LIVING BEYOND THEIR MEANS: BUSH AND GREENSPAN PUSH THE WORLD TO THE BRINK OF ECONOMIC RUIN

Regular readers know I try to fill the void, with short analyses that are intelligible to the average citizen. Here I go again.

The chart above shows something called the Current Account deficit. It shows that, until the 1980s, the Current Account, which reflects the difference between what people and corporations in aggregate save and what they spend, was flat. The Current Account went seriously into deficit in the early 1980s, but was reined in again, until, during the Clinton Administration it began to spiral out of control. Under Bush’s watch, and more importantly under Greenspan’s watch, this deterioration has accelerated over the last four years, so that now it’s running at a $700 billion annnual rate, and forecast to hit one trillion dollars within the next few years, maybe even the next year.

The chart for the US Trade Deficit is virtually identical to the chart above. On an annualized basis, this deficit — the difference between imports of $1.8 trillion and exports of $1.1 trillion, is also $700 billion, heading quickly towards the one trillion mark. Petroleum products alone account for $200 billion, close to 30%, of this deficit, and that proportion is, of course, climbing at an even faster rate. The cost of oil has risen 50% almost overnight, and further increases are forecast.

What do these numbers mean? Well, the Gross Domestic Product (GDP) — the total value of economic activity — of the US is about $10 trillion per year, which is about 1/4 of the total global GDP. So the current account deficit means that Americans are spending about 10% more than they are earning each year, and importing 20% of what they consume while exporting only 10% of what they produce, and financing the difference. Meanwhile, the US National Debt (the total amount the US government owes), after levelling off during Clinton’s second term, is accelerating at an unprecedented rate, to its current level of $7.5 trillion (as much as the entire country produces in 9 months), and its Net International Investment Position (NIIP — the net indebtedness of the US to the rest of the world, is nearing $3 trillion, 30% of GDP. The US National Debt is capped, and three times Bush has had to go to Congress to get authorization to increase this cap. The situation will inevitably get worse no matter who is elected next month, so the cap, put on to safeguard against reckless spending, will have to be raised many times more in the next few years. And with Bush determined to make the tax cuts permanent, or introduce a ‘flat tax’, the National Debt is likely to accelerate further as government revenues fall. This is like your mortgage broker (Congress, echoed by the IMF) telling you your mortgage payments exceed the maximum safe proportion of your income, then you (the US Government) replying that you’ve decided to take a lower-income job, so you’ll have less money to make the payments, and then the mortgage broker (Congress) replying “OK, well, I guess we’ll allow you to increase your mortgage anyway”. This is insanely irresponsible behaviour.

But the press remains mute.

In short, the American people, corporations and government are all living well beyond their means, and borrowing at an accelerated rate to make up the shortfall. And if interest rates go up, and some economists think they could soon hit double-digits, we’re all screwed.

What are the implications of these deficits, especially considering that they are being incurred by an administration that doesn’t know or care about fiscal and economic matters, under the direction of a Fed Chairman with an ideological bent not to intervene?

