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US Economy - Are these Problems?

The article below basically says that the US is overdrawing heavily on a Credit Card and the banks (i.e. China and Japan) may cut the credit line. I do not know enough of economics to fully evaluate the merits of the article.


http://www.guardian.co.uk/economicdispatch/story/0,12498,1038689,00.html

End of the credit line?

America could be in for a nasty shock if foreign investors decide to stop bankrolling its massive trade deficit, writes William Keegan

Tuesday September 9, 2003

A hegemonic economy can do what it likes - or can it? The widespread assumption in the financial markets until recently was that the Bush administration can go on piling up record trade deficits and there is not much the rest of the world can do about it.
Indeed, what the rest of the world does, especially the east Asian part of it, is to recycle hundreds of billions of dollars straight back to New York, in the form of purchases of bonds and Treasury bills.

This arrangement, we are told, produces bliss all round. The US consumer carries on consuming more than he or she produces; the US government carries on borrowing as if there were no tomorrow; and countries such as Japan and China do not have to revalue their currencies, thereby retaining the international competitiveness that sustains the remarkable Chinese growth rate and Japan's slow recovery from recession.

Such is the putative convenience of this process that some commentators have even begun to suggest that Treasury secretary John Snow's recent trip to east Asia - when he did not have much success in persuading governments to revalue their currencies - was just a charade to please those in the US heartlands who are worried about losing jobs to the supercompetitive east.

I wonder. It seems to this distant observer - but regular visitor to the US - that the jobless recovery is a big issue over there. However much the consumer benefits from cheap Asian imports, in the end citizens and voters want jobs, and they hold the government responsible. Hence the famous Clinton remark, now an almost unbearable cliché: "It's the economy, stupid." In this context, one of the paradoxes of the phenomenon known as globalisation is the way US multinationals own many of the companies which manufacture in, and export from, mainland China, thereby profiting - literally - from low-cost labour and an extremely competitive exchange rate.

But how long can the willing recycling of trade surpluses continue? The limits of economic hegemony seem to have occurred to the US administration as it contemplates a $4bn (£2.5bn) monthly bill for military operations in Iraq and estimates that rebuilding Iraq next year could cost $75bn. Suddenly, having gone to war against the wishes of continental Europe, Washington wants the "cheese-eating surrender monkeys" and others to share the bill.

At the same time the combination of escalating US budget deficits and a falling bond market has aroused fears in financial circles about US dependence on foreign funds. As for the Asian investors themselves, there were suggestions in yesterday's Financial Times that flows may not be so generous in the future.

There are precedents for the denting of assumptions that the hegemonic economic power can go on blissfully borrowing indefinitely. Britain in the heyday of empire, and during its long decline from hegemony, found that its economy could be vulnerable to sudden withdrawals of funds that were deposited in London.

In 1979 the US economy itself was hit by a crisis of confidence, which involved a slowdown and withdrawal of foreign inflows. These are early days, and recent reports may prove to be alarmist. But the Bush administration, whose economic policy is obviously dominated by electoral considerations, could get nasty shock if foreign investors began to demand a significantly higher price for their funds.

Ram Dass
Tuesday, September 09, 2003

"A hegemonic economy can do what it likes - or can it? The widespread assumption in the financial markets until recently was that the Bush administration can go on piling up record trade deficits and there is not much the rest of the world can do about it.
Indeed, what the rest of the world does, especially the east Asian part of it, is to recycle hundreds of billions of dollars straight back to New York, in the form of purchases of bonds and Treasury bills.

This arrangement, we are told, produces bliss all round. The US consumer carries on consuming more than he or she produces; the US government carries on borrowing as if there were no tomorrow; and countries such as Japan and China do not have to revalue their currencies, thereby retaining the international competitiveness that sustains the remarkable Chinese growth rate and Japan's slow recovery from recession"

Sounds suspiciously like a perpetual motion machine. Are there economic equivalents to the laws of thermodynamics that prohibit such things?

Ron Porter
Tuesday, September 09, 2003

Yes, it looks like a perpetuum mobile. I guess the hidden engine in this case is China. The Chinese accept very low wages and both China and the US use the remaining of the value of the Chinese people hard work to maintain the perpetuum, for their own reasons: a breaking neck industrialization race at the expense of its citizens for the former and low inflation and money supply for the later.

