By Marshall Auerback
Introduction by Tom Engelhardt
On Tuesday, Greg Ip of the Wall Street Journal wrote a front-page piece on the beleaguered U.S. economy, “As Dollar Weakens, Hidden Strength May Stave Off Crisis,” that, amid much reassurance, caught something of our fraught economic moment. It held more than the usual number of hints of economic Armageddon as it cited a “growing chorus” of experts warning “that the U.S.’s gaping budget and trade deficits will lead to a crisis in which the dollar falls much more sharply, driving up interest rates and squeezing the economy.” Is the United States, the piece wondered, at the edge of the sort of currency collapse followed by deep recession that has in recent years hit lesser powers from Mexico and Argentina to Thailand? While he concluded, as one might expect in the WSJ, that “a review of past crises world-wide suggests the U.S. has enough going for it now to avoid a similar fate,” some of the quotes from experts in the piece must have raised an eyebrow or two in financial circles. For instance, Barry Eichengreen, an economic historian at the University of California, Berkeley, is cited as pointing out ominously that “there is no historical precedent for such a large economy being so heavily in debt to the rest of the world. ”
It seemed the perfect moment then to call in money manager Marshall Auerback. His assignment: To survey the future for signs of onrushing economic apocalypse. His advantage over Ip is that any unvarnished conclusions on the main screen of Tomdispatch are unlikely to start a panicked rush for the financial exits. With the freedom on non-influence deep in his heart, he now offers a guided tour of the possible best of the worst for the year to come, suggesting for us economic tourists what landmarks to future catastrophe we should keep in sight over the next eleven months.
What Could Go Wrong in 2005?
By Marshall Auerback
In his 1849 novel, Les Guepes, Alphonse Karr penned the classic line: “The more things change, the more they stay the same.” In the case of the United States in 2005, however, the opposite might be true: The more things stay the same, the more they are likely to change…for the worse. In that regard, compiling a list of potential threats to the U.S. this year has a strangely déjà-vu-all-over-again feeling. After all, such a list would represent nothing more than a longstanding catalogue of economic policy-making run amok. Virtually the same list could have been drawn up in 2004, or 2003, or previous years.
Such threats would include: a persistent and increasing resort to debt-financed growth and a concomitant, growing imbalance in the trade deficit, leading the U.S. ever further into financial dependency and so leaving it dangerously indebted to rival nations, which could (at least theoretically) pull the plug at any time. This, in turn, is occurring against the backdrop of an increasingly problematic, Vietnam-style quagmire in Iraq, against imperial overstretch, and against a related ongoing crisis in energy prices, itself spurring an ever more frantic competition for energy security, which will surely intensify existing global and regional rivalries.
Just as a haystack soaked in kerosene will appear relatively benign until somebody strikes a match; so too, although America’s longstanding economic problems have not yet led to financial Armageddon, this in no way invalidates the threat ultimately posed. For economy watchers in 2005, the key, of course, is to imagine which event (or combination of them) might represent the match that could set this “haystack” alight — if there is indeed one “event” which has the capability of precipitating the bursting of a historically unprecedented credit bubble.
The odd thing about credit bubbles is that they have no determined resolution, nor is there anything about such a dynamic that specifies the path by which it will be reversed; nor is there some specific level of financial excess guaranteed to eventually put an end to it. The beginning of that end could potentially be set off at any level at any time. Nevertheless, it is possible to sketch out several scenarios which could conceivably, in the eleven months left to 2005, trigger such a reversal or even something approaching economic collapse.
Debt: A Policy on Steroids
The Achilles heel of the American economy is certainly debt. It is generally assumed that increases in credit stimulate consumer demand. In the short run that is true, but the long run is another matter altogether. When debt levels are as high as those the U.S. is carrying today, further increases in debt created by credit expansion can come to act as a burden on demand. Signs of this are already in the air — or rather in what has been, by historic standards, only feeble economic growth in the U.S. economy over George Bush’s first term in office.
Think of the present mountain of national debt as the policy equivalent of steroids. It has so far managed to create a reasonably flattering picture of economic prosperity, much as steroid use in baseball has flattered the batting averages of some of game’s stars over the past decade. But unlike major league baseball, forced to act by scandal and Senate threats, America’s monetary and financial officials still refuse to implement policies designed to curb the growth of a steroidal debt burden. If anything, addiction has set in and policy has increasingly appeared designed to encourage ever larger doses of indebtedness. Each bailout or promise of a government safety net has only led to more of the same: the Penn Central crisis; the Chrysler and Lockheed bailouts; the rescue of much of the savings and loan as well as commercial banking system in the early 1990’s; the 1998 bailout of the hedge fund Long Term Capital Management; and the persistent reluctance of U.S. officials to regulate the country’s increasingly speculative financial system, which has led not only to fiascos like Enron — the 21st century poster child for what ails the US economy — but speaks to the dangers of excessive debt, corrupt financial practices, highly dubious accounting, and endless conflicts of interest.
