SPEAKING
FREELY US living on borrowed time - and
money By Julian Delasantellis
In 1987, Yale historian Paul Kennedy
published The Rise and Fall of the Great
Powers, in which he argued that "military
overstretch" - where conquering nations engaged in
more foreign military adventures than their
economic resources could support - led to the
eventual decline and fall of empires.
So
far, the US attempt at dominion that commenced in
2001 has not been threatened in this manner
because, in essence, the
nation has been able to
borrow the costs simultaneously to maintain both
its new empire and its avaricious middle-class
consumerist lifestyle.
But the times, they
are a-changing. Buried deep in the arcanum of some
recently released economic statistics are
indications that the world is tiring of its role
as America's charge card.
So far the
United States has easily financed its endeavors in
Iraq, as well as undiminished levels of domestic
social-welfare spending, not by the traditional
solution of raising taxes (in fact, taxes have
been cut numerous times since 2001, an occurrence
unheard of during previous wars) but by running
huge budget deficits, such as fiscal year 2006's
projected shortfall of US$423 billion.
Accompanying the federal budget deficit is
the huge US trade deficit, burgeoning out of
control as more and more of previously
domestically produced consumption items are
outsourced to foreign, mostly Chinese,
manufacture. The stimulative US budget fiscal
position assures that Americans will have all the
money needed to buy them.
Standard
economic theory since the adoption of floating
foreign exchange rates in 1973 states that big
trade deficits auto-correct by having the currency
of the profligate nation depreciate. Thus if
Brazil is buying more from, say, South Korea than
South Korea is buying from Brazil, there will be
more South Koreans with Brazilian reals (earned
from the exports to Brazilians ) than there will
be Brazilians with won.
In most cases,
this would lead to selling of the currency of the
deficit country, since there will be a surplus of
the deficit country's currency in these
foreigners' hands. The selling will drive down the
value of the deficit currency; that will
eventually make consumption of the shiny foreign
goodies too expensive, and eventually the trade
deficit will equalize.
This has
traditionally not happened with foreigners holding
US dollars. The United States dollar is what is
called a "reserve currency", ie, foreigners are
willing to hold dollars even though they can't
easily use them as the domestic currency in their
home markets. Without the selling that would
accompany all the exporters to the United States
trading their dollars for their home currencies,
the US dollar stays higher than the economic
fundamentals would theorize it should, and the
great American global shopping spree can continue.
The ledger of how much more capital the US
sucks in to finance its consumption as compared
with how much it sends out to invest is called the
current account deficit. The money that foreign
exporters hold in US dollars and then invest in US
government or private bonds, stocks or short-term
bills is entered in the minus column on the
current account. As the US domestic savings rate
is so pitifully low, the United States must import
a huge amount of foreign capital just to finance
that huge federal government budget deficit.
From an even then huge $531 billion in
2003, the current-account deficit has been rising
in recent years by more than 20% a year, last
year's was $805 billion, and the projection for
2006 is more than $975 billion - that's almost 7%
of gross domestic product. In other words,
America's spending addiction, from DVD players to
destroyers, means that the nation consumes 7% more
than it produces.
But until very recently,
financing this hunger wasn't all that much of a
problem.
The most important US government
economic statistical report that you've never
heard of is called the Treasury International
Capital (TIC) report. The current-account data
report how much the US needs to finance its
lifestyle; the monthly TIC data report what it
actually gets.
Thus in 2003, the
current-account deficit meant that the US needed
to entice $531 billion from the rest of the world.
TIC data reported that what it actually got was
$747 billion. For 2004, the need was $666 billion;
it actually got $915 billion. For 2005, the need
was $801 billion; $1.025 trillion was actually
received. Many economic commentators believe that
as this excess foreign capital started sloshing
around and through the US banking and financial
system, it kept US interest rates low and thus
fired the tremendous rallies in real-estate and
stock-equity prices that have occurred in the past
few years.
But nothing good lasts forever.