19th floor
Tuesday, September 09, 2003

If you had the world's most powerful military and world's largest debt, would you pay it back?

Nope, but you'd probably just make sure to secure enough of the world's oil reserves to see you through the times when the dollar won't buy the things it used to.

Knowledge Maker
Tuesday, September 09, 2003

I'm not really a finance expert, but I doubt the author is either.  I don't think that the trade deficit and the purchase of American treasuries are really part of any sort of cycle, and it certainly isn't a closed system.

The trade deficit merely states that as country we buy from oversees more than we sell to overseas.  That also means that more American money leaves the country due to trade than does foreign money come in due to trade.  In a way, that means that the US is leaking money and taken out to the infinite future will have none, but it isn't quite that simple.  First of all, there are probably money exchanges that don't count as trade, and furthermore money isn't a closed system like energy, money has ways to be fed and grow. America's efficient finance, open marketplace, and high education and productivity are very conducive to that sort of happy healthy economic growth.

Treasuries are the American's government's credit card.  Even if we had no budget deficit and all of our old deficits were paid off, we would probably still have some amount of treasuries floating around just because it is more convenient.  Buying a US treasury is the closest thing to a sure-thing return as anything in all of finance.  Because of that we've got a really good rate on the national credit card.  But the US doesn't have a fixed rate.  We get our loans from whoever will give us the best rates.  There is a suppy and demand at work, and the more we want to borrow, we may have to pay a higher rate to entice more people to give it to us.

This whole thing in the article about foreign nations losing trust in our treasuries is hogwash.  The US treasury is nowhere near insolvency. We have never missed a payment.  We have we never missed a payment?  Because we can take out new debt to pay old debt (kind of like paying our credit card with our credit card), and we can keep that up theoretically until the interest payments become too large a portion tax revenues, or the rest of the world runs out of money, and we still have some ways to go to get to that point.  The government, as a percentage of income is less in debt that you or I are.

So trust isn't an issue.  What is an issue is this: Does needing more money to pay for our large reconstruction budget mean that our treasury rates will have to go up to entice more buyers, and are there other investments available to investments with higher enough returns that investors will prefer them despite their added risk.  In either case treasury rates go up until enough people lend us enough money for us to pay our bills (including our big credit card payments), and they will come because timely payment is guaranteed.  And all the interest rates of the universe are tied together in strange ways and effect the economy in strange ways, so we do have to tread carefully.

But wars, like homes, are the kinds of things you generally can't just plunk down cash for.  You pay it off over time by borrowing, and no one should really expect otherwise.  Is it the best timing for our economy?  You never know, maybe it is.

Keith Wright
Tuesday, September 09, 2003

Jumping on that waggon I'd like to add that the US has a pretty impressive federal budget of more than 2 trillion Dollars. Germany, for instance, has a federal budget of only 270 billion Euros, which makes it hard for them even to cope with last years floods, while the US can "easily" spend some 80 billion Dollars in Iraq.

So the higher the cash flow is which pours through your fingers the more laxity you can allow yourself to handle debts. If you need more cash in one corner you can transfer it over there without other corners running out of business.

Johnny Bravo
Tuesday, September 09, 2003

"If you had the world's most powerful military and world's largest debt, would you pay it back?"

Can someone tell me why communist Russia collapsed?  They had a huge debt problem and a very powerful military.


Tuesday, September 09, 2003

They could not afford to buy fuel for their tanks?

Johnny Bravo
Tuesday, September 09, 2003

Keith, I am no finance expert either but this is a well-known interdependency: the Chinese (and Japanese) trade surplus with US is used to buy US treasuries which are used to feed Freddie Mac and Fannie Mae, which are used to provide cheap mortgages and refinancing which in the end are used to buy Chinese goods and to feed the US trade deficit with China. It looks like a loop to me.

19th floor
Tuesday, September 09, 2003

the soviets had huge oil reserves. 

