As a result of government bailouts and stimulus spending in response to the
global financial crisis, gross government debts around the world have risen to
unprecedented heights by 2010 and are expected to continue on an upward trend
for the foreseeable future as recovery remains anemic in many regions in the
world. Ironically, the list of countries with high sovereign debt is topped by
Japan, notwithstanding Japan's huge foreign
currency reserve and its large export sector and persistent trade surplus.
Japan has been in permanent recession since the 1985 Plaza Accord pushed the
exchange value of the yen up against the dollar without any significant effect
on US-Japan trade imbalance in Japan's favor. Despite continuing trade
surpluses, Japan's gross government debt rose from 170% of GDP in 2007 to
nearly 200% in 2010 as the Japanese government revved up spending to stimulate
in vain the structurally impaired export economy.
A similar fate will fall on all economies that depend excessively on export for
growth as the traditional import markets in the advanced economies such as the
United States and the European Union are themselves trapped in anemic growth by
excessive debt for decades to come.
Yet the world, led by the US, has continued to waste money on military spending
in the middle of a ruinous financial crisis. In 2008, global military spending
totaled US$1.5 trillion. The US alone spent $607 billion on defense (41% of
world total) while many of its citizens were defenseless against losing their
homes through mortgage foreclosure due to falling income.
Stimulus packages dwarfed by military spending
In 2008, congress approved a stimulus package of $819 billion that included
regressive tax cuts, with spending to begin in 2009 and to end in 2019. Taking
away tax cuts, the spending amounts to $637 billion, with peak spending at
$263.4 billion in 2010 - less than half of US military spending in 2008.
Meanwhile, special appropriations have been used to fund most of the costs of
war and occupation in Iraq and Afghanistan so far. Much of the costs for these
conflicts have not been funded through regular appropriations bills but through
emergency supplemental appropriations bills. As such, most of these expenses
were not included in the budget deficit calculation prior to the financial year
ending in September 30, 2010.
From 2001 through February 2009, the Congressional Research Service estimates
that congress approved $864 billion in war-related funding for the Departments
of Defense, State and Veterans Affairs. This total is allocated as $657 billion
for Iraq, $173 billion for Afghanistan, $28 billion for enhanced military base
security, and $5.5 billion that cannot be categorized. Aside from normal
military spending, about $900 billion of US taxpayers' funds have been spent,
or approved for spending, through September 2010 for the Iraq War alone.
Growth needs to come from development, not trade
Not withstanding the fact that in 2010, despite the global financial crisis,
the EU and the US still remain the world's two largest economies by gross
domestic product (GDP) the EU at $16.5 trillion, the US at $14.8 trillion,
about 50% of the world total of $61.8 trillion, the days are numbered when
theses two economies can continue to play the role of the world's main
consumption engines and act as markets of last resort for the export-dependent
For sustainable growth in the world economy, all national economies will have
to concentrate on developing their own domestic markets and depend on domestic
consumption for economic growth.
International trade will return to playing an augmentation role to support the
balanced development of domestic economies. The world can no longer be
organized into two unequal halves of poor workers and rich consumers, which has
been an imperialist distortion of the theory of division of labor into a theory
of exploitation of labor, and of the theory of comparative advantage into a
reality of absolute advantage for the rich economies.
Going forward, workers in all countries will have to receive a fair and larger
share of the wealth they produce in order to sustain aggregate consumer demand
globally and to conduct fair trade between trading partners. Capital is
increasingly sourced from the pensions and savings of workers. Thus it is
common-sense logic that returns on capital cannot be achieved at the expense of
fair wages. Moreover, capital needs to be recognized as belonging to the
workers, not to the financial manipulators.
The idea that workers doing the same work are paid at vastly different wages in
different parts of the world is not only unjust but also uneconomic. For
example, there is no economic reason or purpose, much less moral justification,
why workers in the US should command wages five times more than those of
workers in China doing the same work. The solution is not to push down US
wages, but to push up Chinese wages to reach bilateral parity between the two
International trade driven by cross border wage and income disparity globally
will wither away from its own internal contradiction which ultimately will lead
to market failure. Low-paid workers are the fundamental obstacle to growth from
operative demand management at both the domestic and international levels.
Pitting workers in one country against workers in another will only destroy
international trade with counterproductive protectionism, which is not to be
confused with economic nationalism.
Some small countries may have no easy option other than to depend on export for
growth. These countries, such as the small Asian tigers, are condemned to zero
growth for the coming transitional decade as the world economy shifts from
export-led growth to domestic-development-led growth. They may have to seek
balanced domestic growth through true comparative advantage by symbiotic
integration in large super-national economic blocks, to shift export into
For example, unlike China, Japan's domestic market is simply not big enough to
make up for a rapid slowdown of its huge export sector. Thus Japan will have to
find ways to further boost already saturated domestic consumption while
shrinking its export sector, most likely facing negative growth until the
protracted restructuring of its dysfunctional export-dependent economy is
One option would be for Japan to integrate its oversized national economy with
that of China so that the huge Japanese export sector can be transformed into a
super-national domestic sector of a Sino-Japanese common market. South Korea
faces the same problem and may have to consider the option of integration into
a super-national East Asian economy. However, the East Asian model needs to be
different than that employed by the EU for what are by now obvious reasons.
