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The US is losing economic power

September 11th, 2008 · No Comments

For decades, the US has ran a trade deficit, which means it’s spending beyond it means, buying more abroad than the rest of the world buys in the US. The difference is made up with debt. It has given foreign powers an unprecedented leverage over the US, leverage that they would not hesitate to use in subtle, or even less subtle ways..

In the 1990s, this trend seemed to be slowed or even halted, as at least the government ran a surplus (not the private sector, so the trade deficit remained), but this decade, it has manifested itself again with great vigor, as the US government swang into large deficits again.

Basically, the US is relying on foreigners (especially foreign governments) to keep financing their excesses. So far, they have been willing to do that, not out of a willingness to help the US, but for selfish reason, basically, to keep their currencies from increasing in value against the dollar.

Here is how it works. Countries like China and Japan run big trade surpluses (the mirror image of the US), normally, that would increase the value of their currency, as it means that demand for their products and services (and hence their currency) is higher than their demand for foreign products and services (and hence the supply of yens and yuans to convert them in foreign currencies in order to pay for those foreign products and services).

Now that the US, in the words of Nouriel Roubini, turns out to have a ‘sub-prime financial system’, the distrust against American assets has increased, and that’s a very dangerous development. Here is an example:

Foreign Bondholders, not the mortgage market, drove the Fannie/Freddie bailout

  • For anyone who still doubted the growing global influence of such emerging powerhouses as China, consider this: The U.S. government’s decision to take control of foundering mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) was driven not by worries about the fading U.S. housing market, but by concerns that foreign central banks in China, Japan, Europe, the Middle East and Russia might stop buying our bonds.
  • As the bailout announced Sunday is currently structured, more than $1.3 trillion worth of Fannie Mae and Freddie Mac debt currently held by the central banks and other investors in those regions will be guaranteed by the U.S. government – even if one or both of the two government-sponsored enterprises (GSEs) were to fail. That means that U.S. taxpayers – government parlance for you and me – will ultimately foot a big part of the bill for making sure those foreign bondholders are “made whole.”
  • The government apparently felt it had no choice. As speculation about the possible collapse of the two firms spiraled higher in recent weeks, central banks, sovereign wealth funds and foreign investors throughout the world were reportedly threatening to halt their purchases of Fannie and Freddie debt, grousing that the mounting risk was making them leery of buying any more bonds. And that would make it virtually impossible for the two mortgage operators – and by extension, the U.S. mortgage market – to function effectively.
  • “It was the mounting evidence that central banks, sovereign wealth funds, and other global investors were growing [increasingly] reluctant to invest in the debt that was the catalyst for the Treasury Department’s actions,” Mark Zandi, chief economist for Moody’s/ in West Chester, Pa., wrote in a recent research report. “Fannie and Freddie debt is now effectively U.S. Treasury debt, ensuring that holders will remain whole.”
  • If China were to lose confidence in the U.S. currency – dumping the dollar – it’s hard to say with certainty just how bad things could get. Should foreign investors rampantly discard the dollar, the greenback would plunge against other currencies.
  • And that would be highly inflationary, translating into what would effectively be big price increases on such key imports as oil, steel, electronics, and other wares.
  • That could finally force the U.S. Federal Reserve to raise interest rates – a move the central bank has been trying to avoid, due to concerns that markedly higher rates would shove the U.S. economy into a deep recession.

And while the US election lingers on topics like lipstick, the world-order is changing.

Tags: The Markets