I am no economist. I do not know how to make good investments, never have known and probably will never know. I know one thing about economy: you have to spend less than what you earn. Otherwise, the expenses overcome the income and you go bankrupt. Simple as that. This is the number one rule of home economics. So, how did we get to the current mess?
We got there by simply not following the rules. I'm sorry, not rules - a rule. There isn't much really to it. But why didn't we follow one simple, 6-words rule? I think that the reason is quite simple: we, the people, wanted to have more, better, and fancier stuff. Somehow during the last 50 years the US-led Western economy has shifted from manufacturing based to consumer based. Instead of a positive influx of money into the US (and Germany, Japan, and other Western countries) we now spend much more than what we get. To get them, we shifted the plants that manufacture them to areas of the world that do not observe the same workers rights that we do in the west. It can be merely not paying the same salaries, but often it also involves longer working hours with little rest or no weekends, under-aged workers (not to say child slavery in the extreme cases), and so on. The average price of a T-Shirt has been dropping for ages at a rate of several percents, mainly because it is cheaper to manufacture them in places like China, Indonesia, or the Philippines, while Western textile factories have shut down. As another example think about the demise of the shoe-repair shops. Until 20-30 years ago when a shoe was torn, people went to repair them, now we buy a new pair of shoes. There is no incentive to keep shoe-repairing shops anymore and they shut down. This is one part of the equation - buy more products with the less money spent per each product. This not necessarily reduces the amount of money we spend on consumer products, and surely enough - we as a civilization have been spending more and more.
At the same time, the same factories and manufacturing that were shifting to the undeveloped world caused the Western civilization to have ever bigger gaps in the balance of trade between the West and the 3rd world. For example, the American balance of trade with China and Japan has been in a great deficit over the last 25 years (since 1985), causing an ever growing debt to these countries, as can be seen in the figure below, which is the work of Alex1011 and is taken from Wikipedia.
If the same debt had been accumulated by a single person, or a single company, they would have had to pay it or go bankrupt. When it comes to countries, things are more complex. However, I think that it can be safe to assume that such great deficits are not healthy to any economy.
But it gets even worse, I'm afraid. At first, manufacturing was out-sourced to economies with cheaper, but less proficient, work-force. However, two parallel processes have been developing over time based on this move: 1) the work force in those 3rd world countries has become more and more proficient, and 2) as they become more proficient the West have shifted the manufacturing of more complex goods to these countries. Let's take Brazil for example. Cars have been manufactured in Brazil since the late 1950s, starting with Toyota and Volkswagen, and in the last 50 years this industry have evolved with almost all modern car manufacturers working there (see link above). Brazil manufactures about 3 million cars and has passed France as of 2008, with high end models like Volkswagen Beetle as an example. However, if one can manufacture cars in Brazil, why not progress to the aerospace industry? Embraer is Brazil's most important aerospace manufacturer, and one of the four major manufacturers of commerce airplanes in the world (in the same league with Boeing, Airbus). Its major growth started in the 1970s. Nowadays, many commuter airlines in the US use Embraer models, especially the smaller ones that carry about 50-100 passengers.
There is nothing wrong with having 3rd world countries developing. On the contrary: when they develop there is a growing market for products that they could not afford earlier. However, as the manufacturing of more and more products is shifted, the local workers in the West lose their ability to manufacture complex products. In the last decade things have deteriorated to the point that Asian companies also design many of the "American" products. The Harvard Business Review writes that American companies have lost their ability to manufacture and design many of the small and simple things they used to be able to manufacture in the past. They even lost their ability to manufacture cutting-edge technology stuff, like the Kindle or the Boeing 787's carbon-fiber components.
Trade balance is just one angle. There is another one: government deficit, which also has been rising constantly. American administrations have always had problems with balancing their sheet, but since Clinton's administration the situation has been going from bad to worse. The 2009 deficit is projected to be more than 1 trillion dollars, some say even 1.8 trillion dollars.
On the lower end of the scale one can look at the consumers. Until the burst of the credit bubble Americans just spent without any second thought, or so it appears. That's why more and more people have huge debts and they turn to defaults and bankruptcies. This in turn is just a symptom of the illness I tried to present earlier: if manufacturing is low, as a whole, then each worker should have less money to earn. Less money to earn - and increased consumerism - must boil down to debt, that's simple math.
So, what is the correct way? How do you fix it? If I had the answer to that, I would probably win the Noble prize. However, it seems to me that the government has to reign in the uncontrollable masses. How? First, levee much higher taxes. This will also improve the government deficit. For example, if each American paid additional $1000 a year in taxes, the deficit would decrease by 350 Billion dollars. $5000 more a year, and the deficit is gone! Tax rates in America are low, compared to the rest of the Western world, however, Americans are not likely to allow this tax raise, and the administration will not be able to do it until the crunch gets much worse. One may argue that higher taxes will result in lower growth rates, which is the last thing desired during an economic crisis. That is true, but high deficit also boils down to more expensive debt for anyone, and higher credit costs, which in turn hinders long-lasting and healthy growth. So, which problem is bigger? Higher rates or higher taxes? Interesting. If I were the president I would increase taxes significantly and try to eliminate the deficit or at least reduce it almost to zero, even at the cost of immediate, short-lived, growth. He has 4 years in office and can afford it. Short-lived "bubble" growth that stems from the stimulus plan will likely to evaporate faster than we think - perhaps before the next presidential elections.
Another thing to consider is investment in bringing back the industry and science to the US. This should be done cleverly, as not all fields will yield the same desired results. However, science, engineering and information technology should come back to the US. Perhaps a new race to the moon is in order? On the other hand, the US has nothing to gain from its failing auto industry until this industry sheds all the excess and starts to make small, fuel efficient and cheap cars. In any case many Americans buy smaller cars from Japanese manufacturers that produce in America, so why support GM or Chrysler?!
Economy: hard to grasp. Let's stick to the basics: spend less than what you earn.
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