The result of this reluctance to confront the consequences of America’s credit excesses — a federal government debt level that is now at $7.5 trillion. Of this, $1 trillion is ancient history; the other $6.5 trillion has built up over the past three decades; the last $2 trillion in the past eight years; and the last $1 trillion in the past two years alone. According to the economist Andre Gunder Frank, “All Uncle Sam’s debt, including private household consumer credit-card, mortgage etc. debt of about $10 trillion, plus corporate and financial, with options, derivatives and the like, and state and local government debt comes to an unvisualizable, indeed unimaginable, $37 trillion, which is nearly four times Uncle Sam’s GDP [gross domestic product].” This rising level of indebtedness will become a huge deflationary weight on economic activity if debt growth should seriously slow – which is the economic equivalent of a Catch-22.
The “Blanche Dubois” Economy
The situation of the American economy becomes yet more precarious when you consider that the country’s major creditors are foreigners. Today, the U.S. economy is being kept afloat by enormous levels of foreign lending, which allow American consumers to continue to buy more imports, which only increase the already bloated trade deficits. In essence, this could be characterized in Streetcar Named Desire terms as a “Blanche Dubois economy,” heavily dependent as it is on “the kindness of strangers” in order to sustain its prosperity. This is also a distinctly lopsided arrangement that would end, probably with a bang, if those foreign creditors — major trading partners like Japan, China, and Europe — simply decided, for whatever reasons, to substantially reduce the lending.
China, Japan, and other major foreign creditors are believed willing to sustain the status quo because their own industrial output and employment levels are thought to be worth more to them than risking the implosion of their most important consumer market, but that, of course, assumes levels of rationality not necessarily found in any global system in a moment of crisis. All you have to do is imagine the first hints of things economic spinning out of control and it’s easy enough to imagine as well that China or Japan, facing their own internal economic challenges, might indeed give them primacy over sustaining the American consumer. If, for example, a banking crisis developed in China (which has its own “bubble” worries), Beijing might well feel it had no choice but to begin selling off parts of its U.S. bond holdings in order to use the capital at home to stabilize its financial system or assuage political unrest among its unemployed masses. Then think for a moment: global house of cards.
Already China has given indications of its long-term intentions on this matter: Roughly 50% of China’s growth in foreign exchange since 2001 has been placed into dollars. Last year, however, while China saw its reserves grow by $112 billion, the dollar portion of that was only 25% or $25 billion, according to the always well-informed Montreal-based financial consultancy firm, Bank Credit Analyst.
Beijing has already made it clear that it will spread its reserves and put less emphasis on the dollar. As one of America’s largest foreign creditors, China naturally has the upper hand today, like any banker who can call in a loan when he sees the borrower hopelessly mired in IOUs. If such foreign capital increasingly moves elsewhere and easy credit disappears for consumers, U.S. interest rates could rise sharply. As a result, many Americans would likely experience a major decline in their living standards — a gradual grinding-down process that could continue for years, as has occurred in Japan since the collapse of its credit bubble in the early 1990s.
Even if China, Japan, and other East Asian nations continue to accommodate American financial profligacy, a major economic “adjustment” in the U.S. could still be triggered simply by the sheer financial exhaustion of its overextended consumers. After all, the country already has a recession-sized fiscal deficit and zero household savings. That’s a combination that’s never been seen before. In the early 1980’s, when the federal deficit was this size, the household savings rate was 9%. This base of savings enabled the government to finance its vast deficits for a time through a huge one-time fall in net savings, the scale of which was historically unprecedented and not repeatable today in a savings-less America.
At the Edge: Imperial Overstretch
A restoration of national savings is fundamentally incompatible with continued economic growth, all other things being equal. And the United States can ill-afford even lagging economic growth, given the magnitude of its burgeoning – and expensive – overseas military commitments, especially in an Iraq that is beginning to look like Vietnam redux.
President Bush likes to compare his combination of economic, military, and diplomatic strategies with President Reagan’s blend of tax cuts, military assertiveness, and massive borrowing in the 1980s. His economic advisers, especially Vice President Dick (“deficits don’t matter”) Cheney, appear to believe that the present huge trade and fiscal deficits will prove no more disruptive in the next decade than they were in the Reagan years.
But if we turn to the Vietnam parallel, we find a less comforting historical precedent: the decision, first by President Johnson and then by President Nixon, to finance that unpopular conflict through borrowing and inflation, rather than higher taxes. The ultimate result of their cumulative Vietnam decisions was not just a military humiliation but also a series of economic crises that first caught up with the country in the late 1960s and continued periodically until 1982.
In a sense, the dollar’s continuing fall last year (especially against the euro) in spite of significant interventions by central banks in the global foreign exchange markets, reflects a similar loss of respect for U.S. policy-making – and especially for the linking of the dollar and the Pentagon through an endless series of foreign adventures. In addition, a national economy that cannot itself produce the things it needs and invests instead in military “security” will eventually find itself in a position in which it has to use its military constantly to take, or threaten to take, from others what it cannot provide for itself, which in turn leads to what Yale historian Paul Kennedy has described as “imperial overstretch”:
“[T]hat is to say, decision-makers in Washington must face the awkward and enduring fact that the sum total of the United States’ global interests and obligations is nowadays far larger than the country’s power to defend them all simultaneously.”