• It means the US dollar will continue to weaken, and may even collapse.
• Wachovia’s economist says “it’s just a matter of time before foreigners will become less willing to lend to the US”. That means they will have a choice: Stop selling to Americans, or at least insist that payment be made in a stabler currency than the US dollar. “When that point is reached, interest rates will rise as foreign lending slows.” Those rising interest rates, reflecting the perceived growing risk of repayment, will increase the cost of the US National Debt proportionally, which will require the US government to cut spending elsewhere (i.e. defense and social services, and rollback tax cuts), or run the risk of bankruptcy. It’s been said cynically that that has been the neocon plan all along, but the reality is that cutting social services alone won’t do it — military adventures will have to stop, and sharp tax increases will have to be introduced as well. The alternative is to play a game of “chicken” with foreign lenders, which appears to be the Greenspan approach — let’s see how far foreign sellers will let the deficits go, before they’re willing to hurt their own economies by curtailing sales to the US or demanding they be repaid in a stabler currency. Problem is, in this game of chicken there are only losers.
• Back in 2002, the Institute of International Economics warnedthat the Current Account deficit could rise to 7% of GDP by 2006 (it has already reached that level this year), and that only a level of 2-2.5% was sustainable — anything above 4% will trigger a continued and sustained fall in the US Dollar until that deficit falls back to sustainable levels. This suggests that despite its 25% declines in the past year, it has additional declines of 25-50% in store in the next couple of years. Now suppose you’re a foreign vendor who’s sold a billion dollars worth of goods to American consumers, secured by US Dollar loans — with the US Dollar in free fall, are you going to continue to sell when your profits are wiped out in foreign exchange losses? The answer of course is no, and when the Arabs or the Asians move to the Euro as the currency of all transactions, the game of “chicken” will be called, and the US Dollar will drop through the floor, making US debt repayment and new borrowing unaffordable (at all levels — government, corporate and consumer), precipitating a crash in US stock markets as the value of $US assets tumbles below the value of Euro debts, and hence a crash in markets worldwide as one fourth of the world’s buying power stops buying. As the IIE put it two years ago: “The United States must attract about $2 billion of net capital inflow every working day to finance the deficits at their current level. Since gross US capital outflows have been running about as large as the current account deficit, our gross capital inflows must average about $4 billion per working dayóand totaled about $1 trillion in 2000. Any decline in the level of these inflows, let alone their reversal via a selloff from the $10 trillion of outstanding dollar holdings of foreigners, would produce increases in the US price level and higher interest rates (and almost certainly a fall in the stock market as well). This triple whammy would severely hurt the US economy.”
• In a more recent analysis, the IIE predicted a Euro soaring past $1.50 USD in value (i.e. a USD worth only 0.66 Euros). What is especially astonishing about this is that the European economies are not doing particularly well. What we are seeing is the world embracing another currency not because its supporting economies are strong, but because they are so worried about the overextension and unsustainability of the US economy and its underlying policies.
• The Chinese currency is currently overheated, with inflation there approaching double-digit levels and threatening to lead to economic collapse. Prevailing view is that if China doesn’t immediately revalue its currency upwards by 20-25% (so much for the benefits of offshoring!), it will suffer a hard correction and severe recession. The consequences of that will be a sharp, inflationary increase in the cost of Chinese goods, and great difficulties for the many, many American companies that are now utterly dependent on cheap Chinese goods for their survival. Thanks, Wal-Mart!
• The 50% jump in oil prices is going to start working it’s way through the economy soon. If you look at the cost of materials and overhead for many businesses: chemical companies, plastics manufacturers, agribusiness, transportation, heating utilities, asphalt companies, medi-tech and pharmaceuticals, clothing companies using man-made fibres, furniture companies, floor coverings, cosmetics, household products, paints and dyes, you’ll find that oil cost is a key determinant of their product cost. If half the cost of their products is tied to the cost of oil, expect retail prices to rise accordingly, adding inflationary pressure to the economy big-time.

What should individuals do in light of the precarious condition of interest rates, stock markets, debt levels and trade imbalances? I caution you that I’m not an investment advisor, but these actions would appear to be prudent — and the mainstream media are simply irresponsible for not telling you so:

• Do your best to pay down debts, especially variable-rate debts, and avoid incurring new ones. I know, that’s easy to say and hard to do, but that’s the best protection against interest rate spikes and bubbles.
• Be leery of investments in the stock market, especially in US stocks, and especially those of companies that have offshored much of their production or service to China. They’re especially vulnerable to the triple whammy: Falling US Dollar, rising interest rates, and slowing of consumer demand. That applies to investments in retirement savings plans as well.
• If you’re exposed, as an investor from another country, to volatility in the exchange rate of the US Dollar against your national currency, consider moving your assets into those denominated in your own currency, or at least hedging your positions so if (when) the US Dollar slides further, you don’t take a bath.
• If you’re running an American public company with cash to invest, this might not be a bad time to consider buying back your shares and going private.
• If you’re a consumer with cash to burn, consider buying products that take oil to produce, because they’re going to go up in price; and don’t invest in the companies that make these products, because when prices start to soar, sales will plummet.

The news gets even worse. For reasons that are historical and purely political, Americans get a tax deduction for interest secured by a mortgage on their homes, but not for interest on unsecured or otherwise-secured borrowings. As a result, a horde of usurous companies have been offering unwitting American consumers, who, like their governments and corporations have been living far beyond their means, ‘consolidation’ loans that convert a bunch of unaffordable, unsecured debts into one unaffordable debt secured by their homes. The result, in tens of thousands of cases, is foreclosure on those homes when consumers, unable to afford principal repayments, let alone interest at rates that run as high as 30%, miss payments. One fourth of new US mortgages are now credit card debt consolidation loans, and victims are losing their homes at a rate of 200,000 per year. But what these hapless citizens are doing pales in comparison to the policies of Bush and Greenspan, who are doing exactly the same thing on a massively grander scale — buying and spending more than they can possibly hope to repay, and hoping the world doesn’t foreclose on them.

No wonder they call economics the ‘dismal science’.