The
Real Fiscal Cliff
9
July, 2012
It’s
that time of year again — time to kick the can.
No
prizes for guessing what investors expect Congress to do:
And
2013 seems likely to give way to can-kicking in 2014, and 2015 and
2016 and 2017 and on — the
GAO estimates that by 2080 the US public could hold 8 times as much
government debt as the US generates GDP.
Just as Japan has never truly dealt with its debt complex — and
instead chose the path of cycles of deflation, an endless liquidity
trap, a soaring debt-to-GDP ratio and mandating financial
institutions into buying treasuries — so America will continue to
kick the can as long as rates and nominal inflation can be kept low,
and goods and energy (the real underlying economy) kept flowing.
Which — going by the Japanese example — could be a very long
time.
Yet
America is not Japan. The key difference? The balance of trade, and
the flow of goods and services. While Japan’s
debt is overwhelmingly domestically held, and
while Japan has long been a net-exporter,
the USA imports more goods and services than any nation in history:
And more
and more US debt and
currency is in the hands of the nations that export the goods and
services on which America’s economy functions. Here’s the total
debt held by foreigners:
And
here’s the dollar reserves of various Asian exporter nations:
So
when the can is kicked, the Asians — and especially the Chinese —
feel they are getting screwed.
The U.S. has long been facing the same problem: living beyond its means. At present, the country has debts as high as 55 trillion U.S. dollars, including more than 14 trillion U.S. dollars of treasury bonds.
Economists agree that as the United States’ largest foreign creditor, China should contemplate ways to pull itself out of the “dollar trap,” as the U.S. economy is faltering with its debt piling up and its currency on the brink to depreciate.
China must make fuller use of the non-financial assets in its foreign reserves, as well as speed up the diversification of investing channels to resist a possible long-term weakening of the dollar, said Xia Bing, director of the Finance Research Institutes of the Development Research Center under the State Council.
Zheng Xinli, permanent vice chairman of China Center for International Economic Exchanges, has suggested that Chinese companies boost overseas investment as a way to absorb trade surpluses and fend off the dollar risk.
Now
to some degree the Asians knew the bargain they were getting into in
buying US treasuries. They were never buying a claim on the US
economy, or on the US gold reserves. They were buying a claim on
reproducible Federal Reserve notes, and since 1971 the bargain has
been that this is a purely fiat currency. Ultimately, if they do not
feel like the US will be solvent in the long run, they should not
have started lending to it. But now they are the largest real
creditor, they have no choice but to keep on buying and keep on
stabilising, simply because a functional US economy and a solvent US
treasury is about the only way they will see any return at all.
Yet
if they don’t exert leverage on the US, then the US is unlikely to
do much at all. Without a little turmoil, legislators have very
little incentive to act. If the exporter nations feel as if they are
getting screwed, they
are only more likely to escalate via the only real means they have —
trade war. And
having a monopoly on various resources included rare earth minerals
(as
well as various components and types of finished goods)
gives them considerable leverage.
More
and more Asian nations — led by China and Russia — have ditched
the dollar for bilateral trade (out
of fear of dollar instability).
Tension rises between the United States and Asia over Syria and Iran.
The Asian nations throw more and more abrasive rhetoric around
— including
war rhetoric.
And
on the other hand, both Obama and Romney — as
well as Hillary Clinton —
seem dead-set on ramping up the tense rhetoric. Romney seems
extremely keen to brand
China a currency manipulator.
In
truth, both sides have a mutual interest in sitting down and engaging
in a frank discussion, and then coming out with a serious long-term
plan of co-operation on trade and fiscal issues where both sides
accept compromises — perhaps Asia could agree to reinvest some of
its dollar hoard in the United States to create American jobs and
rebuild American infrastructure in exchange for a long-term American
deficit-reduction and technology-sharing agreement?
But
such co-operation would require real trust and respect — and I just
don’t see it. China’s leaders deeply resent the West for the
opium war years, and the humiliation that came with the end of the
Chinese empire — and they see America as profligate, and culturally
degenerate. And America’s leaders see China as
an unstable anti-democratic
dictatorship, not a prospective partner.
So
the future, I think, will more likely involve both sides jumping off
the cliff into the uncertain seas of trade war, currency war,
default-by-debasement, tariffs, proxy war and regional and global
political and economic instability.
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