U.S. economy shouldn’t surprise anyone. It is a direct result of
the questionable nature of the so-called economic recovery. Any
other country faced with these many imbalances would have collapsed
long ago. But the U.S. dollar was spared this fate when Asian central
banks began accumulating the dollars needed to avoid rises in their
Both the United
States and China practice credit excess, but with a crucial difference:
In the United States, the credit excesses went into higher asset
prices and, more notably, into personal consumption.
In Asia, credit
excesses went into capital investment and production. The result
is an odd disparity between the two economies: Americans borrow
and consume, and the Asians produce. This symbiosis plays out in
the trade gap. Ironically, this ever-growing problem is ignored
on the national level and plays virtually no role in U.S. economic
policy or analysis. In the second quarter of 2004, the increase
in the trade gap subtracted 1.37 percentage points from GDP (based
on domestic demand growth). In comparison, during the 1980s, policy
makers and economists worried about the harm that trade deficits
were causing in U.S. manufacturing.
In a September
1985 move orchestrated by James Baker, the U.S. Treasury secretary,
the finance ministers of the G-5 nations agreed to drive the dollar
sharply down in concerted action. By the mid-1990s U.S. policy makers
decided that trade deficits were beneficial for the U.S. economy
and its financial markets.
were playing an important role in preventing inflation and, as a
result, higher interest rates. Had the decision been to allow interest
rates to rise, it would have had the effect of slowing down consumer
spending. Instead, spending is out of control and the trade gap
is the consequence. Ultimately, the victim in all of this is going
to be the U.S. dollar.
cycle involving inflation, higher interest rates, monetary tightening,
recession, and recovery has a predictable postwar pattern in America
and in the rest of the world. But we’ve taken a departure from this
for the first time. A critic might argue that now the United States
is enjoying a prolonged period of strong economic growth with low
inflation and low interest rates. What could be bad about that?
bad about that is the fact that we are not experiencing strong economic
growth. U.S. net business investment has fallen to all-time postwar
lows, under 2 percent of GDP in recent years. At the same time,
net financial investment is running at about 6 percent of GDP. In
other words, the counterpart to foreign investment in the U.S. economy
has been higher private and public consumption, accompanied by lower
saving and investment.
in America says that the huge U.S. trade gap is mainly the fault
of foreigners, for two reasons. One is the eagerness of foreign
investors to acquire U.S. assets with higher returns than in the
rest of the world; the other is supposed to be weaker economic growth
in the rest of the world. In this view, the trade gap directly results
from foreign investment because it provides the dollars that the
foreign investors need.
The first thing
to realize about a deficit in foreign trade is that, by definition,
it reflects an excess of domestic spending over domestic output.
But such spending excess is actually caused by overly liberal credit
at home, and not really by cheaper goods produced elsewhere.
Just as shaky
is the second argument, ascribing the trade gap to higher U.S. economic
growth. Asian economies, in particular China, have much higher rates
of economic growth than the United States. Yet they all run a chronic
trade surplus, which is caused by high savings rates. This is the
crucial variable concerning trade surplus or trade deficit.
of U.S. domestic spending to foreign producers is, in effect, a
loss of revenue for businesses and consumers in the United States.
Is this important? Yes. The loss is higher than $500 billion per
year. This is America’s income and profit killer, and it can’t be
fixed with more credit and more consumption. This serious drag of
the growing trade gap on U.S. domestic incomes and profits would
have bred slower economic growth, if not recession, long ago. This
has so far been delayed by the Fed’s extreme monetary looseness,
creating artificial domestic demand growth through credit expansion.
The need for ever-greater credit and debt creation just to offset
the income losses caused by the trade gap is one of our big problems.
big problem is a distortion of the numbers. We are officially in
great shape, but the numbers don’t support this belief. Personal
consumption in the past few years has increased real GDP at the
expense of savings, while business investment has grown only moderately.
This can only
end badly. Normally, tight money forces consumers and businesses
to unwind their excesses during recessions. But in the latest round,
the Fed’s loose monetary stance has stepped up consumers’ spending
excesses. Our weight trainer is feeding us Big Macs. If we were
to measure economic health by credit expansion, the United States
has the worst inflation in history. And still our experts are puzzled
by a soaring import surplus.
here is that American policy makers and economists fail to understand
the significance of the damage that is being caused by monetary
excess and the growing trade gap. The trade gap is hailed as a sign
of superior economic growth, while the hyperinflation in stock and
house prices is hailed as wealth creation.
Until the late
1960s, total international reserves of central banks hovered below
$100 billion. At the end of 2003, they exceeded $3 trillion, of
which two-thirds was held in dollars. By far the steepest jump in
these reserves, of $907 billion, occurred in the years 2000–2002.
With China and Japan as the main buyers, Asian central banks bought
virtually the whole amount.
In a speech
given in Berlin in 2004, Alan Greenspan was amazingly frank about
the “increasingly less tenable U.S. current account deficit,” suggesting
that foreign investors would eventually reach a limit in their desire
to finance the deficit and diversify into other currencies or demand
higher U.S. interest rates. He expressed the new consensus view
in America that the dollar has to bear the brunt of reducing the
U.S. federal budget deficit.
makers seem to want a lower dollar, apparently believing (or hoping)
that this will take care of the U.S. trade deficit, and they appear
to regard this as an easy solution to this problem.
But this will
not solve the problem at all. The premise is wrongly based on the
assumption that an overvalued dollar has caused of the U.S. trade
deficit – an entirely unsupported view.
It is widely
assumed that rising stock and house prices will keep American consumers
both willing and able to spend, spend, spend their way to wealth
– indefinitely. But the transfer of U.S. net worth to interests
overseas is alarming, and it endangers U.S. economic and political
health. Warren Buffett, who kept his vast fortune invested at home
for more than 70 years, decided in 2002 to invest in foreign currencies
for the first time. Buffett and management of Berkshire Hathaway
believe the dollar is going to continue its decline. We should not
need confirmation such as this to recognize the inevitable; but
it bolsters the argument that the dollar is, in fact, in serious
trouble, and that this trouble is likely to continue.
to debt problems at home, Buffett made his decision based at least
partially on the ever-growing trade deficit. He warned:
were taught in Economics 101 that countries could not for long sustain
large, ever-growing trade deficits. At a point, so it was claimed,
the spree of the consumption-happy nation would be braked by currency-rate
adjustments and by the unwillingness of creditor countries to accept
an endless flow of IOUs from the big spenders. And that’s the way
it has indeed worked for the rest of the world, as we can see by
the abrupt shutoffs of credit that many profligate nations have
suffered in recent decades. The U.S., however, enjoys special status.
In effect, we can behave today as we wish because our past financial
behavior was so exemplary – and because we are so rich.
ownership of our assets will grow at about $500 billion per year
at the present trade-deficit level, which means that the deficit
will be adding about one percentage point annually to foreigners’
net ownership of our national wealth. As that ownership grows, so
will the annual net investment income flowing out of this country.
That will leave us paying ever-increasing dividends and interest
to the world rather than being a net receiver of them, as in the
past. We have entered the world of negative compounding – goodbye
pleasure, hello pain.”
him mail] is the editorial director and publisher of The
Daily Reckoning. He is the author, with Bill Bonner, of Financial
Reckoning Day: Surviving The Soft Depression of The 21st
Century and the upcoming Empire
of Debt. This
article is taken from his soon-to-be released new book, The
Demise of the Dollar…and Why It’s Great for Your Investments.