Thursday, July 08, 2004

Debt Discussion: A Disagreement With Max

MaxSpeaks is an informative and interesting blog. Recently he's written about the whole debt issue.

What's left are privately-owned physical assets -- land, structures, and equipment. In 2003 this was estimated at $38.9 trillion, up from $34.5 in 2000, an increase of $4.4.

Meanwhile, net foreign claims increased from $2.8 to $4.2 trillion. As we all know, there is no stock of physical wealth underlying Federal debt, only the all-powerful taxing authority. So in principle, the share of the increase in private wealth in the U.S. vulnerable to foreigners' claims since 2000 is 32 percent (1.4/4.4), which I claim is big.

As a nation, in short, we may be consuming more than we are producing at a rising rate. Foreigners take the difference in ownership of dollar-denominated assets. These assets are claims on future income produced in the U.S. Interest on private debt is paid by corporations and households. Dividends are paid out of profits. Interest on public debt is paid with your tax dollars. To some extent, debts can be rolled over, so the concern is with the direction and rate of change, not necessarily the level.

However Max seems to have been infected by the complacency that many people have taken toward the levels of debt.
The trade deficit is typically elevated to be a second prophecy of economic doom, along with the budget deficit, and one whose solution is held to be fiscal austerity. But the fact that ownership of capital in the U.S. trends from native to foreign would seem to be an irrelevance to working people. So too, in and of itself, the trade deficit.

An exception to this is the possibility discussed by my colleague Rob Scott that increasing imbalances in the U.S. current account lead foreigners to refuse to buy or hold dollar assets, leading to a financial crisis and tsuris for everyone.

Robert Eisner told me he discounted this eventuality, since such a move would cause a drastic decline in the value of the dollar and foreign holders of dollar assets would take a bath. There is the old adage that if you owe someone a hundred bucks, he's a creditor; if you owe him a million, he's a partner.

Short of a crisis, the likelihood is that current trends in trade and budget deficits are unsustainable. We have nearly exhausted the topic of how to fix the budget deficit. Climbing down from the trade deficit also raises the question of whose ox will be gored. Politics again. To buy less than we sell, we have to sell more -- not an easy thing to finagle -- or consume less, not a popular thing.

In the interim, I think it's fair to say the trade deficit is somebody else's problem.

I think this view neglects the fact that the reason why the debt service is artificially low is the artificially high demand by foreign central banks that need to do this to artificially depress their currencies to artificially inflate their export marketshare competition for US consumption. Got that? As such it creates profound problems for US labor right here and now. Part of the reason why globalization and capital flight is going overseas is that their structural labor costs are cheaper. However when China is lowballing their currency part of that cost savings premium is completely artificial. In addition US firms have a more difficult time competing for foreign markets, again because our currency is priced too highly compared to the artificially depressed foreign competitors.

Without this artificial demand for our sovereign debt however the interest rates and therefore debt service would be much higher. This would necessitate difficult choices of governance. Did you think that the Bush Administration was penny pinching and stingy when it came to spending other than military, tax breaks for their buddies, and a few social entitlement bribes for the general public? Well even a Democratic Administration would have to significantly scale back spending if debt service rose precipitiously. Indeed even with the artificial demand, the debt is growing so big it may soon significantly impact social spending by the government.

That's the big picture. But people have been so complacent for so long that even intelligent guys like Max can think "it's someone else's problem." No it's our problem here and now, and for similar reasons if things did go sour our situation would significantly worsen. A hyperinflation or debt default scenario with attendant interest rates surging through the roof - who would buy our debt afterall to depress our interest rates once we welched? - would cause either a burning out of the economy with inflation or a massive economic contraction.

Yet people can't see it.

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