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
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
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
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.)