December 5, 2010
The Chinese Ant and the American GrasshopperBy Bill Costello
"The Ant and the Grasshopper," a fable by Aesop, provides a moral lesson about hard work and saving. During the warm months, the ant works hard to store up food for the winter, while the grasshopper sings and plays. When winter arrives, the grasshopper asks the ant for food because it has none. In today's world, China is like the ant, and America is like the grasshopper.
America tends to focus on enjoying today instead of preparing for tomorrow. This trait has led to a nation of debtors. And, like for the grasshopper, our lack of savings may lead to our demise.
The grasshopper's indulgence affected only its own life and not the lives of others. In America, however, that is not the case. America's indulgence will negatively affect future generations in the form of debt.
America's federal debt is almost $14 trillion and rapidly rising. Yet the government is still spending more money than it collects in taxes. For the 2010 budget year, it spent approximately $1.3 trillion more than it collected -- the second-largest deficit in American history. For the 2009 budget year, it spent roughly $1.4 trillion more than it collected -- the largest deficit in American history.
If we don't pay down the federal debt, our children and grandchildren will end up paying for our excesses plus compound interest. Part of the American Dream is making life better for future generations. A recent poll by Bloomberg found that a majority of Americans "are not confident or are just somewhat confident their children will have better lives than they have."
While the American Dream is eroding, members of Congress fail to cut spending that would reduce our deficits and debt, and thus we continue to sing and play like the grasshopper.
America used to invest in the future. From highways to high-rises, we used to build stuff that was the envy of the world. Now we mostly consume.
Meanwhile, China is busy storing up food for the winter. China tends to focus on preparing for tomorrow instead of enjoying today. This trait has led to a nation of creditors. And, like with the ant, their savings will help them survive.
When comparing net national savings as a proportion of Gross National Income from the mid-1990s to 2005, American savings decreased from over 5 percent to nearly zero, and Chinese savings increased from roughly 30 percent to almost 45 percent.
In Aesop's fable, the grasshopper asks the ant for some food, but the ant refuses. In the metaphor I'm using here, however, China is loaning America some of its savings -- with interest, of course. In fact, China is the largest foreign lender to America.
How did China get so much money that it could loan some to us? The combination of American overconsumption and a Chinese strategy of export-led growth led to export surpluses that the Chinese monetary authorities converted into dollar-denominated reserves to prevent their currency from appreciating. In other words, we bought a lot more stuff from them than they bought from us, they kept their currency cheap so their exports would be cheap while their imports from America would be expensive, and they ended up with a lot of our dollars.
We've been borrowing money from China at very low interest rates to finance our current account deficit. The rates have been low because the Chinese have consistently intervened in the currency markets.
China's savings helped to finance America's debt habit. And the low long-term rates helped to inflate the real estate bubble, which led to the financial crisis.
That the financial crisis threatens the dollar is making the Chinese very nervous because they own vast numbers of dollars. China has currency reserves of $2.5 trillion, of which roughly 70 percent are dollar-denominated. The Chinese are exposed, and they will lose if the purchasing power of the dollar and/or the price of U.S. government bonds falls. The grasshopper's problems now threaten the ant.
Because America is experiencing record-high budget deficits and appears to be on an unsustainable fiscal course, the Chinese have been gradually reducing their exposure by cutting back their holdings of U.S. Treasuries and diversifying in other nations. But it is not likely that they will make dramatic reductions because they need a strong American dollar.
Kenneth Lieberthal, a senior fellow specializing in China at the Brookings Institution, recently said, "I don't think we're going to see any massive flight from China's holdings of U.S. debt. That would be self-defeating, and they well recognize that."
However, other nations could also become nervous and reduce their holdings of U.S. Treasuries. A sustained drop of total foreign holdings would likely lead to higher interest rates and falling stock prices in America. We are, therefore, vulnerable to foreign lenders.
It's time for America to focus on preparing for tomorrow instead of enjoying today. We can no longer behave as the grasshopper. We must become the ant.
Bill Costello, M.Ed., is the president of U.S.-based Making Minds Matter, LLC and the author of Awaken Your Birdbrain: Using Creativity to Get What You Want. He can be reached at www.makingmindsmatter.com.