The point is that foreign (mostly asian) ownership of our debt has been growing year-after-year, and at a certain point they will decide that owning a certain percentage of US government debt is either too much and/or has reached a threshold where they can use their economic muscle aggressively in US policy. In either case, we're not in control, and the situation has the potential to snowball.
I'm not talking about who'll eventually pay for the debt. We all know that we pay the interest now, and our kids owe the principal. But the issue is who lends us the money now, at what rates, and how much power do they exert over us?
Metaphorically speaking, we're close to reaching our credit limit and now our bankers can walk away or set onerous terms. If we want to spend more, it's not business as usual where we just draw up the bonds and people compete to buy them. The shoe is on the other foot now. We have to jump through hoops in order to get a buyer to purchase our debt.
Most of the Current Account deficit is due to the Trade Deficit and the Federal Budget Deficit. With the Trade Deficit, foreign companies send the dollar revenues back to US via several paths (either they invest directly or they exchange the dollars into their local currency and their central bank intervenes to pick up extra dollars as reserves.. the central bank then invests the reserves into the US). The Federal Budget Deficit is more direct, where the debt (of the government, the Iraq War, the tax cuts) has to be picked up by someone - and Americans don't save enough to fully feed the administration's debt levels.
We've now allowed the federal government $0.8Trillion room on national debt for a total of $8.18Trillion. It's unclear who will buy up those bonds and under what terms. Europeans have no interest in funding us now. Asians officially hold $1.2Trillion of our debt and have the finances to purchase more, but not the desire. Most of that (about $0.82Trillion) is funded from Japan, which has had a very interventionist central bank when the times were good. The times are different now. China, the beneficiary of much of the Trade Deficit gave indications yesterday (and quickly retracted) that it will even sell it's existing US government bond holdings. Because the perilous situation is well recognized, such indications spook the foreign exchange markets, leading others to get rid of their dollars.
Last year Richard Duncan explained the effects of a trade deficit in the book The Dollar Crisis: Causes, Consequences, Cures The credit bubble hasn't broken yet. What happens when the credit bubble breaks? Not only does the government pay interest at much higher rates for new debt and debt they "roll", but many individuals are locked into adjustable-rate debt and will immediately have to react to higher interest payments.
All of this has lead top economists who have been bearish in the past (example1, example2, example3), to now be speaking in terms of economic armageddon.
Where to go from here? Even if we solve the Federal Budget Deficit by getting Bush out in 2008, we still have the Trade Deficit. Devaluation is being spoken of in many circles, but that's a one-time (hopefully, only a one-time) effect and doesn't deal with the fact that foreign owners of our debt can be more agressive in arranging the terms of the debt.
There has been very little desire of either political party to take on the issue. About all that has been mentioned was Bill Clinton's reference of China and Japan as our bankers at last August's DNC speech. In referring to the Republican's efforts to borrow:
So then they have to go borrow money. Most of it they borrow from the Chinese and the Japanese government.
Sure, these countries are competing with us for good jobs, but how can we enforce our trade laws against our bankers? I mean, come on.
OK, but it's too little. Not only was that too quick and went right past most people's understanding, but it's coming from someone who put in place many of those trade laws.
The progressive left was correct on the issue of trade, and I dare say, also the paleo-conservative right. The paleo-conservative right will try to take the moral high ground first, but they have a tough fight within the republican party. I would like to see a democratic leader take the initative and take the moral high-ground first.
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