America’s borrowing bonanza

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There are sometimes pots of gold at the end of the rainbow, but it is rarely wise to count on them to pay your debts. Writing from overseas, John points out that the solution to America’s economic problems will not be a problem for America alone.

In the past decade Americans believed themselves richer than they were, spent accordingly, and borrowed the money from the rest of the world to pay for it. Stripped of rhetoric and jargon – new paradigms, cycles and recessions, globalisation and outsourcing – these are the simple facts you need to know about the world economy today.

The level of the stock market is a measure of national self-congratulation. It tells you how much you think your children and grandchildren owe you. And that indicator has been running at unprecedented levels. The value of the endowment we plan to sell on has increased steadily since 1980 and doubled between 1995 and 2000 alone.

This perception of success made it less necessary to provide for the future in more conventional ways: a fall in the savings rate more or less mirrored the rise in stocks. If a massive reassessment of the likely future earnings of companies were justified, this would have been an appropriate reaction. Since the technology bubble burst in 2000, the value of stocks has fallen somewhat, but is still high by any historical measure except the 1998-2000 period.

As the myth of the new economy has dissolved, however, two new illusions have emerged: not only are the businesses we have created worth more to future generations than we had previously supposed, the houses we have built are also worth far more. Better still, the beneficial effects of tax cuts on productivity and growth are so large that not only are George W. Bush’s friends better off today but everyone, including the federal government itself, will be better off in the future. The American dream that the power of positive thinking alone will make you rich has finally been brought to fruition.

“Deficits do not matter” – the mantra of profligates through the ages – is today the slogan of the US government. The principles of arithmetic and accounting require that the US trade deficit is matched by a corresponding capital account surplus. The ability to finance this deficit is represented as an indicator of the confidence the rest of the world has in US economic performance – the precise analogue of my claim that my rapidly rising credit card bill, far from being a measure of overspending, is a demonstration of the credit card company’s confidence in my future prospects. There is a sense in which the claim is true, and a more important sense in which it completely misses the point.

For a time, the rising value of financial assets masked the effect of rising deficits on American’s overseas liabilities. Dumb investment in the US by foreigners also helped. But private institutions have become less willing to increase their holdings of US assets. The trade deficit is now mainly financed by the rising dollar holdings of Asian central banks.

The best outcome for everyone would be that the dream comes true – that the underlying growth prospects for the US economy are so strong that productive capacity leaps ahead of growing consumption and spiralling military expenditure. There are sometimes pots of gold at the end of the rainbow, but it is rarely wise to count on them to pay your debts.

John Kenneth Galbraith’s greatest contribution to economics is the concept of the bezzle – the increment to wealth that occurs during the magic interval when a confidence trickster knows he has the money he has appropriated but the victim does not understand that he has lost it. The gross national bezzle has never been larger than in the past decade.

What cannot continue must end, though not necessarily quickly. Since there is no policy to reduce deficits, the market will eventually do the job. Revived inflation would reduce the value of domestic savings, domestic indebtedness, and the dollar assets of foreigners. Or the unwillingness of those foreigners to accumulate such assets in ever larger quantities might lead to a plunge in the value of the dollar. Or the collapse of financial institutions might provoke a revival of domestic spending.

However it comes about, the inevitable consequence of the US ceasing to spend more than it produces is that other countries must cease to produce more than they spend. The solution to America’s problems will not be a problem for America alone.

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