In 2010, on a purchasing power parity basis, China's GDP is $9.7 trillion,
Japan's is $4.3 trillion and South Korea's is $1.4 trillion. An integrated East
Asian super-national economy will have a PPP (purchasing power parity) GDP of
$15.4 trillion, bigger than that of the US of $14.8 trillion.
The availability of a large domestic market with a large population and ample
land are the reasons why large countries such as the BRIC (Brazil, Russia,
India, China) are going to be dominant core economies going forward with
symbiotic integration with neighboring smaller countries.
Foreign holders of US sovereign debt
China's foreign reserve hit $2.5 trillion in March 2010. In April 2010, Japan's
foreign reserves fell below $1 trillion. By another calculation, at the end of
March 2010, China's total funds outstanding for foreign exchange were around 20
trillion yuan ($2.93 trillion at concurrent exchange rate), showing around $110
billion of growth compared to the end of 2009.
On February 16, 2010, the US Department of Treasury reported that Japan boosted
its holdings of US Treasuries by $11.5 billion in December 2009, bringing the
total to $768.8 billion, making Japan once again the largest creditor to the
US. China, after briefly occupying top position, became once again the
second-largest holder of US Treasuries, having sold $122.1 billion earlier to
bring its total to $755.4 billion, down from $877.5 billion in January,
relinquishing the top position creditor back to Japan.
The most US Treasuries China had held in reserve was $939.3 billion in July
2009, two years after the global financial crisis broke out in July 2007 and
five months after congress approved the $787 billion stimulus package to be
funded with debt.
Outside of Asia, the United Kingdom bought $24.9 billion of US sovereign debt
during the same month, bringing its total to $302.5 billion. Brazil bought $3.5
billion, bringing its total to $160.6 billion. Russia sold $9.6 billion,
reducing its total to $118.5 billion. Foreign creditors, nervous about US
stimulus spending, of future money sold the most amount of US sovereign debt in
December 2009, $53 billion, surpassing the previous record drop of $44.5
billion in April 2009. At the end of February 2010, total Treasuries
outstanding were around $13 trillion; the amount held by foreigners was around
As of March 2010, China's foreign exchange reserve totaled $2.45 trillion,
about 60% of which was invested in US securities. These securities include
long-term Treasury debt, long-term agency debt, long-term corporate debt,
long-term equities, and short-term debt.
Hillary Clinton during her first visit to China as secretary of state in
February 2009 urged China to continue to buy US Treasury securities. A month
later, in March 2009, Chinese Premier Wen Jiabao responded by stating publicly
that he was "a little worried" about the safety of China's holdings of US
sovereign debt. In addition, some Chinese government officials have called for
replacing the dollar as the world's main foreign reserve currency with
International Monetary Fund special drawing rights, harking back to John
Maynard Keynes' proposal of "bancors" for an international clearing union at
the Bretton Woods Conference in 1943.
Foreign investors had been a mainstay of the market for US government-sponsored
enterprise (GSE) debt (such as that issued by Fannie Mae and Freddie Mac), but
uncertainty over the GSE mortgage financiers' capital positions and the timing
and structure of an anticipated government rescue by September 2008 made
investors reassess their risk exposures. Asian investors in particular became
net sellers of US agency debt.
Federal Reserve custody data show that for 2008 up to July, foreign government
and private investors bought a monthly average of $20 billion of US agency debt
issued by GSEs such as Ginnie Mae, Freddie Mac and the Federal Home Loan banks.
Foreign purchases of US Treasuries averaged $9.25 billion a month. All told,
the average monthly purchase of US public debt by foreigners was around $30
From July 16 to August 20, 2008, foreign buyers sold $14.7 billion of US agency
debt, trimming their overall holdings to $972 billion. They purchased $71.1
billion of Treasuries in the same period with dollars earned from trade
Bailing out GSEs to protect foreigners' exposure
In his just published memoir, On The Brink, former Treasury secretary
Henry Paulson revealed that Russia made a "top-level approach" to China "that
together they might sell big chunks of their GSE holdings to force the US to
use its emergency authorities to prop up these companies". Paulson wrote he
learned of the "disruptive scheme" while attending the Beijing Summer Olympics.
"The report was deeply troubling - heavy selling could create a sudden loss of
confidence in the GSEs and shake the capital markets," Paulson wrote. "I waited
till I was back home and in a secure environment to inform the president."
The Bank of China, the nation's major foreign exchange bank, cut its portfolio
of securities issued or guaranteed by troubled US GSE home mortgage financiers
Fannie Mae and Freddie Mac by 25% since the end of June 2008. The sale by the
Bank of China, which reduced its holdings of US agency debt by $4.6 billion to
about $14 billion, was a sign of nervousness among foreign buyers of Fannie and
Freddie's bonds and guaranteed securities. China holds about $400 billion of US
agency debt in total.
A month after secretary Paulson returned from the Beijing Olympics with the
disturbing message for President George W Bush, the Treasury on September 7,
2008, unveiled its extraordinary takeover of GSEs Fannie Mae and Freddie Mac,
by invoking Section (14) authority under of the 1932 Federal Reserve Act, as
amended by the Banking Act of 1935 and the FDIC Improvement Act of 1991.