I knew something unusual was in the air when I first entered the Congress Centre, the hub of the World Economic Forum. Prominently positioned just before the security screening stations were signs emblazoned with the shocking message, �Ties Forbidden.� This is unheard of in formal European conference circles � to say nothing of the special ambience of Davos. Borrowing a page straight out of the final days of America�s dot-com mania, the World Economic Forum had reinvented the rules. The intellectual debate was quick to follow suit.

The mood this year at Davos is vastly improved from a year ago. Back then, the world had the prewar jitters, and there was an uncomfortable sense of angst that filled the halls of the World Economic Forum. Anti-Americanism was rampant, and the prognosis for the global economy and world financial markets was grim, to say the least. Yet time, that great healer, has done its trick again. The war has come and gone, the global economy has reawakened, and financial markets are on a tear. As always, the crowd at Davos personified the market sentiment of the moment � there is a growing sense of conviction that this is the start of something big and lasting.

Not surprisingly, my view ran very much against the grain of the hopes and dreams of this year�s crowd at Davos. In the opening economics session, I had the audacity to make the argument that imbalances matter. A one-engine world, in my view, is utterly incapable of providing a sustainable growth dynamic for a $36 trillion global economy. That�s the case even if that engine is America � the unquestioned global hegemon that rescued the world economy from the brink of last year�s feared abyss. That�s especially the case if the engine is constrained by historic imbalances � a record shortfall of net national saving, a record current-account deficit, record household sector debt loads and sharply elevated debt-service burdens, and near-record budget deficits. And it�s even more the case if the engine is sorely lacking the traditional fuel of job creation and income generation that has driven every cyclical recovery in the past. While I conceded the near-term outlook to the momentum crowd, I dug in my heels on what I continue to believe is the key bone of contention in the macro debate � sustainability.

The response was right out of the script of the late 1990s. One new paradigm after another was offered as explanations as to why this global recovery is for real. The Davos crowd embraced the notion that US-centric global growth was sustainable indefinitely. Drawing support from recent pronouncements by Alan Greenspan, the related view was expressed that there would be no problem in financing the extraordinary external imbalances that were spawned by such lopsided global growth (see Greenspan�s January 13, 2004 remarks before the Bundesbank Lecture 2004 in Berlin). As he did at the end of the equity bubble, Greenspan seems to be making a special effort to portray old concerns in a new light. Last time, it was a productivity breakthrough; this time, it�s the nimble financing of a new globalization.

The Davos consensus was quick to agree. With the entire world perceived to be on a de facto dollar standard, America�s rapid build-up of external dollar-denominated debt was not perceived to be a problem. After all, Asia is funding the bulk of the new increments to that debt, and most were utterly convinced that nothing could break the �daisy chain.� As long as America continued to buy Asian-made products, Asian investors would continue to buy American-made bonds � thereby avoiding the lethal back-up in real interest rates that such imbalances would normally spawn. One participant characterized this arrangement as �a massive Asian export subsidy program.� Another cited the artificially depressed US interest rates that fall out of this arrangement as a foreign subsidy to the spendthrift American consumer. Either way, no one could conceive of any circumstances that would cause Asian investors � private or official � to change their mind on the funding of America�s massive external imbalance. And so the Davos crowd believes the music will continue to play on.

Quite honestly, none of this really surprised me � these are precisely the assumptions that ever-frothy financial markets must be making in order to sustain asset values at current levels. If imbalances were perceived to be the problem I suspect they are, markets would be in a very different place. As predictable as this response was, I was totally unprepared for what hit me immediately after the conclusion of this opening session. Two of America�s leading academics rushed the stage � one a renowned economics professor and the other the president of a top university � and loudly proclaimed that the traditional macro of saving shortages and current-account deficits is a scam. America was not in any danger whatsoever, they argued vociferously. The imbalances that I worried about are simply the logical and entirely rational manifestations of a New Economy.

Seems to me I had heard that one before. But I held my tongue and pressed for more. The New Paradigm in this case is that America has now become an asset-based, wealth driven economy. As such, it need not worry about scaling its imbalances by national income � instead they need to be judged against economy-wide net worth. On that basis, debt loads � either internal or external � can hardly be characterized as worrisome when measured against the elevated wealth of the US economy. Sure, that wealth took a �bit� of a hit when the equity bubble popped in 2000. But the baton of the US wealth creation machine was quickly passed on to property markets, and the US economy never even skipped a beat.

This argument bears serious consideration, but I am convinced it is wrong. For starters, it makes the critical presumption that asset appreciation is permanent. When I pressed this point with my adversary, he bristled in response, claiming that permanently rapid rates of financial asset appreciation were entirely justified by the productivity breakthroughs of recent years. He went on to add that property cycles had all but been abolished � that the American home was a lasting store of ever-rising value. Needless to say, if that�s the case, then I�m the one who�s dead wrong. Ever-rising asset values would then qualify as permanent sources of saving � obviating the need for consumers to rely on traditional income-based saving strategies. Quite frankly, I couldn�t believe what I was hearing. Here we are, just a few years after America�s most devastating post-bubble carnage, and the apostles of the New Economy were back with a vengeance.

This debate cannot be taken lightly. It underscores the important distinction between an income-based and an asset-driven economy. In my opinion, beginning in the mid-1990s, the US economy did, indeed, adopt many of the behavioral characteristics of an asset-driven economy. I know of no other way to explain the sharp decline in income-based national saving that occurred during the late 1990s. Moreover, it�s continuing to the present day, with well-maintained personal consumption growth occurring against the backdrop of an unprecedented $350 billion shortfall of real wage income growth over the 25 months of this recovery. Nor do I expect this transformation to be unwound for as long as the Fed remains in its highly accommodative post-bubble, anti-deflation policy stance (see my January 9, 2004 dispatch, �Fed Hubris�).

But have we truly learned nothing from the Great Bubble? As was the case in the late 1990s, the sustainability of a wealth-driven US economy is critically dependent on the permanence of asset appreciation. Yet bubbles are, by definition, the antithesis of such permanence. The Fed, through its extraordinary monetary accommodation, is doing its best to keep the magic alive. Unfortunately, that only underscores the dangerous moral hazard implications of a post-bubble containment strategy � massive liquidity injections and rock-bottom interest rates that ultimately lead from one bubble to the next.

Davos is always one of the highlights of my year. It offers a spirit of engagement and open debate that cannot be found at any other gathering in the world. It forces you think well outside your comfort zone. It is a forum that is always filled with surprises. For me, the big surprise this year was the prompt and aggressive comeback of the New Paradigm crowd. As for me, I never did take off my tie.