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Monday, September 15, 2003

A Tearful Ending?

I don't know what's happening to me, these days I'm enjoying Eddie's Straits Times column almost as much as reading Stephen Roach:

Ballooning US foreign debt spells trouble for Asia
By Eddie Lee

The signs are all there.

United States manufacturing activity is picking up nicely, consumers are doing what comes most naturally to them - that is, spend - and the result is a sparkling 3.1 per cent growth in the US economy during the second quarter. Meanwhile, the US Federal Reserve continues to assure everyone that interest rates will remain low for as far as the eye can see. Economists believe third-quarter growth should accelerate further - hitting at least 4 per cent. Unquestionably, economic recovery is here.

So, what's the problem? First, start with the symptoms. There's US Treasury Secretary John Snow making use of his trip to Beijing and Phuket last week to push for 'flexible' exchange rates. He explained the source of his concerns: 'What we're really worried about is that if you don't have the right relief valves in an economic system, you're inviting trouble. Adjustable currencies are the relief valves, the antidote to those problems.' He was talking about Asia's fragile economies, but he could just as well have been referring to the US economy. The US is saddled with the largest foreign debt in its history. Net foreign debt (what the rest of the world owes the US minus what the US owes the rest of the world) is equivalent to about 35 per cent of its gross domestic product. Over the past 10 years, while US GDP grew by 64 per cent, foreign debt grew by 257 per cent. In short, debt is growing much faster than income.

The problem with the US foreign debt is not so much that it's so large; it's just how much bigger it'll grow in the future that's really troubling. There are two reasons. First, the US does not save sufficiently for the amount it spends, whether in consumer goods such as television sets or investments in factories. So the US has to borrow from abroad. This habit, however, has become a dependency. The US needs to sustain the rising tide of cheap imports in order to support its standard of living. The result is that the US imports a far larger amount than it exports. The other source of the problem is that the US government spends far more than it collects in revenue. It is able to do this, increasingly, only by borrowing from abroad. Of course, it makes economic sense to be running budget deficits this year and next; given the uncertain state of the US economy, a boost is required. But the US budget deficit is ill-conceived, giving little bang for the buck in terms of short-term simulative effects, and yet, the deficit is expected to grow even larger in the long term with no end in sight.

The Centre on Budget and Policy Priorities estimates a 10-year deficit of US$5.1 trillion (S$8.9 trillion), with deficits exceeding US$400 billion every year and hitting US$650 billion by 2013. The US' need for foreign financing has grown so large that, now, even foreign private investors have become increasingly reluctant to invest in US assets. To cover the shortfall between what the US needs to borrow and what private investors are willing to lend, foreign central banks have stepped in to fill the gap.

And the main player here: China. As it runs the largest single trade surplus with the US, creating a huge demand for yuan by US importers, its central bank needs to buy a lot of US dollars (with a lot of yuan) to stop the Chinese currency from appreciating. This is particularly so as China fixes its currency to the dollar. While most Asian countries do not peg their currencies to the US dollar, they are concerned over a sharp rise in their currencies undermining still-fragile economic recoveries. Japan is estimated to have bought US$80 billion so far this year, an amount close to Singapore's gross domestic product, to support the US dollar and prevent the yen from appreciating.

Typically, foreign central banks park their dollars in US assets. They have been doing so to such an extent that foreigners, private and public, now hold almost 20 per cent of the total US national debt, and about 40 per cent of all Treasury debt outside the US Federal Reserve. Now you know why the US Treasury Secretary is all bark but no bite. The US has little leverage over China (or Japan). Purchases of US Treasury bills by China's central bank are one of the main ways in which the US finances its trade deficit. Just how high US interest rates would have to rise if the Chinese or Japanese decide to switch out of US Treasuries is open to speculation. But the US wouldn't want to risk finding that out too soon.

Still, the sheer size of its foreign debt also means that its foreign creditors have a vested interest in propping up the system. The analogy here: If you owe your bank a small sum of money and you can't repay it, you've got a problem. But if you owe your bank a big sum and can't repay it, then the bank has a problem. It's a case of economics gone awry. Asian economies, lower down the development path, naturally have a greater need for foreign capital to finance their growth - in particular, to purchase imports of capital equipment. But this growth must be curtailed to ensure trade surpluses so that there are excess funds that can flow from Asia to finance the US trade deficit. How is Asia's growth restricted? By the threat of appreciating currencies and a spike in interest rates if Asians pull out of US Treasuries. However, US growth sustained by further injection of Asian capital, eventually, can lead only to tears. In a global economy standing on wobbly legs, each economic upswing contains the seeds of its own demise. As I said, the signs are all there.
Source: Straits Times

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