December 8, 2006
Deficits: Should we worry?By Dennis Sevakis
When it comes to this country's trade and budget deficits, just how concerned are America's taxpayers? The future impact of continuing trade and budget deficits requires attention..
Over the last few years most of the public "discourse" - a description undoubtedly overly generous - has centered around the Terror Wars, Iraq, and President Bush's supposedly unprecedented usurpation of power. The economy and budgetary concerns have generally been more in the background, with the occasional exception of the drunken-sailor spending habits of the formerly Republican-controlled Congress.
But the Administration and its exuberant cheerleaders, such as the ebullient Lawrence Kudlow, have repeatedly reminded the American public of all the jobs created, along with the record-low unemployment that has been happily accompanied by low inflation and super-low interest rates.
That low inflation led to low interest rates, which led to low mortgage rates, which led to a housing boom is no great surprise. But when the Federal Reserve pulls out its interest-rate-raising inflation fighting sword, up go the rates and down goes the boom. Lowered, if you will. And so, the air has already started to come out of the inflated-single-family-home-value balloon. It hasn't yet burst, arguably. But many who jumped in with maxed-out mortgages as the boom peaked now find themselves under water. Just ask the Japanese about the consequences of inflated real estate values.
At present there are those calling for a lowering of U.S. interest rates as our economy appears to be cooling. That could keep those property values propped-up a bit. However, over on the other side of the Atlantic pond, the European Central Bank is raising interest rates. And if we start lowering rates while they're raising theirs? Well, just as quickly as all those big-time money managers can click a mouse, dollars will be sold and Euros bought. So much for the almighty buck continuing to defy gravity.
If the dollar continues to fall as it has over the last few years, the price of imported goods will undoubtedly rise. The Chinese may finally find it impossible to maintain the Yuan's peg to the dollar. And since American consumers are imported-goods crack addicts, inflation will once again rear its ugly head. And then? Well, you know, the Fed will raise interest rates. But what about those big mortgages on all that bloated real estate? And what about... Well, the short answer is - tough!
And there is no long answer. At least not if you're one of those in a sinking property-value boat.
Over the last several years the financial administrations of the world's trading nations have been engaged in conducting an experiment of heroic proportion and historic impact. The bulk of the effort has been directed at keeping the trade treadmill running at whatever speed is required or desired, and keeping those jogging upon it from collapsing and falling off. All over this planet there are legions of economic gurus and witch doctors who, along with policy makers, are working day and night reading trading tea leaves and examining economic entrails. They labor tirelessly attempting to divine the meaning of all the trillions of bits of economic and trade statistics in an attempt to keep conflicting economic forces from colliding and bringing the economic treadmill to a screeching halt.
How can the untrained and uninitiated ever hope to fathom the depths of this morass? How can we gain some smattering of understanding of these arcane matters so as to better judge the veracity and wisdom our economic policies?
It's not easy. And the more one looks at a smattering of those trillions of bits, the more confused and uncertain one tends to become. The wide variance of expert opinion as to what those tea leaves and entrails signify doesn't help. But a little reading and study does lead to one inexorable conclusion: the world's finance ministers, treasury secretaries and keepers of national banking systems are all diligently working behind the scenes to keep the dollar afloat, the American consumer spending, and their respective economies humming. So great is the level of activity that it must certainly signify a task of Sisyphean proportion.
Picture the Wizard of Oz - the man behind the curtain who told us to "pay no attention to that man behind the curtain" - feverishly pulling levers, turning knobs and flipping switches all while issuing his proclamations, exhortations and admonitions. This isn't the picture one got while watching a Greenspan testify before a House or Senate committee. But that's only because you don't get to see the action with the curtain pulled back. Where's Toto when you need him?
But all over the world, behind those curtains, there's a veritable army working to keep the planet's economic treadmill from breaking down. And just what would a breakdown entail?
Well, it could become dump-the-dollar day!
Since 1976 the United States has run a trade deficit. No big secret there. For a time that deficit was offset by a surplus in services and earnings from overseas investments. However, in 1983 "Net goods, services and payments" went into the red and has stayed there ever since. In 1991 it did shrink to a paltry $7 billion deficit (payments received for our Gulf War expenses?) but has risen ever since then, and for the first half of 2006 stands at $783 billion on an annual basis. Yes, that's three-quarters of a trillion. Despite these enormous annual deficits, the dollar has not as yet tanked and still remains the world's number-one currency and comprises 66% of the world's foreign currency reserves held by national treasuries.
Why? Because the dollars get recycled. They come back to the U.S. in the form of foreign entity purchases of U.S. government issued debt, privately issued debt or equity instruments, or direct investment in other assets. In 1986 the net investment position of the U.S., that is, what the U.S. had invested overseas minus what "they" had invested in the U.S., went negative, and at the end of 2005 stood at a minus $2.7 trillion on a cost basis. So over the last twenty years, foreign governments, corporations and wealthy individuals have ended up owning that much more of the U.S., be it financial instruments or hard assets, than we have invested overseas. One consequence is that for the first time in 90 years the U.S. earned less overseas than we paid out to foreign entities, and so "Net Income Receipts" went to an annualized minus $13 billion for the first six months of 2006. As a result, if current trends continue, in the future we'll be paying a lot more interest and earnings to foreign entities than domestic ones earn overseas. That seems a tad difficult to put into the plus column of factors affecting America's economic future.
Of course, "if current trends continue" is a big "IF." The diligent efforts of European and Asian finance ministers to support the dollar has, until the present, worked fairly well. Yes, the dollar has declined over the last few years relative to the Euro, British Pound and Yen with the Chinese Yuan being pegged to the dollar. But it hasn't "broken" in a hard rush downward. This is due to the determination of the countries with whom we trade to keep their exports up and American consumers buying goods as if there were no tomorrow. If the dollar tanked, the sudden increase in the cost of imported goods to the American consumer would skyrocket and the economies of the exporting countries would suffer. That's why they're willing to finance our purchases. How convenient.
And that's also why the Chinese keep the Yuan pegged to the dollar. So whatever happens to the dollar relative to other currencies, China's trade position relative to the U.S. will remain unaffected. How can they do this? Because the U.S. cooperates with China to keep the economic treadmill running. We won't rain on their parade as long as they keep recycling the dollars through purchase of U.S. government issued debt. That's how we're financing our current budget deficits. Rather cozy arrangement, isn't it?
One does have to wonder how long the world can keep this treadmill running. A major economic dislocation, such as a significant interruption in oil supplies, could bring it to an abrupt halt. Despite our consumption profligacy of the last couple of decades, the U.S. is still in a better position than our trading partners since exports are a smaller percentage of our GDP than they are of theirs.
We are financially accommodated because the U.S. is the engine that keeps the world's economic wheels turning. The Gross Domestic Product (GDP) of the U.S. is nearly equal to that of the five next-largest economies combined. At an estimated $13.3 trillion for 2006, this is just a trillion or so shy of the combined total for Japan, Germany, China, U.K. and France of $14.5 trillion. We run trade deficits with all these countries. China being by far the largest at $202 billion for 2005 with Japan a somewhat distant second at $83 billion. Three of our top six trade deficits are within our own hemisphere, that being Canada at $78 billion for 2005, Mexico at $50 billion, and our buddy Chavez's Venezuela at $28 billion. We sure do keep a lot of economies going, don't we? You'd think they'd show a little more gratitude, wouldn't you?
But then, they're doing the financing. And since when does a loan shark not put you on a leash?
First of a series
Dennis Sevakis is an occasional contributor to American Thinker.