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  Gustav
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Friday, February 18, 2005

US debt about to bite back

By Zbigniew Piekarski
The Warsaw Business Journal

“To say that economic and corporate growth in the US were good is a joke. Measured in Polish złoty, the US economy contracted by 19 percent last year.” Marc Faber, quoted in Barron’s

On the eve of the February 5 meeting of the G7 in London, Federal Reserve chairman Alan Greenspan finally admitted that the Americans have mortgaged the economic future of generations to come and that the present state of affairs is due to debt-induced consumption.

Thus the increase in the purchasing power of the American consumer was and is based on debt, on the selling of the putative value of their major asset, their homes. This has been stimulated by a lax monetary policy and artificially low rates of interest and has resulted in one of the largest spending binges in history.

Consummate consumers

As Stephen Roach points out, the consumption share of the US GDP rose to 71.1 percent in early 2003 and it is still at 70.7 percent, far above the norm of 67 percent that prevailed from 1975 to 2000. And this has occurred at a time when real wage and salary growth have increased a mere four percent over the first 37 months of this recovery–a full 10 percentage points less than the average gains of more than 14 percent that occurred over the five preceding cyclical upturns.

In his speech in London, Greenspan acknowledged that the men at the Fed have played their part in facilitating the greatest spending excess that the world has seen to date. However, he assured the audience that there was no need to worry, as “natural market forces” will remedy the situation without aggravation.

Spread it around

Thus the American consumer will become a prolific saver and restore the budget deficit to a surplus; the debilitating interest that has to be paid will become more manageable as the dollar devalues further and spreads that burden onto citizens of other nations; and the ‘voices of fiscal restraint’ will finally prevail in Washington.

Unfortunately, as, according to the UN, the US military is visibly ensconced in 130 out of a total of 191 countries and seems determined to add a few more to their military misadventures, the demands on the exchequer from this sector will not abate. Only the poor citizens will suffer.

Chinese checkers

On February 11, the Commerce Department informed the world that the trade deficit for all of 2004 was up 24 percent from the previous year to $617.7 billion. For all of 2004, US exports rose 12.3 percent to $1.15 trillion, but imports rose even faster by 16.3 percent to a new record of $1.76 trillion. And the deficit with China was up 30.5 percent at $162 billion, the largest ever recorded with a single country.

The reaction to this news was predictable. Legislation is being introduced in the US Senate that will slap 27.5 percent tariffs on all Chinese products sold in America if the yuan is not revalued by a similar amount. Once again, the politicians seem determined that their poorer constituents shoulder the burden as Wal-Mart, the largest retailer in the world, buys as many Chinese goods as the whole of the Netherlands and more than the whole of the UK. The destructive palliative of protectionism is gathering pace without the realization that without Chinese banks’ purchasing, the US Treasuries’ interest rates would be far higher than they are.

Obligation to consume

On that same Friday, on CNBC television, Steve Leisman and a guest described American consumption as being “a sacrifice,” and American consumers as “bearing the brunt of world consumption,” and of having an “obligation to consume.” Thus the motivation behind the Protestant Crusaders’ messianic zeal of spreading freedom and democracy throughout the world, in particular to those countries with proven oil reserves, is made clear. It is to maintain the Holy Grail of gross and feckless over-consumption.

In 2000, Clinton left Bush junior a surplus of $236 billion and the forecasted 10-year surplus pursuing similar policies was projected to be around $5.6 trillion. Bush immediately reversed Clinton’s policies and ladled out some $630 billion in tax cuts to the top one percent of income earners. They returned the favor by investing over $200 million to ensure Bush’s re-election. Republicans know about good investment returns. A $630 billion return on a $200 million investment amounts to $3,160 per $1.

Bush blew through Clinton’s surplus in his first year and by 2003 the deficit had reached $415 billion.

Fuzzy math

But its real size was masked by the fact that Bush shifted $150 billion from the social security trust fund in order to make the shortfall look smaller. The real amount borrowed was the $415 billion ‘nominal’ deficit plus the $150 billion from social security, or $565 billion. This run-up in debt represents the most rapid, predatory looting of public wealth in the history of the world.

Interest costs alone will consume the government and, soon, the entire economy. In 2004, interest costs came to $321 billion against a deficit of $415 billion. So, three-quarters of that year’s borrowing was spent paying interest on past borrowing. This is a key symptom of the “deficit death spiral” when borrowings have to cover interest payments rather than reduce the principal and bankruptcy is only a matter of time.

Yet loose monetary policy, artificially low rates of interest, the easy availability of credit and extreme liquidity has meant that over 2003 and 2004 all asset classes, bonds, equities, commodities and property, rose in value.

Exotic złoty

Even the dollar rose in value; it appreciated by 85 percent against the Zimbabwean dollar.

Fortunately for the largest debtor nation on the planet, its currency depreciated against all of the other major currencies, making its debts easier to repay. It also plummeted against the aptly named “exotic” currency, known as the Polish złoty, losing 23.9 percent in the last year. Thus the widows who were encouraged a couple of years ago to set up dollar-denominated savings accounts must be suitably impressed with the respective banks.

The fall in the value of the dollar was expected to reduce the level of imports, as they would become more expensive, and increase the amount of exports and so reduce the deficit. Instead, the deficit increased. To the American consumer, as to all human beings, habits are hard to break.
Over the next year the dollar will recover and retrace at least 33.33 percent of its fall from January 2002 for the Fed has warned that it will drop the words “measured” and “accommodative” when it refers to future increases in interest rates. In addition, since December, it has been reducing liquidity and where liquidity leads psychology follows.

The ‘soft patch’ that Greenspan has successfully avoided will become a quagmire.

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