A Reversal of Fortune
by Charles Lemos, Sat Dec 27, 2008 at 01:09:13 PM EST
Over the past 30 years, there has been a significant redirection of global capital flows. One of these capital flows has been the flow out of the wealthy but mostly energy resource poor OECD countries towards the energy producing states largely in the Middle East but also in Latin America and more recently Africa. The other major new capital flow is from the OECD in general but significantly more from the United States towards China. The Chinese, it turns out, have also been on a shopping spree. They have been buying, well, us. This year China surpassed Japan as our largest lender. China now holds over 10% of the US dollar denominated debt, a little more than a trillion dollars.
From the New York Times comes a must read article on China's rise and our fall:
In March 2005, a low-key Princeton economist who had become a Federal Reserve governor coined a novel theory to explain the growing tendency of Americans to borrow from foreigners, particularly the Chinese, to finance their heavy spending.
The problem, he said, was not that Americans spend too much, but that foreigners save too much. The Chinese have piled up so much excess savings that they lend money to the United States at low rates, underwriting American consumption.
This colossal credit cycle could not last forever, he said. But in a global economy, the transfer of Chinese money to America was a market phenomenon that would take years, even a decade, to work itself out. For now, he said, "we probably have little choice except to be patient."
Today, the dependence of the United States on Chinese money looks less benign. And the economist who proposed the theory, Ben S. Bernanke, is dealing with the consequences, having been promoted to chairman of the Fed in 2006, as these cross-border money flows were reaching stratospheric levels.
In the past decade, China has invested upward of $1 trillion, mostly earnings from manufacturing exports, into American government bonds and government-backed mortgage debt. That has lowered interest rates and helped fuel a historic consumption binge and housing bubble in the United States.
China, some economists say, lulled American consumers, and their leaders, into complacency about their spendthrift ways.
"This was a blinking red light," said Kenneth S. Rogoff, a professor of economics at Harvard and a former chief economist at the International Monetary Fund. "We should have reacted to it."
In hindsight, many economists say, the United States should have recognized that borrowing from abroad for consumption and deficit spending at home was not a formula for economic success. Even as that weakness is becoming more widely recognized, however, the United States is likely to be more addicted than ever to foreign creditors to finance record government spending to revive the broken economy.
To be sure, there were few ready remedies. Some critics argue that the United States could have pushed Beijing harder to abandon its policy of keeping the value of its currency weak -- a policy that made its exports less expensive and helped turn it into the world's leading manufacturing power. If China had allowed its currency to float according to market demand in the past decade, its export growth probably would have moderated. And it would not have acquired the same vast hoard of dollars to invest abroad.
Others say the Federal Reserve and the Treasury Department should have seen the Chinese lending for what it was: a giant stimulus to the American economy, not unlike interest rate cuts by the Fed. These critics say the Fed under Alan Greenspan contributed to the creation of the housing bubble by leaving interest rates too low for too long, even as Chinese investment further stoked an easy-money economy. The Fed should have cut interest rates less in the middle of this decade, they say, and started raising them sooner, to help reduce speculation in real estate.
Today, with the wreckage around him, Mr. Bernanke said he regretted that more was not done to regulate financial institutions and mortgage providers, which might have prevented the flood of investment, including that from China, from being so badly used. But the Fed's role in regulation is limited to banks. And stricter regulation by itself would not have been enough, he insisted.
The full story is at the New York Times but I'll be blunt and concise, the Bush Administration has done more to compromise the national security of the United States on more levels than most care to admit. The financial mismanagement by the Bush Administration is beyond the pale but in truth it is what should have been expected from a conservative economic agenda based on dubious premises.
The National Debt has now reached a level that is frankly stupefying. It is now more than 70% of the US Gross Domestic Product. That's a level last seen in the Truman Administration in the wake of World War II. And it's sure to grow even if the incoming Obama Administration weren't to attempt to revive the economy with a fiscal stimulus, simply because the denominator, GDP, is shrinking. Our National Debt has climbed from under a trillion dollars when Reagan took office to almost $11 trillion now with $5.7 trillion of this coming under Bush. Under George W. Bush the national debt more than doubled or alternatively you could say that Bush borrowed more money than all his predecessors combined. So much for the myth of limited government and the image of the GOP as fiscal conservatives.
How did we finance all this debt? Well, we borrowed it increasingly from overseas investors. Prior to 1980, the United States ran trade surpluses and thus exported capital on net. Only after 1980 did we start to run current account deficits that required external financing. The share of US debt that is owed to foreign nationals and foreign governments has risen from under 10% in 1992 to 31% by 2000 and up to 46% today. Put another way, this means that every inhabitant of the United States, every man, woman and child owes approximately $9,000 to some other country. Over the next ten years, the cost of the last eight years of GOP-led binge borrowing is going to cost $1.5 trillion alone in terms of interest payments according to the Congressional Budget Office. Servicing the interest on the National Debt is now the fourth largest line item in the Federal Budget.
Here's the worst part. For all this spending, we have so precious little to show for it. It wasn't put to productive use in terms of rebuilding infrastructure, expanding healthcare, achieving energy independence or financing education for the next generation. No, it went into either Iraq or it went for a tax windfall for those who then used it more for personal consumption than for investment purposes.
If nothing else, it's clear that the incoming Obama Administration will reorient our spending into infrastructure, energy independence and job creation as well as into more productive uses of capital by reforming the healthcare system whose costs are simply out of line with other OECD nations. It's easy to be a pessimist these days. Though cognizant that dark days do lie ahead, I'm optimistic because the President-elect will reset our priorities and that that in the end will lead to a reversal of fortune.