CPI statistics (which are in any case arbitrary in their calculation). Volatile asset inflation has been a characteristic of the last decade precisely because the real economy hasn't been able to absorb the flood of money issuing from central banks and amplified by a secular rise in bank leverage until last year's crash.

While markets are celebrating the imminent return to positive US economic growth, the composition of that growth is critical to its sustainability. US economic fragility predates the credit crisis, which in fact was simply a dramatic symptom of the underlying structural stresses. Over the past decade, the US economy has generated no net new jobs (and in gross terms healthcare and government have been the biggest job generators), while the contribution of capital investment to GDP growth has been the lowest since the 1930's. Put another way, the productive capacity of the US economy has been severely impaired  as excess consumption funded by ever growing leverage has squeezed out long-term investment in public infrastructure and corporate fixed assets.

That same debt accumulation has postponed the impact on living standards of stagnant real median household incomes, and low labor rate participation (so that almost 17% of the potential workforce is now unemployed or underemployed on BLS statistics). Without the capacity (or indeed appetite) to expand an already crushing debt burden, and with clear evidence in recent data of higher-earning US households using discretionary income to pay down borrowings, the medium term trend for US consumption is distinctly negative. The charts below track the long-term trends in total US consumption (private and public) and fixed asset investment, highlighting the remarkable divergence of both from trend since 2000.

Investment bankers on starvation rations as the M&A slump bites should get busy learning Mandarin, because there are growing indications that China is about to make its presence felt in global capital markets. Chinese policymakers have been debating with increasing urgency how to gradually divest themselves of the $1.7 trn of dollar paper assets they have accumulated, without precipitating a dollar crisis in the process.While recent bilateral trade deals with commodity exporters like Brazil help to stem the flow of fresh dollars, even China's much reduced trade surplus with the US means its dollar pile keeps growing. Buying $50bn in IMF SDRs offers only a marginal diversification against $800bn of Treasury holdings alone (although it does help to internationalize the yuan). The $300bn CIC, which is effectively China's sovereign wealth fund, is now exporting dollars at a furious pace, largely to invest in private equity but also recently buying 17% of Canadian miner Teck Corporation.

In recent months, the approval process for overseas investment by private Chinese companies has been greatly simplified, as has access to foreign currency credit lines. Although we continue to see large energy focused deals, such as the $1.7bn PetroChina investment in Canadian oil sands, strategic acquisition targets span a range of second-tier companies operating in resource markets from uranium to rare earth metals. The debacle surrounding the attempted Rio and Unocal investments has convinced Beijing to set its sights lower in terms of corporate targets.Technology also remains a key focus, particularly battery and alternative energy know-how that can help domestic manufacturers achieve critical mass. As well as accelerating M&A, China is also likely within months to allow  local retail investors access to foreign markets for the first time, via global ETFs and managed funds, again releasing domestic capital into international markets. How significant could these moves be for international markets?