Day of Reckoning Soon to Come
All this is just an amusing horror story except many credible economists and writers (James Fallows, Arnaud de Borchgrave, Nouriel Roubini, Igor Panarin, Maurizio Orlando, Niall Ferguson) concur to varying degrees with spins. The bottom line … there is a serious possibility that America faces major economic chaos.
Popular perception is that “investment banking” problems began with what citizens saw in the summer of 2008. A great technical explanation by Robert Stowe England printed in an Oct. 11, 2007, issue of Mortgage Banking or his book Anatomy of a Meltdown is very worthwhile reading. A street-language version of events by Michael Lewis appears in Liar’s Poker and in December 2008 on the website www.portfolio.com (“The End of Wall Street’s Boom”). Read these and your view of bankers will sink below that of used car salesmen, lawyers and politicians, and deservedly so. However, the true problem is much deeper than the subprime mortgage scandal or automotive industry ineptitude and goes back over 20 years.
In the early 1980s, America had no foreign debt. By 1998 it exceeded $2 trillion and by now is over $13 trillion. The dollar is not secured by anything. Danger of debt insolvency is growing in a country that has a GDP of about $14 trillion. By year-end 2008, government used $8.55 trillion to stifle the current financial crisis, bringing total direct and indirect public debt to $25.4 trillion.
In 2007, total public debt ($10.6 trillion) was 76.75% of GDP, and beginning 2009 total debt was 181.4% of GDP. At the end of 2007, non-resident foreigners owned 61.82% of public debt, and total foreign-owned debt now stands at 109.4% of GDP. All international economists say that 60% of total debt owned by foreigners is the upper limit to assure solvency.
The U.S. Treasury has run the printing press to cover the shortfall, but the day will come soon when debt owners will place a “call.” And owners of U.S. debt notes are quite aware that total U.S. commitments (spending for Medicare, Medicaid, Social Security) amount to 429.27% of GDP as America begins 2009. There is or has been a line drawn of what is good financial practice to keep confidence in the dollar. The dollar is only paper and sensible partners have/will reach a point where they decline confidence and demand payment on U.S. obligations. A large call can produce a “run” on the dollar in a time of declining confidence.
Economists (and people with common sense) know that borrowing from abroad for domestic consumption, plus deficit spending at home, is not a formula for national economic success. Add to this picture the fact that foreign investments (mostly China) have fueled this foolishness and that 40% of China’s GDP is in manufactured goods export. This clearly shows that, while China holds $1 of every $10 of U.S. public debt, it owns the U.S. consumers’ soul, who hasn’t the foggiest notion about what you are reading.
This diatribe is leading somewhere. The global economy runs today on two engines, Western (mainly U.S.) consumption and Chinese (Asian) production. China needs a 9-10% growth rate to sustain its industrialization (24 million new jobs annually in the labor force), and their bilateral trade growth rate is now 0%. Quick examination of 2008 data shows that 10,000 factories in south China’s (Pearl River Delta) closed and 20,000 more will shutter by the time you read this. When Chinese exports decline and investments stop, a surge of non-performing loans will appear as well as popular uprisings that threaten the regime.
With the risk of a hard landing for the Chinese economy under way (much more of an issue than for rich, pampered Americans), if you were a banker and economic guru for the PRC, wouldn’t you “call” debt paper that assists your country? When it comes down to thee or me, do you doubt the intent or outcome?
The hope for salvation is that if consequences are too severe and too fast, the chaos I mentioned could appear but can be forestalled. That is a weak stick to lean on. Patience, however, wears thin when the U.S. shows financial irresponsibility. Financial bailouts that appease voters but solve no problems do not defer the day of reckoning. IH