What Could Go Wrong in 2005?
By Marshall Auerback
TomDispatch.com via Truthout
http://www.tomdispatch.com/index.mhtml?pid=2141
Friday 21 January 2005
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
d�j�-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":
"That 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.
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