More on t-bill rates.  It is my current feeling that the administration is working against greenspan's monetary policy by going on a borrowing binge.  Flooding the market with T-bills keeps market interest rates high even though short term lending rates are near zero.  Greenspan warned congress against deficit spending and I believe this is main reason why.  I am bit concerned that Bush doesn't really understand financial markets and is a bit arrogant about the U.S. borrowing strength.  If the foreign buyers of T-bills stopped buying it would for surely cause chaos and potentially sink the U.S. economy into a hopeless depression.

Boy that was a uplifting thought.

christopher baus
Tuesday, September 09, 2003

Do you think the Chinese and Japanese will ever stop buying US treasury Bills? They have as much to loose as we do, if they stopp buying the T bills.

But I guess even a momentary flicker of reluctance of China/Japan to buy T-bills will cause the market to panic.

I have another question now - if the US is so dependant on China/Japan are we really a superpower? Seems like those guys have can our nuts over a flame pretty pronto if they desired to do so.

Ram Dass
Tuesday, September 09, 2003

this has been debated quite a bit in the financial press, and the issues are a bit too complicated to cover here.

There are a lot of factors to consider ...

banks creating money; exchange rates; exchange reserves and policy; faith in the US economic engine; wages and industrialisation in China; bad bank debt in Japan;

Whether it is a good thing depends on whether you are a half full or half empty kind of guy. Is it better to owe the bank  £1 or £1k??

If you owe the bank $1 billion, then you have an interest in the well being of that bank, because if they cease to be, you have lost your source of funding.

Similarly, they have an interest in yours because if you cease to be, they stand to lose not only the interest, but the capital too.

One's response to the questions will also be dependent on how one expects the lenders to react should one not pay.... bankruptcy protection like the US allows, or a couple of broken fingures like the Mafia handles it.

Tapiwa
Tuesday, September 09, 2003

I still don't understand the throwing around of the word "trust" so much here talking about US treasuries.  There is nothing so sure as the US paying its debt on time.  I think this "trust" thing is really just a question of how stable the interest rates are going to be, which is just plain market speculation.  I think it is quite clear the low rates that treasuries have been paying are very much at risk to move up, and there is no way to know how much and when.  The war debt is certainly a factor in that but so is the stock market.

If people stop buying US debt it is probably one of two reasons:  Either they are choosing to use some other financial istrument, or they don't have as much money available to invest.  In either case, the drop in demand and increase in supply will cause rates to spike up.  In the first case, the increase in rates will make US debt more attractive to investors, and rates will plateau.  Remember that like mortgage rates, treasuries rates have been amazingly low, meaning buyers of treasuries got very little return on their investment.  If there just aren't enough people willing to invest their money, treasury rates will go way up, and just about all debt will follow, and possibly inflation as well.

As for FNMA and FHLMC: they don't get our tax dollars, just some tax breaks and a lot of very favorable regulatory policy. they are actually buyers of treasuries, often to use as hedge instruments.  But even more than buyers, they are competetors of the treasury market.  Almost all of the money they loan you comes from them selling the money you pay them in principal and interest into the financial markets as MBS pass-throughs.  If treasury rates spike it they have to lower the prices on the debt they sell to compete, which means they have to raise mortgage rates so as to not sell the debt for less than they paid for it.

Keith Wright
Wednesday, September 10, 2003

Keith:: "There is nothing so sure as the US paying its debt on time.  "

I could name a few things that are more certain.

This unquestionable belief in politicians maintenance of the status quo is at best naiive and more likely dangerously expensive.

Case in point, when Messr Soros et cie made a billion, it was in a bet against the Bank of England. A few years earlier, if you had said that someone could take on the bank of England and win, you would have been comitted to an asylum.

Granted, it was exchange rates vs the repayment of debt, but the idea is the same. For years the strength of a nations currency was a source of pride.....

When I was doing my honours in Finance, the Asian crisis was underway. The one thing we noticed was that the more senior the official who vowed to not devalue the currency, the more likely it was to happen.

A couple of years later, the same thing happened in Russia. I remember seeing a news bulletin on a Friday where Yeltsin himself vowed to never devalue the rouble. When the markets opened on Monday, the rouble was devalued. Made a bit of money on that!