That descent into imperial overstretch explains how in the early 1940s an America much weaker in absolute terms, fighting more evenly matched opponents, could nonetheless prevail against its enemies more quickly than a state with an $11-trillion Gross Domestic Product and a defense budget approaching $500 billion (without even adding in the $80 billion budgetary supplement for Iraq and Afghanistan that the Bush Administration is reputedly preparing for the current fiscal year) fighting perhaps 10,000-20,000 ill-armed insurgents in a state with a pre-war GDP that represents less than the turnover of a large corporation. The U.S. today is a nation with a hollowed-out industrial base and an increasing incapacity to finance a military adventurism propelled by the very forces responsible for that hollowing out.
Oil: The Dividing Line of the New Cold War
And then there is the problem of crude which, despite predictions from ever optimistic financial analysts has once again begun to approach $50 a barrel. The one thing Mr Bush has never mentioned in relation to his Iraq war policy is oil, but back in 2001 former Secretary of State James Baker presciently wrote an essay in a Council on Foreign Relations study of world energy problems that oil could never lurk far from the forefront of American policy considerations:
“Strong economic growth across the globe and new global demands for more energy, have meant the end of sustained surplus capacity in hydrocarbon fuels and the beginning of capacity limitations. In fact, the world is currently precariously close to utilizing all of its available global oil production capacity, raising the chances of an oil supply crisis with more substantial consequences than seen in three decades. These choices will affect other US policy objectives: US policy toward the Middle East; US policy toward the former Soviet Union and China; the fight against international terrorism.”
The CFR report made another salient point clear: “Oil price spikes since the 1940s have always been followed by recession.” In its current debt-riddled condition, further such price spikes could bring on something more than a garden-variety economic downturn for the U.S., especially if some of the major oil-producing nations, such as Russia, follow through on recent threats to denominate their petroleum exports in euros, rather than dollars, which would substantially raise America’s energy bill, given the current weakness of the dollar.
The most recent spike in the price of oil was not simply a reflection of rising political uncertainty and conflict in the Middle East. There are other reasons to expect higher energy price levels over the next two to three decades – the most notable among them being strong demand from emerging economies, especially those of China and India.
The parallel drives for energy security on the part of the United States and China hold the seeds of future conflict as well. Yukon Huang, a senior advisor at the World Bank, recently noted that China’s heavy reliance on oil imports (as well as problems with environmental degradation, including serious water shortages) poses a significant threat to the country’s economic development even over the near-term, the next three to five years.
China’s already vigorous response to this challenge is likely to bring it increasingly up against the United States. Venezuelan President Hugo Chavez, for instance, returned from a Christmas trip to China where he apparently sold America’s historic Venezuelan oil supplies to the Chinese together with future prospecting rights. Even Canada (in the words of President Bush, “our most important neighbors to the north”) is negotiating to sell up to one-third of its oil reserves to China. CNOOC, China’s third largest oil and gas group, is actually considering a bid of more that $13 billion for its American rival, Unocal. The real significance of the deal (which, given the size, could not have been contemplated in the absence of Chinese state support) is that it illustrates the emerging competition between China and the U.S. for global influence — and resources.
The drive for resources is occurring in a world where alliances are shifting among major oil-producing and consuming nations. A kind of post-Cold War global lineup against perceived American hegemony seems to be in the earliest stages of formation, possibly including Brazil, China, India, Iran, Russia and Venezuela. Russian President Putin’s riposte to an American strategy of building up its military presence in some of the former SSRs of the old Soviet Union has been to ally the Russian and Iranian oil industries, organize large-scale joint war games with the Chinese military, and work towards the goal of opening up the shortest, cheapest, and potentially most lucrative new oil route of all, southwards out of the Caspian Sea area to Iran. In the meantime, the European Union is now negotiating to drop its ban on arms shipments to China (much to the publicly expressed chagrin of the Pentagon). Russia has also offered a stake in its recently nationalized Yukos, (a leading, pro-Western Russian oil company forced into bankruptcy by the Putin government) to China.
In a one-superpower world, this is pretty brazen behavior by all concerned, but it is symptomatic of a growing perception of the United States as a declining, overstretched giant, albeit one with the capacity to strike out lethally if wounded. American military and economic dominance may still be the central fact of world affairs, but the limits of this primacy are becoming ever more evident — something reflected in the dollar’s precipitous descent on foreign exchange markets. It all makes for a very challenging backdrop to the rest of 2005. Keep an eye out. Perhaps this will indeed be the year when longstanding problems for the United States finally do boil over, but don’t expect Washington to accept the dispersal of its economic and military power lightly.
Marshall Auerback is an international strategist with David W. Tice & Associates, LLC, a USVI-based money management firm. He is also a contributor to the Japan Policy Research Institute. His weekly work can be viewed at prudentbear.com
Copyright C2005 Marshall Auerback
This piece first appeared at Tomdispatch.com