The monstrous typhoon that pounded away at coastal areas of the Pacific last
weekend certainly qualified as a disaster for anyone who happened to be in its
path. For those of us safely in bed and far from Typhoon Morakot's path, the
storm provided some remarkable meteorological footage and a stealth lesson in
economics.
The most dramatic image, which involved a water torrent sucking away the sand
beneath a stoutly built six-story hotel in Taiwan, struck me as an apt metaphor
for the current economic environment. As the hotel's foundations became
exposed, the building toppled over like a domino. It was a vivid reminder that
no structure, no matter how mighty, is safe if its foundation is weak.
Since the financial deluge erupted last year, the authorities, at
least in the United States, have concentrated their repair efforts on the upper
floors of the economy and have virtually ignored the rotting foundation
beneath.
Since 1971, when president Richard Nixon broke the last link between gold and
the US dollar, American politicians have unleashed an ever-increasing number of
entitlement projects designed to boost consumerism. With some 70% of the
economy now based on consumption, we can safely say they accomplished their
aim.
Following former US Federal Reserve chairman Alan Greenspan's financing of the
largest asset boom in the history of the Fed, America now faces massive
deleveraging and a severe recession. However, it is becoming increasingly clear
that neither the Barack Obama administration nor the US Congress have the
slightest appetite for the political costs of deleveraging. Instead, the
government has decided to lavish unprecedented trillions more of borrowed
dollars on preventing a natural deleveraging from taking place.
Today, the official US Treasury debt stands at a shocking US$13 trillion, or
100% of the (declining) total wealth created in the US each year (gross
domestic product, or GDP). But total federal debt amounts to an almost
unimaginable $56 trillion, or 4.3 times GDP.
Notwithstanding this precarious state of affairs, the government intends to
spend trillions more dollars on wealth-consuming entitlement projects such as
education, healthcare, auto sales and the pursuit of fruitless wars in Iraq and
Afghanistan.
America still has the largest economy in the world, but that doesn't mean that
it is the richest. Although Americans enjoy one of the world's highest
standards of living, they are also its largest debtors. As a result of the
debt, which is subtracted from output, the worldwide rank of US GDP is not
first, as most would expect, but fifteenth!
For many years, two factors have prevented rank-and-file Americans from
perceiving the weakness of the US's economic foundation. First, the
international reserve status enjoyed by the US dollar has delayed severe price
erosion and allowed Americans to buy imports at a falsely advantageous price.
Second, American living standards have long been heavily financed from abroad,
most notably today by China.
The Chinese have recently expressed grave concerns about depreciation of their
dollar-denominated assets and openly challenged the reserve status of the
dollar. As Chinese support is vital to the US currency's continued viability,
these threats are bound to exert downward pressure on the price of the dollar.
In short, China is increasingly unwilling to finance America's falsely high
standard of living. If the Chinese pull out, where else can the US turn?
Last week, in response to questions about the sustainability of Washington's
spending spree, US Treasury Secretary Tim Geithner uttered one of the more
ambiguous phrases ever from someone holding that office, saying, "The
government will have to do what the government has to do." His comments went
unexplained and could have referred to massive future tax increases. More
ominously, they could have hinted at any measure, from an extended "bank
holiday", to currency exchange controls, or even to a massive devaluation of
the US dollar (similar to the 75% devaluation instigated by Franklin Roosevelt
in 1934).
Increasingly, it appears that the government is aware that its reckless
expenditures will be financed less by foreigners and increasingly by current,
and more importantly future, US taxpayers - and potentially by a severe
devaluation of the dollar.
It does not take a student of architecture to grasp that America's very
structure is becoming more and more vulnerable to the shifting sands of
economic policy being made in foreign capitals, and blowing upon our shores.
John Browne is senior market strategist, Euro Pacific Capital. Euro
Pacific Capital commentary and market news is available at
http://www.europac.net. It has a free on-line investment newsletter.
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
