Barry Eichengreen

Now that the green shoots of recovery have withered, the debate over fiscal stimulus is back with a vengeance. In the United States, those who argue for another stimulus package observe that it was always wishful thinking to believe that a $787 billion package could offset a $3 trillion fall in private spending. But unemployment has risen even faster and further than expected. Combine this with the continued fall in housing prices, and it is understandable that consumer spending remains depressed.

The banks, having been recapitalized only to the extent necessary to keep them afloat, still have weak balance sheets. Their consequent reluctance to lend constrains investment. Meanwhile, state governments, seeing revenues fall as a result of lower taxable incomes last year, are cutting back like mad. If there was a case for additional stimulus back in February, that case is even stronger now.

But the case against additional stimulus is also strong. The US federal deficit is an alarming 12% of GDP, and public debt as a share of national income is already projected to double, to 80% of GDP. The idea that the US can grow out of its debt burden, as did Finland and Sweden following their financial crises in the 1990's, seems unrealistic.

Given all this, more deficit spending will only stoke fears of higher future taxes and inflation. It will encourage the reemergence of global imbalances. And it will not reassure consumers or investors.

It is possible to argue the economics both ways, but the politics all point in one direction. The US Congress lacks the stomach for another stimulus package. It has already faced intense criticism for its failure to get the country's fiscal house in order. The slowness with which the first stimulus has been rolled out, and the fact that it will take even more time for its full effects to be felt, provides more fodder for the chattering classes.

Disappointment over the effects of the TARP has already destroyed popular - and Congressional - support for more public money to recapitalize the banks. So, even those who find the economic logic of arguments for fiscal activism compelling must acknowledge that the politics are not supportive. A second stimulus simply is not in the cards.

If there is going to be more aggregate demand, it can come from only one place. That place is not Europe or Japan, where debts are even higher than in the US - and the demographic preconditions for servicing them less favorable. Rather, it is emerging markets like China.

The problem is that China has already done a lot to stimulate domestic demand, both through government spending and by directing its banks to lend. As a result, its stock market is frothy, and it is experiencing an alarming property boom. Through May, property prices were up 18% year on year. Understandably, Chinese officials worry about bubble trouble.

The obvious way to square this circle is to spend more on imports. China can purchase more industrial machinery, transport equipment, and steelmaking material, which are among its leading imports from the US. Directing spending toward imports of capital equipment would avoid overheating China's own markets, boost the economy's productive capacity (and thus its ability to grow in the future), and support demand for US, European, and Japanese products just when such support is needed most.

This strategy is not without risks. Allowing the renminbi to appreciate as a way of encouraging imports may also discourage exports, the traditional motor of Chinese growth. And lowering administrative barriers to imports might redirect more spending toward foreign goods than the authorities intend. But these are risks worth taking if China is serious about assuming a global leadership role.

The question is what China will get in return. And the answer brings us back, full circle, to where we started, namely to US fiscal policy. China is worried that its more than $1 trillion investment in US Treasury securities will not hold its value. It wants reassurance that the US will stand behind its debts. It therefore wants to see a credible program for balancing the US budget once the recession ends.

And, tough talk notwithstanding, the Obama administration has yet to offer a credible roadmap for fiscal consolidation. Doing so would reassure American taxpayers worried about current deficits. Just as importantly, it would reassure Chinese policymakers.

We live in a multipolar world where neither the US nor China is large enough to exercise global economic leadership on its own. For China, leadership means assuming additional risks. But for this to be tolerable, the US needs to relieve China of existing risks. Only by working together can the two countries lead the world economy out of its current doldrums.

Barry Eichengreen is Professor of Economics at the University of California, Berkeley.