Rating firm Moody’s on January 10 signaled
its belief that the long-term credit rating of US
government debt might have to be cut - downgraded
- below AAA. The firm was clearly neither
downgrading nor about to downgrade in the
foreseeable future. It was a warning about pension
costs, healthcare costs and the track our
government is on.
I would urge you to take
this announcement to heart for three reasons.
First, this is a serious warning about the
long-term health and standing of the US in the
community of global economies. Second, Moody’s has
provided us with another
symbolically powerful
milestone. Third, this warning foreshadows looming
political battles.
We have overspent and
face retrenchments. This means struggles over what
to cut and whom to stick with the bills. The
terrible retail numbers of the Christmas season,
fire sales of leading US firms, a sliding dollar
and falling asset values - homes and securities -
are all urging in the same direction. Economic
downdraft and increased struggles over how to
spend remaining funds will be the order of the day
in households, legislatures and boardrooms.
What does a downgrade warning statement
mean? Moody’s is one of the three dominant
research and ratings firms that monitor public and
private issuers of bonds and stock. Thus, Moody’s
rates the quality of the IOUs - bonds - sold by
governments around the world. At the present time
they rate the credit quality of government bonds
sold by 100 nations. Moody’s has rated US
government bonds since 1917 and in the intervening
period we have been awarded the highest rating
there is, AAA.
Many developing countries
have fought and struggled with ratings downgrades
over past decades. This is no minor matter. Debt
ratings affect the ability to obtain credit, the
size of the interest rate and the amount of credit
available. Credit ratings signal the safety level
and success of a nation’s economy. Downgrades -
even warnings of possible downgrades - tend to
rattle investors and reduce business confidence.
Trouble is usually close on the heals of warning
and downgrade. A US downgrade would be disastrous.
Official downgrade is very, very unlikely. Even
so, there is much worth pondering.
The
first reason you should care about the statement
is purely economic. America borrows billions of
dollars a day from the rest of the world to keep
her economy going. We import between US$53 billion
and $63 billion more than we export each month.
This gap is filled by borrowing and selling
assets. Lately this has been occurring at a fever
pitch.
Foreign entities inject tens of
billions per month into government bonds, home
mortgages, stocks, bonds and loans. Lately, Middle
Eastern oil exporter sovereign wealth funds and
East Asian export surpluses are channeled - by the
tens of billions - into leading US financial
institutions. Anyone who exports oil, or goods and
services to the US ends up with dollars. The more
they sell and the higher the price they get, the
more dollars they end up with.
The US runs
huge, persistent and rising trade deficits with
oil exporters and Asian goods producers. Oil
prices have been rising fast. Huge pools of
dollars have built up in state administered
accounts and been channeled into international
investment funds, sovereign wealth funds.
On January 15, we received the
announcement of $22 billion more being invested in
Citigroup and Merrill Lynch by these sources.
According to the most recent available data from
the US Treasury Department’s TICS System, across
September and October 2007 foreign entities were
net purchasers of $76 billion in US government
debt. This means that foreign entities purchased
$76 billion in claims on future tax collections or
asset sales by the US government.
Across
the same two months foreign entities were net
purchasers of $26.4 billion in agency bonds -
largely US government-supported home mortgages.
This largely means that billions of dollars in
mortgage payments will be collected and sent to
the foreign owners of our mortgages. In September
and October 2007, we were net sellers of $39.2
billion in corporate bonds. This can be seen as a
series of promises to repay loans with interest
from the future earnings of US corporations.
Last but not least, the US net sold $32.8
billion in stock to foreign holders across
September and October. Stocks represent ownership
in US corporations and claims on possible future
dividend.
All the above is sold to keep
the international financial markets functioning
and the US economy moving forward. We need more
money to continue purchasing and they are left
with more dollars than needed or wanted. We borrow
and sell to get access to spending power and they
loan or buy to preserve their position. Thus, the
rating and perception of American assets are no
minor matter.
