How do you know the economy is on the mend? The US government decides against the bailout of a near bankrupt finance company.

This is not a sick joke.

Instead it is a fair representation of convoluted logic that reflects the reality of these extraordinary times. After bailing out CIT Group to the tune of $US2.33 billion in December last year, the US government last week baulked at requests for more support.

The 101-year old CIT, which has reported $US3 billion of losses over eight quarters on home mortgages, student loans and business lending, is seeking an accommodation with its lenders.

What this means is that it will, in all likelihood, convert some of its debt into shares, diluting the existing shareholders' claims on the company out of existence.

This is the type of restructuring that was commonplace during the collapse of the dotcom bubble at the start of the decade. Then, in stark opposition to today, private sector balance sheets were sufficiently strong to weather the fallout from such a wholesale destruction of wealth.

Certainly the losses were huge but they were manageable with resort to the public purse.

Imagine the market reaction had the government followed such a course of action during the latest trough of financial markets in March, when fears about a potential currency crisis in eastern Europe presented a very robust argument that the march southward had only just begun.

Instead of a collapse, equity markets turned in their best week since March. During the week, the S&P 500 rose seven percent to 940.38 for the second-steepest weekly gain of 2009, while the Dow Jones jumped 597.42 points, or 7.3%, to 8743.94.

Meanwhile, the Chicago Board Options Exchange VIX index, a gauge of investors' concern, tumbled 16% to 24.34 for the steepest weekly decline since December.

Dominating the economy

These developments came as OECD leading indicators improved, even for some of the larger European economies; Japanese business confidence rose; and improvements in US manufacturing surveys and credit markets suggest an unambiguous turn.

Part of this reversal is due to one-off factors that are part and parcel of any economic downturn that could always be counted upon to give growth a boost once confidence returned.

Businesses have been rebuilding inventory, reversing the trend during the credit crisis to run down inventory as a way of reducing working capital and their reliance on the providers of credit.

This restocking led to a surge in demand that was most evident in the recent surge in commodity prices.

Meanwhile, certain variable costs can be delayed only so long before delays in spending begin to weigh on production.

US farmers' emphasis on cashflow, for instance, has left American soil nutrient levels at historic lows, suggesting the time is right for a spike in demand.

And in this cycle the rebound has been more pronounced simply because the contraction was so severe.

The biggest factor in the recovery is the public sector.

The US government, for instance, has committed nearly $US800 billion on programmes ranging from investment in education to tax breaks for individuals and businesses, health care and transportation.

This is already staring to show up in official data: US public construction spending is also up firmly, growing at an average rate of about 2% in the June quarter.

Similar trends are evident all around the world, giving way to another question: is the revival sustainable?

The US consumer, who before the financial market turmoil accounted for about 70% of real US GDP, can no longer be relied upon to drive growth.
This past demand was fuelled by a massive expansion of credit and irresponsible lending.

The first of these factors has reversed into rapid ebb, while the consequences of the second have been so imprinted on the collective psyche that the chances of a repeat at least in the short term are as good as nonexistent.

The result is a sharp contraction in consumer spending and an associated rise in savings.

Even though real US disposable personal incomes grew 1.6% in May and 1.2% in April, real personal consumption fell 0.1% in April and rose just 0.2% in May. The US personal saving rate was at 6.9% of disposable income for May, its highest level since 1993.

There is no obvious contender to take the US consumer's place. There is some talk of a recovery in private spending and capital investment in manufacturing, as businesses seek to reduce costs and reconfigure their business for exports.

This, however, will matter not a jot unless consumers in China, India and Southeast Asia pick up the slack. This is not yet a bankable proposition.

Richard Inder is an investment advisor at Macquarie Private Wealth. His disclosure statement is free and is available on request. His clients may hold shares in the firms mentioned. Write to richard.inder@macquarie.com