The point I am making is that the sole fact that the US has never defaulted on debt does not mean that it will never happen. The reason the US can maintain such huge deficits is the fact that Japan and China, instead of strenthening their currencies and possibly lowering exports, are using their surpluses to buy T-Bills.

What happens when that tap runs dry??

Tapiwa
Wednesday, September 10, 2003

While I don't think all the international buyers will one day just walk away, I do believe they could be buying fewer t-bills in the future.  Any measureable decrease in buying combined with an increase in supply do to an enormous debt burden by the US govt could drive prices on t-bills down and interest rates up significantly.  I believe this to be a huge systematic risk the US economy as a whole.

christopher baus
Wednesday, September 10, 2003

"I could name a few things that are more certain."

Sigh.

I think it was pretty clear the intended meaning was "there is no safer investment than U.S. treasury notes".

If you don't believe that, you should be able to figure out an arbitrage scheme that allows you to take over the world, because the entire finance industry is pretty much based on that assumption.

Maybe you know something they don't.

Jim Rankin
Wednesday, September 10, 2003

It must be mentioned that the US had to go to the IMF for a loan sometime in the 1960's.

On another tack, it is doubtful that the dollar is all that high. It was a couple of years ago, but it is probably about right now compared to the Euro or the sterling pound.

The US can't go on running a trade deficit for ever. All that should be considered is whether you will have a hard landing or a soft landing.

Stephen Jones
Wednesday, September 10, 2003

The USSR never had a strong military. They poured all their money into trying to keep up with the US.

It was always old equipment and a lot of FUD. The US lied to it's public about the "vast Russian evil empire".

I believe the US also said that Iraq had the 4th largest army in the world before the 1st Gulf war. Big Deal.

Komrade Boris
Wednesday, September 10, 2003

"The US lied to it's public about the "vast Russian evil empire"."

Sigh.

Never assume conspiracy where incompetence suffices.  Was the capability of the USSR overestimated?  Probably.  Was it conscious and intentional?  More likely, it was motivated by fear, and the risk of underestimating being far more severe than overestimating.

Furthermore, I am quite pleased with the end result.  Namely, the implosion of the Soviet Union.

Jim Rankin
Wednesday, September 10, 2003

Jim

I think I did understand the intended meaning. All I am suggesting is that projecting the past historical safety of investment in the US T-bill, into the infinite future could cost a lot of people a lot of money.

There was a time when people swore on investments in salt.
At some point it was gold. Property had its 15 minutes too.

History had shown that even these sure bets can tank. That is my argument. To base any argument on the premise that the US T-bill will always be a safe bet, I argue, could be an expensive investment decision.

Again, to argue that just because the entire finance community thinks it is so, it must be so, could be an expensive mistake. Most of the pricing of financial instruments is based in one guise or another on the Nobel Prize winning work by Black and Scholes.

What most people forget is that one half of this duo was very involved in the largest finacial collapse of modern time... http://www.wileycanada.com/WileyCDA/WileyTitle/productCd-0471899992.htmlhttp://www.wileycanada.com/WileyCDA/WileyTitle/productCd-0471899992.html

I hate to harp on this point, but the Black-Scholes option pricing method bases the risk of an investment on historical performance. To base one's investment solely on the past is almost like driving by looking in the rear view mirror. Patch at best.

Tapiwa
Thursday, September 11, 2003

Adding more fuel to the foreign bond buying spree:

http://tinyurl.com/n5fn

Again I think the Bush administration is way too optimistic about how much debt the rest of the world is willing to absorb.  I am bit nervous about this considering Bush is asking Congress for another 90Billion for Iraq.  All for a war that was supposed to cost under 50 billion.  To make matters worse a lot of this is going into Cheney's pocket via Haliburton. 

I wish someone in Congress would get some guts and step up and say, hey you neo-cons lied about the cost of this war.  You were way off, what else are you going to be way off on?  What happened to accountability? 

The other thing is we don't have enough troops to fight these wars.  Reservists are quickly becoming full time members of the military with less than 1 year between activation.  This doesn't look good.

I am conservative, but I am fiscally conservative, and believe the neo-cons are quickly over stepping their bounds fiscally.

Ok that is off topic... but..

christopher baus
Friday, September 12, 2003

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