Sunday, November 21, 2004

U.S. is Squanderville?

There has been lots of newspaper coverage recently about the increase in the national debt ceiling, the new federal budget, and Alan Greenspan's comments on U.S. finance at a meeting in Frankfort.

See for example this account on the debt ceiling which says

The government's borrowing limit has climbed by $2.23 trillion since President Bush took office: by $450 billion in 2002, by a record $984 billion in 2003 and by $800 billion this year. Just the increase in the debt ceiling over the past three years is nearly 2 1/2 times the entire federal debt accumulated between 1776 and 1980.

On Greenspan's comments, see for example, this brief report which says straightforwardly that the "huge current account deficit cannot be indefinitely financed by foreign countries and investors."

Greenspan's statements track pretty closely with the Washington Post editorial I wrote about recently (see "Falling Dollar").

I understand the main points to be the following: (1) Americans tend to spend a lot more than they earn. (2) Instead of putting their money into savings, they tend to purchase merchandise, much of it goods from abroad, particularly Asia, and within Asia particularly from China. (3) As a whole, the U.S. buys vast amounts more from foreigners than we sell to them. (4) To some extent we've been able to export services to reduce the amount of our export deficit, but recent offshoring of service jobs (all those computer programmers in India) has changed this trend. (5) Like U.S. citizens, our government spends more than it takes in. Since U.S. citizens can't or won't finance the whole of the federal deficit, we rely on foreigners to purchase Treasury securities; they currently hold about half the federal deficit. (6) Foreigners are willing to buy Treasury securities because they have confidence in the U.S. economy, which is very large and -- partly by showing nice increases in productivity -- has been growing faster than other economies. (7) They also finance the U.S. debt because the economies of other nations are dependent on that of the U.S.; put otherwise, their failure to finance the debt would provoke a world-wide crisis. (8) Nonetheless, there's a possibility that foreigners will lose faith in the strength of U.S. economy and its economic policies. They might come to think they have less to lose from ceasing to finance our debt than they have to lose from a collapse of the U.S. economy. (9) It's also possible that they won't have any choice but to decrease their purchase of Treasury securities. This could come about as a by-product of the sharp decline in the value of the U.S. dollar. One scenario involves the problems that China faces with inflation (discussed below). (10) And finally it's possible that even a small decrease in confidence in the U.S. economy and small reduction in foreigners' willingness to buy Treasury securities will force up U.S. interest rates, and this, for all practical purposes, could reduce the U.S. government's control over its own economy by limiting the what monetary policy can achieve. (This is presumably why Greenspan was so widely quoted as saying that world leaders need to maintain flexibility as much as possible.)

There seems to be a huge amount of risk of things going wrong.

Other risk factors, in addition to the ones listed above, include the administration's commitment to tax cuts, the unwillingness of the U.S. Congress to restrain federal expenses, and uncertainties about the effects of the plummeting value of the dollar.

There's an interesting article on all this at a site called It's "Lawrence Summers Comes Clean On The US Current Account" by Marshall Auerback on a recent paper by Lawrence Summers. Summers is now head of Harvard University. He previously served as US Treasury Secretary and as chief economist for the World Bank. Here is a link to the paper itself: THE 2004 PER JACOBSSON LECTURE, The U.S. Current Account Deficit and the Global Economy, October 3, 2004. (Note that Auerback isn't entirely unbiased; he works for a mutual fund company whose products are "designed to help protect investors against stock market declines.")

The article says, to paraphrase a bit, that we in the United States have become much too dependent "on the kindness of strangers" meaning the foreign nationals and foreign governments who buy our treasury securities and finance our national debt. Auerback quotes billionaire investor Warren Buffett, who refers to the United States as "Squanderville." He concludes that, "With foreign central bankers showing increasing signs of 'buyers’ fatigue' in the US Treasury market, the day of reckoning for the US economy approaches ever nearer."

Like many other accounts (see list below), this one points out that Europeans are being forced to suffer the worst consequences of America's debt problems. The Asian countries are keeping their currencies artificially high, relative to the dollar. A huge chunk of the U.S. trade deficit is with these countries (particularly China). However, the U.S. finds it difficult to convince any of them to let their currencies rise since they hold so much of our national debt and we rely on them to continue financing it. What's happening, to some extent, is that Americans buy Asian goods and Asians use the dollars they earn to purchase Treasury securities.

Auerback says economists have been saying that the decline in U.S. exports, which could help offset the huge deficit in imports to the U.S. will be offset by increases in export of U.S. services. "The problem today, however, is that as more service jobs are offshored, even that surplus is shrinking rapidly."

More from this article:
When foreign economies resist dollar devaluation and the dissipation of their current account surpluses, the risk is that the U.S. may therefore have to raise interest rates in order to induce creditors to continue financing its debt build-up, a highly dangerous policy, given overall debt levels in the domestic economy.

Simply choking off US domestic demand in order to reduce the current account is not without substantial costs as well, given that “any attempt to adjust a large part of the US current account deficit by simply slowing down growth in the US economy will involve a slowdown in growth that would be unacceptable in the United States, and would have very severe consequences for growth globally.

>The Bush Administration must continue the delicate balancing act of convincing its major trading partners, especially China and Japan, to stay at the table and keep lending huge sums even as it encourages the dollar's decline in the hope of boosting US exports, discouraging imports from Asia and Europe and thus shrinking America's trade gap (with little success so far). If Asia refuses to concede a currency realignment, then the US may simply force deflation on the euro zone (as it appears to be doing now), given that the latter currency continues to bear the strain of US dollar devaluation. This is already creating manifest strains in Europe. The 12-nation euro zone's finance ministers, the European Commission, and the European Central Bank unanimously agreed at a meeting in Brussels that recent currency moves were unwelcome and could further undermine their stuttering economic recovery.

An Asian currency revaluation, however, is not without its risks, given the precarious state of China’s own financial system. China is now slowing somewhat, with a banking system riddled with bad loans to its domestic enterprises. If a banking crisis developed, Beijing might have no choice but to sell off its US bonds and use the capital at home to stabilize its financial system or to assuage political unrest among its unemployed masses. Similarly, Tokyo has for some years anticipated an eventual American reckoning but hoped to keep the United States from doing anything rash until the Asian sphere was strong enough to prosper on its own, without depending so heavily on American consumers.

Still, creditor nations, such as China or Japan, naturally have the upper hand, like any banker who can call the loan when he sees the borrower is hopelessly mired.

Some links

Debt Limit to Rise to $8.18 Trillion"

Greenspan Urges Trade Gap Reduction"

Greenspan: Appetite for Dollar Will Wane


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