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Empire of debt has its limits
Japan Times
February 21, 2006

HONG KONG -- Recent news about U.S. current-account deficits with the rest of the world gives grim pause for thought from Beijing and Tokyo to London, and especially in Washington, for it shows the United States approaching the financial equivalent of a nuclear meltdown.

The U.S. trade deficit reached a record $ 725 billion in 2005, thanks to rising oil prices and the growing influx of imports from China. The deficit with China alone was $ 202 billion. What should be scary for Americans is that the value of imports was almost 60 percent more than that of exports and that the trade deficit was 5.8 percent of national income. The overall current account deficit, a more comprehensive measure of financial flows, was larger still at a whopping 6.5 percent of U.S. national income.

Meanwhile, new estimates of the budget deficit showed the government going deeper into hock, thanks to the swelling costs of the war in Iraq. The budget deficit is likely to reach $ 400 billion, up from the $ 340 billion previously forecast.

Predictably, the deficit with China has led to calls from Washington for Beijing to revalue the yuan and, if it doesn't, for the U.S. to impose a tax of up to 25 percent on Chinese goods. American congressmen are blaming everyone except the real culprit -- Americans themselves.

A yuan revaluation, or a tax, would have to be massive to dent China's export ability, and neither would solve the root cause of U.S. woes -- spendthrift habits and a seemingly arrogant inability to produce the kind of goods that the world wants at an affordable price.

Increasingly the U.S. relies on the kindness of strangers to save it from going bust. In Japan's case, almost all government debt is owed to the Japanese people. American debt is increasingly in the hands of foreigners, who now hold trillions of dollars of it. Moreover, the U.S. must import almost $ 2 billion a day to support its spending spree.

Of course, global accounts must balance and, perversely, some economists claim that the 2005 figures point to a U.S. boom instead of a bust. They say the widening trade gap reflects the strength of a U.S. economy that sucks in foreign imports faster than less vigorous economies in Europe and Japan can buy American goods.

What a turkey of an argument! Before the American empire existed, countries used to settle their foreign business accounts in silver or gold so that the outflow of the precious metals would exert a sobering effect on a country that was spending above its means.

Ever since U.S. President Richard Nixon severed the link between gold and the dollar in 1971, the world has been living in a "pax dollarium." The U.S., like the rest of the world, pays for its goods with a hard currency, but uniquely that currency is its own. As long as the central banks of China, Japan, South Korea and other big exporting countries are prepared to accept IOUs in the form of U.S. Treasury paper, the U.S. does not have to make the forced economic adjustment that any other economy with a heavy deficit would endure.

Some economists believe that this is a wonderfully cozy deal for everyone: China and the other exporters build more and more factories to provide jobs for their people and keep their economies at full employment, while the U.S. imports all the geegaws, knickknacks, dolls and toys that can keep its people happy.

The deal has its own built-in equilibrium, not least because the more U.S. debt the exporting countries hold, the more costly it will be for them to try to switch to another reserve asset. If Beijing or Tokyo, for example, tried to offload some of their holdings of U.S. dollars, the amount is such that not only would global currency markets suffer an earthquake, but China, Japan and all other holders would realize big losses in the real value of their reserves.

It is also a dangerous equilibrium. Had the U.S. used the period of massive deficits as an opportunity to make adjustments, such as investing in new export industries and bringing its labor costs under control, then the world might live happily ever after, at least as far as trade relations are concerned.

Far from investing, though, Americans have been spending wildly. Warren Buffet has rightly nicknamed the U.S. "Squanderwille." The personal savings rate, which stood at 7 percent during the previous three decades -- even then at the bottom internationally -- has dropped to 1 percent as Americans pile on debt with credit cards and remortgage their homes to extract the maximum value from the housing boom.

What madness! Properly maintained homes are likely to be a cost center rather than a profit center. But such is the craziness of the modern U.S. economy that property has become the red-hot game, with houses changing hands several times even before they're built and most banks joining in the lending game.

"If you can fog a mirror (that is, still breathe), you can get a home loan," declared the Los Angeles Times recently.

The question is how long the ride will last. Will Americans wake up when foreign debt holdings reach 50 percent of U.S. gross domestic product? Or when China and Japan and other creditors finally tell Washington to mend its ways and to stop lecturing them about how to run their economic and political regimes?

Maybe it will end when something that has been tolerable in ordinary people's lives suddenly ceases to be so, such as U.S. President George W. Bush's imperious ways with regard to the war in Iraq, global environmental controls, his demands on the World Trade Organization. It could be a setback in Iraq or elsewhere that wakes the world up to the fact that the U.S. is not particularly efficient at running its affairs.

Breaking with pax dollarium is likely to be painful for everybody. A sharp drop in dollar values will not only cost creditors dearly as their reserves lose value but will also set off a vicious struggle for export markets to replace the U.S.

Still, at the end of the day, China and Japan and India will have their factories and production lines, with people who are richer and able to afford the goods they produce and who can even trade with each other. The Americans will have their debts, and lots of dollars, attesting to a great capitalistic system whose virtues they ignored.
Kevin Rafferty is a former managing editor of publications for the World Bank.

The Japan Times: Feb. 21, 2006
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