As Deflation Fears Rise, Boosting Exports Is Key to U.S. Recovery

Ways to avoid a painful Japan-like deflationary spiral are gripping investors and policymakers alike following Friday's disappointing jobs report. And what more the Fed can do with maneuvers such as quantitative easing remains a big question.

Last ditch measures to avoid turning Japanese get all the attention. But the truest gauge of the U.S. turning the corner might be if it is turning German instead. Banking more on sectors like manufacturing to tap into surging global demand, as Germany is already doing, rather then finding ways to artificially prop up demand is the way to recovery over the long haul.

Lessons from Germany

Global demand for real goods is impressively high, as German industry shows. Exports rose by 3.8% on a seasonally adjusted basis in June after a 7.9% surge in May. The country's unemployment recently dropped to levels not seen since before the financial crisis. Now, exports have regained all the ground lost on an absolute level as well and are forecast to hit new highs in the year ahead.

GDP expansion over the last quarter is expected to come in at 2%, the highest level since German reunification in 1990. Strong growth is leading to massive import demand, which grew 1.9% month-over-month to the highest level since record keeping started in 1950 on an absolute basis.

A U.S. economy, where much of the labor force has spent the last years catering to a bubble-fueled sector like home construction, is having a tough time keeping pace with worldwide demand for real export goods, though.

Parts maker Mechanical Devices, which counts manufacturing giants such as Caterpillar (CAT) as clients, can't grow because of a skills shortage. Difficulty finding workers like machinists is "the key limitation to the growth of our business and meeting our customers' expectations," a company executive told The Wall Street Journal, estimating that sales would get an immediate 20% boost if workers with the right skills could be found.

Lattes and Sketchy Loans

Plenty of funding may be needed to reorient a U.S. workforce that has become overly dependent on brewing lattes and writing sketchy home loans for its paychecks. And policymakers should concentrate resources and their attention on this missing piece rather than esoteric interventions in asset markets or additional stimulus spending to boost demand.

While a fraction of the size of the American economy, Germany is, nevertheless, a bigger exporter than the United States. A stable capital base in the country has allowed a skilled and highly unionized workforce to maintain a high standard of living despite predictions that a race to the bottom was inevitable in the era of globalization.

Earlier in the summer, prominent U.S. experts predicted a dire outcome for Europe when Germany declined additional stimulus measures in favor of going back to basics. The tide has turned dramatically since then and surging German imports will help further shore up a region.

Armies of analysts will speculate endlessly about whether the Fed struck the right policy balance to avoid a Japan-like trap following its meeting this week. But if the U.S. is able to rebalance its workforce behind the scenes will ultimately determine how the story unfolds.