From reaching a high of $117.2 billion in August
2005, the TIC reports are showing a steady decline
in foreign inflows, down to $74 billion in
December, and $78 billion for January, the last
month for which data are available. The nasty
thing about this is that with a projected $975
billion current-account deficit for this year, the
US is no longer getting what it needs from the
world to maintain its lifestyle. The
foreign-capital food supply is dwindling just as
the hunger increases.
True, the actual
shortfall is not yet very large, right now less
than $5 billion a month. But I see the salient
fact here as not being the current-account deficit
minus TIC-inflow shortfall right now, but the
rather significant 35% absolute reduction in
inflows since last summer. As the US political
system shows absolutely no indication of being
either desirous or even able to deal with its
fiscal profligacy (the recent congressional farce
surrounding the increase in the debt ceiling being
an example), the current-account deficit will only
rise; unless US households are willing to increase
their savings rates massively (very unlikely,
since I haven't seen any "going out of business"
signs on Best Buy or Circuit City lately) or the
declining-TIC-inflow trend reverses, there's
trouble ahead for the latest US experiment in
cut-rate conquest.
There are many ways
this trouble could manifest itself. Since much of
this foreign-capital inflow finds its way into
long-term US Treasury securities, it's hardly
surprising that, with the recent shortfall in TIC
inflows, Treasury interest rates are rising to
their highest levels in two years. If demand is
falling, then the market is marking down prices,
and the basic rule of bond markets is that yields
move in inverse directions to prices. Rising
mortgage rates will put the US real-estate boom in
real jeopardy, and it has been US homeowners
pulling spendable cash out of the inflated values
of their homes that has generated much of the
consumption component of recent US growth.
It is also possible that this could lead
to a sharp selloff in the US dollar, as has been
happening in the dollar-euro market since
November. If foreigners with export earnings from
the US do not put it back into US assets, they
will not just keep it stuffed in their mattresses;
they will look around for interest-bearing
instruments denominated in euros, sterling, yen,
or a dozen other currencies.
This will
cause these currencies to appreciate in value, and
the dollar to fall. If you've ever looked at the
back page of The Economist magazine you'll have
seen the huge foreign-exchange reserves being
built by countries that have recently been the
winners in the global trading game. As of
December, the International Monetary Fund lists
Japan's reserves at $847 billion, China's at $819
billion, Taiwan's at $253 billion, South Korea's
at $210 billion, Russia's at $194 billion, and
India's at $137 billion. These reserves, held
overwhelmingly as US dollars, are the potential
gasoline just waiting for the match to set alight
a huge global economic conflagration.
If
somebody starts selling his dollar reserves, even
if it's only a portion of his dollar portfolio,
other countries could be forced into panic selling
of their huge dollar reserves. The
foreign-exchange markets are the biggest and most
liquid in the world, but whether they would be
able to absorb the amount of selling that could
emerge from portfolio adjustments this large is a
very open question.
More likely there
would be a sharp overshoot in the dollar-selling,
leading to a perhaps 20-30% decline in dollar
values within a very short time. For the US, this
would mean a sharp rise in the prices of
everything it imports, especially crude oil. That
would mean inflation, with the Federal Reserve
raising interest rates to contain it, or maybe the
economy would bypass the intermediate inflationary
phase and head straight into deep recession or
depression.
Either way, the great run of
US prosperity would be over. Worldwide, along with
the global contractionary effects of US economic
growth suddenly stopping or going into reverse,
the effect of an almost instantaneous 20% haircut
in the value of the world's financial reserves
would be no picnic, either.
On the first
day of class, business teachers like me love to
introduce our sleepy students to the concept of
TANSTAAFL - there ain't no such thing as a free
lunch. The United States may soon be introduced to
the concept of TANSTAAFE - there ain't no such
thing as a free empire. Specifically, will the
nation still think it's so important to control
the sands of Samarra, or the streets of Fallujah,
or, for that matter, those of Baghdad if, like the
signs say in US doctors' offices, "payment is
expected at the time of service"?
Julian Delasantellis is a
management consultant, private investor and
professor of international business in the US
states of Washington.
(Copyright 2006
Julian Delasantellis.)
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