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An Empire of Debt -- Collapsing Under Its Own Weight

The central problems started with the "supply-side revolution," and the policy of borrowing instead of growing is finally catching up with the great debtor that is the US.
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Over at the Washington Note, Steve Clemons linked to a 2003 article titled "The Debtors Empire." What I find incredible about this article written almost four and a half years ago is how prescient its observations are today.

Isn't it just a little twisted that the United States, the world's richest country, is on track to borrow more than $500 billion from abroad this year? Isn't it even stranger that this borrowing includes sizable chunks from countries such as India and China, many of whose 2.3 billion people live on less than a dollar or two a day?

Sure, I know there are reasons why money flows the way it does. For one thing, the United States has a long history of treating foreign investors pretty decently, going back to the 1780s, when the first Treasury secretary, Alexander Hamilton, decided to honor pre-Revolutionary War debt. And the United States is growing decently (roughly 4 percent next year), albeit less than India (6 percent) or China (8 percent).

But whatever the reasons, and they are admittedly complex, isn't it still a bit nutty that the world's richest country has become by far the world's biggest borrower, with a net debt to the rest of the world (assets minus liabilities) of more than $2 trillion? The Romans would be jealous: They went to a lot of trouble to extract taxes from their empire; the world just gives money to the United States.

Even with the morality of it all set aside, pure self-interest ought to dictate that the United States be a net lender to the rest of the world rather than a borrower. We are an aging population that ought to be saving for retirement in real assets abroad. Unfortunately, you'd never know it from the consumption frenzy of recent years. We Americans may have coined the phrase "a penny saved is a penny earned," but these days it's "I'll gladly pay you Tuesday for a genetically modified hamburger today."

State governments are bleeding red. California alone is still running a deficit that by many measures is bigger than those of many countries. As for the federal government -- well, Washington is on track to achieve deficit records that could take a generation to break. And the American consumer? We save less of our income than any other rich economy. China's citizens save more than 40 percent of their income; the United States would be lucky if its citizens ever decided to save at half that rate. No matter how rich you are, if you continually spend more than you earn, you are eventually going to run into problems.

These are the exact same sentiments expressed by former Federal Reserve Chairman Paul Volcker on April 10, 2005 in an article titled "An Economy on Thin Ice":

It's all quite comfortable for us. We fill our shops and our garages with goods from abroad, and the competition has been a powerful restraint on our internal prices. It's surely helped keep interest rates exceptionally low despite our vanishing savings and rapid growth.

And it's comfortable for our trading partners and for those supplying the capital. Some, such as China, depend heavily on our expanding domestic markets. And for the most part, the central banks of the emerging world have been willing to hold more and more dollars, which are, after all, the closest thing the world has to a truly international currency.

The difficulty is that this seemingly comfortable pattern can't go on indefinitely. I don't know of any country that has managed to consume and invest 6 percent more than it produces for long. The United States is absorbing about 80 percent of the net flow of international capital. And at some point, both central banks and private institutions will have their fill of dollars.

I don't know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change.

The central problem is the US is addicted to consumption that our pocketbooks cannot pay for. So we borrow. Consider the following charts:

Gross Federal Debt now stands over $9 trillion dollars.

In the last 7 years, we have doubled the amount of debt we we borrow from abroad to a little over $2 trillion.

The central problems started when the Republicans began their "supply-side revolution." Notice in the chart above that starting in 1980 government expenditures continually outpaced expenditures by a wide margin. Hence the massive build-up in debt. Under Reagan's tenure, total federal debt outstanding increased from a little over 30% of GDP to over 60% of GDP. While Bush inherited a surplus, he again increase total debt outstanding from about 57% to 64%. In short, we have Republican economic policy to thank for this problem at the national level.

But it's not just the national government. US consumers are massively indebted as well. Consider the following charts:

All of that debt has to go somewhere. And it has -- it is currently on the balance sheets of literally every financial player in the market. And that's a large part of why Bear Stearns failed -- it owned a ton of loans that weren't any good.

And the end result of this policy is foreigners don't have any confidence in our economy. How do I know this? Take a look at a chart of the dollar.

It's dropping like a stone.

The policy of borrowing instead of growing is finally catching up with the great debtor that is the US. And the cost isn't pretty.