The holes opening up in US
books are requiring greater and greater foreign
capital to cover over. There are no free repair
jobs. All this money comes with strings attached
and returns required. Downgrades make money harder
and more expensive to come by. It is neither cheap
nor fun to be downgraded.
Over the past
several years US assets have inflated. Over the
last few months this has run in reverse. In many
cases other regions were inflating faster before
July and are deflating more slowly now.
America’s assets are almost universally
priced in dollars and dollars have been declining
against most other currencies. This acts to
further reduce the international relative
performance of US assets. Declining dollars and
lagging asset price inflation downgrade our market
returns.
This brings us to number two. We
have reached milestone dependence on foreign
wealth. East Asian goods exporters and Middle
Eastern energy exporters have been pumping vast
sums into our economy and into leading financial
firms. Citigroup, Merrill Lynch, Morgan Stanley,
Bear Stearns and others have received tens of
billions from sovereign funds directly and are
actively seeking more. Governments of potent net
exporters sit atop $3-$5 trillion in assets. This
is being deployed to increase their returns and
assure their positions in the global economy.
Lately, this means the money is used to
rescue and purchase influence in leading US
financial firms. By extension, these purchases
extend - at very least the possibility - of
broader influence in the US. Part of being in a
downgraded position is the increasingly intense
hunt for foreign money and favor.
Again
there is no free repair service. The East Asian
exporters and Middle Eastern funds allocating tens
of billions of dollars into distressed and
declining value US firms are not motivated purely
by an urge to help. Recent past investments have
returned huge losses. We can assume they are
knowingly taking risks and throwing good money
after bad. You can be sure the guiding intent is
not benevolence. We are not guided by good will
when our monies flood into their economies.
Thirdly, these developments and the
weakening state of economic affairs, beg a series
of political questions that are likely to shape
debate and decision for the next several years.
What is given in return for all this investment,
purchase and borrowing? I am not arguing against
these actions, I am asking what are the costs? Be
assured, there are costs.
The past few
months have seen foreign wealth funds pour tens of
billions after tens of billions of dollars into US
firms. All the while they must have been
experiencing huge losses on dollar investments and
past purchases. Major exporters and oil producers
have needs and wants from US firms, consumers and
government policy. Interdependence grows with
diversified ownership and our presently profound
owership. Floods of needed cash by distressed
firms and trillions in assets owned intertwine the
interests of far-flung owners and lenders with
firms and others in the US.
Our monies and
credits have been deftly extended around the world
with plenty of attached strings. It seems only
reasonable to assume this will be true of the
wealth now flowing into the US. There will be a
deep pocketed new player sitting - in spirit or
flesh - at the boardroom table, the kitchen table
and in the halls of state power.
As
belt-tightening looms, government tax and spending
decisions are made, foreign policy actions are
debated, free trade is contested; our new partners
will be in the mix. Middle East oil exporters have
regional needs and issues. Alliances, markets,
security arrangements and political realities are
in flux these days. East Asian exporters fear a
free-trade lash-back, market access restrictions
and external policy meddling.
Today’s
deals and credit could influence future actions on
these fronts. As spending is paired by American
state agencies, households and firms, pressures
intensify. This creates political disagreements
and raises the stakes of debate. Free-trade and
foreign-policy issues are hugely important around
the world and loom large in the 2008 election
cycle. The risks to change and the return to
allies heighten during weak economic times and
presidential elections.
We muddled through
the closing months of 2007 by selling our assets
at a rate of $87 billion per month in September
and October. That rate has risen over the past
three months. All this begs two questions: Why do
they buy? What exactly are we selling? These
questions should be asked by the citizens of any
nation in the age of globalized markets. Suspicion
of foreign buyers is not an answer; it is bigoted
and narrow minded. It is equally naïve to assume
that recent purchases are benevolent billions from
far off lands.
Max Fraad Wolff
is a doctoral candidate in economics at the
University of Massachusetts, Amherst and managing
director of GlobalMacroScope.
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