China, U.S. Debts, and the Economy
January 03 2009 / by DSMason / In association with Future Blogger.net
Category: Economics Year: 2009 Rating: 3
Cross Posted from The End of the American Century
In my book The End of the American Century, I point to China as one of America’s new rivals, but 
also as a major factor in U.S. profligacy and in U.S. economic decline. To a large extent, the false U.S. affluence of the last decade has been underwritten by China, in two ways: the country has supplied American consumers with cheap toys, gadgets and clothes; and has been bailing out the federal government by purchasing U.S. debt.
The rapid growth of foreign ownership of U.S. debt is yet another dimension of the unraveling of the U.S. economy. In 1970, only 4 percent of U.S. debt was held by foreigners; now almost half is. In recent years, foreigners have financed about 80 percent of the increase in public debt. The two biggest holders of U.S. debt are Japan and China, with China alone owning about $1 trillion in U.S. debt. Senator Hilary Clinton raised concerns about foreign ownership of U.S. debt in early 2007, when she sent a letter to Secretary of the Treasury Henry Paulson and Fed Chairman Ben Bernanke. “In essence,” she observed,
"16% of our entire economy is being loaned to us by the Central Banks of other nations."
This was a major reason why both the American consumer and the federal government could spend so far beyond their means in the last twenty years, and why the U.S. economy has gotten so severely out of whack. The large-scale purchases of U.S. debt by foreigners helped keep interest rates low, encouraging consumers to borrow more than they could afford for the purchase of cars and houses and other consumer goods. It was a kind of giant international Ponzi scheme. The Chinese lent us money so we could purchase their products. But when the bottom fell out, the economies of both countries began to fall apart.
It is astonishing that so few public officials and economists recognized this enormous looming problem. It is not so surprising, perhaps, that the Bush administration missed the boat on this, because they were either oblivious or willfully ignorant on just about every major issue facing the United States, economic or otherwise. As the New York Times observes in a long and helpful overview of the situation, former Fed Chairman Alan Greenspan and the Bush administration “treated the record American trade deficit and heavy foreign borrowing as an abstract threat, not an urgent problem.”
Ben Bernanke, an esteemed economist if there ever was one, acknowledges that “a better balance of international capital flows early on could have significantly reduced the risks to the financial system.” But “this could only have been done through international cooperation, not by the United States alone.” Bernanke’s view of the problem, according to the Times, “fit the prevailing hands-off, pro-market ideology of recent years.”
This illustrates, in two ways, why the U.S. has fallen so far, so fast. The problem, as Bernanke correctly noted, required international cooperation. This has been a serious weak spot for the U.S. of course, particularly in the last eight years. The U.S. has ignored, denigrated or flouted international laws, conventions and institutions—especially during the Bush administration but before that as well. Because we did not welcome international cooperation in the past—on global warming, the Iraq War, the International Criminal Court, etc.—other countries were increasingly disinclined to look for the U.S. for leadership. This is now being played out in the international economic realm as well as the political.
The second telling aspect of the Bush/Greenspan/Bernanke approach is the “pro-market ideology of recent years.” Under Bush, the “hands off” approach to economic and social problems in the U.S. has indeed taken on the rigidity of an “ideology.” It is no longer simply a policy advocated by policy-makers, but a set of ideas promoted by ideologues. We see this in a whole array of hugely important issues facing the U.S., which have all been ignored or marginalized for eight years. The lack of regulation of financial markets is the most obvious example, but one also sees the “hands off” approach causing tremendous deterioration of U.S. schools, health care, welfare, infrastructure, and the environment, to say nothing of the elephants in the room—Social Security and Medicare.
Treasury Secretary Paulson told the Times “you don’t get dramatic change, or reform or action, unless there is a crisis.” This seems a strange way to run the ship of state. But the crisis is here, Mr. Secretary. Now what do we do?
Comment Thread (2 Responses)
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The US government and US consumer have spent beyond their means – so the economy will return to its proper value. This signals a sharp crash for a few years, but it is by no means a disaster. It simply means that China will overtake the US GDP sooner than expected.
Actually, even pre-crash, the total GDP of the USA is what you would expect if its GDP per capita is the same in advanced European economies. For example, the USA has five times the population of the UK and its GDP is about five times bigger. Simple arithmetic.
However this will change, since the US has inbuilt systemic problems. It has high crime (1 in 10 american adults is in prison) it has old infrastructure in need of repair, and half its population believes that the universe was created after the Sumerians invented glue. In comparison to most other developed nations its children are poor at math and science, and its most recent election was characterised by an inane debate about “Jo the plumber”.
There won’t be a disaster anytime soon, but the GDP per person of the US is about to be corrected so that the absurd facade where people who despise science nevertheless drive around in fancy cars and obsess about their advanced smart phones cannot be continued. It’s a chance for those who previously got something for nothing to wise up and learn that to have a mortgage and a nice car, you need to be a professional worker.
Posted by: CptSunbeam January 03, 2009
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@ DSMason – Nice piece. What really resonates for me is how you point to Greenspan and the finance bulls treating “the record American trade deficit and heavy foreign borrowing as an abstract threat, not an urgent problem.” That seems to be the fundamental problem, one that recurs cyclically: the gradual and then suddenly disastrous outdating of our collective simulation (aka abstraction) of the economy and system.
It appears we are still running roughly the same simulation that we rallied around coming out of the Great Depression: American-centric (unilateralism, support of the inefficient auto industry, huge defense spending), belief in a market rooted in spending and home purchases (bad metrics, American home dream, etc), same basic education system based on local property tax that doesn’t take into account critical developmental periods, lack of scientific understanding, lack of realism re: available resources, and so forth (I could list many more). Over time, as this abstract simulation gets out of whack with reality, it creates an environment full of structural entropy in which the easiest path to $ is through participating in the system, which begins to trend toward nepotism. But at some point it becomes obvious that 1) the now dumb system cannot defend itself adequately against threats (Madoff, incomprehensible hedge funds, terrorism), and 2) there is a gross human capital misallocation, and 3) the fundamentals of such an economy cannot be sustained by using the same thinking.
It is not easy to change a collective simulation supported by hundreds of millions of people that benefit or perceive that they benefit from thinking that way. It does seem to require a period of crisis to break up the idea space that is supported by established institutions, in order to allow for a software upgrade. Just as OS releases com in spurts, so too do new versions of our national software.
@ Cpt Sunbeam – re: U.S. GDP as compared to Europe. The obvious counter to that assessment is the possibility that because we are so inter-twined, both European and American GDP is overvalued, which I think is highly probable.
When contemplating a gradual recovery vs. a sharp crash I think we need to estimate how much more money in Junk Hedge Funds is due to be taken off the board and off the books of international juggernauts. IT could still be many, many trillions.
In the end, I totally agree that we need to shift back to creating fundamental value individually, and in industry. The software upgrade has begun, but the load bar is still at 1-2%. In the meantime, we are vulnerable to say the least.
Posted by: Alvis Brigis January 05, 2009
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