The backstory for this election year lacks the urgency of war or of defeating George W. Bush but focuses on a most fateful question: When will this hemorrhaging debtor nation be compelled to pull back from profligate consumption and resign its role as "buyer of last resort" for the global economy? The smart money assumes such a momentous reckoning probably won't occur in time to disrupt Bush's re-election campaign, but it may well become the dominating crisis in the next presidential term, whoever is elected. At that point, the United States will lose its aura of unilateral superiority, and globalization will be forced to undergo wrenching change. The American economy, in other words, is in much deeper trouble than most people realize.
The facts are not secret. Despite ebbs and surges, the gap between US exports and imports has been steadily widening across three decades. The trade deficits of the early 1970s (due mainly to soaring oil prices) were trivial in size, but Americans were shocked in 1978 when the deficit hit $30 billion (TV sets and some cars were now made in Japan). During the 1980s, the trade deficit expanded enormously, as Washington's strong- dollar policy crippled US manufacturers and companies moved jobs and production offshore in swelling volume. After a recession and dollar devaluation, the gap shrank briefly, but soon began expanding again.
For several decades, in fact, the federal government has tolerated and even encouraged the dispersal of American production overseas--first to secure allies during the cold war, later to advance the fortunes of US multinationals. No other major economy in the world accepts perennial trade deficits; some maintain huge surpluses. But American leaders and policy-makers are uniquely dedicated to a faith in "free market" globalization, and they have regularly promised Americans that despite the disruptions, this policy guarantees their long-term prosperity. Present facts make these long-held convictions look like gross illusion. By 1998, the trade deficit was back to a new high and expanding ferociously, despite supposed improvements in US competitiveness. Last year it set another new record: $489 billion.
Yet no one running for President has found the nerve to discuss these facts in a straightforward manner. Nor do the candidates have anything to say about how the country might avoid a potential calamity. A few wise heads in finance, like billionaire investor Warren Buffett, have sounded the alarm--Buffett refers to the United States as "Squanderville" and is shifting billions offshore into foreign currencies for safety. Meanwhile, political leaders remain silent.
The US economy, in essence, is being kept afloat by enormous foreign lending so that consumers can keep buying more imports, thus increasing the bloated trade deficits. This lopsided arrangement will end when those foreign creditors--major trading partners like Japan, China and Europe--decide to stop the lending or simply reduce it substantially.
That reckoning could arrive as a sudden thunderclap of financial crisis--spiking interest rates, swooning stock market and crashing home prices. More likely it will be less dramatic but equally painful. As foreign capital moves elsewhere and easy credit disappears for consumers, many Americans will experience a major decline in their living standards--a gradual grinding-down process that could continue for years. If the US government reacts passively and allows "market forces" to make these adjustments, the consequences will be especially severe for the less affluent--families already stretched by stagnating wages and too much borrowing.
Normally, I wouldn't use an economic chart to make my point, but the one you see on page 11 tells the story of America's predicament more effectively than words. Prepared by University of Wisconsin economist Menzie Chinn (and illustrated by Stephen Kling/Avenging Angels), with dollar values adjusted to remove the distortions of price inflation, it's a visual display of the US economy's performance in the global trading system during the past three decades. Year by year, it traces the line of US imports versus the line of US exports. The red ink in between represents America's trade deficits.
The red ink, as you can see, is exploding. The thick red blob in the upper right-hand corner represents our present condition--the record trade deficits of recent years. Starting six or seven years ago, these two lines diverged dramatically: The volume of imports soared, while export growth leveled off. Historically, when a mature economy suffers perennial trade deficits, it is usually understood as a sign of weakness, especially if the deficits keep getting larger.
The red ink can also be read as a rough approximation of America's indebtedness to the rest of the world. Last year the US economy (business and households as well as the federal government) was compelled to borrow $540 billion from overseas creditors. Since the United States first became a debtor nation fifteen years ago, it has accumulated nearly $3 trillion in debt obligations abroad. At the current pace, the foreign debt load will double again in the next six or seven years. You can see why we have depicted the debt as a serpent, rising to strike. The serpent, I suggest, is biting the debtor nation that has fed it. Actually, it ate our lunch.
Leading authorities typically explain what is happening by observing correctly that Americans are collectively "overconsuming"--that is, living beyond their means--but experts assume that "market forces" will eventually correct the situation. Once the global economy regains robust growth, it is said, other nations will buy more US exports. Or, once the dollar has depreciated in value sufficiently, Americans will buy fewer imports. Some even claim the indebtedness is America's good fortune--a sign of strength that other nations are so eager to finance US consumption.
I think the authorities are wrong. When I look at the chart, I see the United States sinking into financial dependency--dangerously indebted to rival nations that are holding our debt paper, collecting the interest on Treasury bonds and private bank loans, or repatriating the profits from companies that used to be American- owned. A very wealthy nation can tolerate this negative toll for many years, but not forever. Unless the historic meaning of debt has been repealed, no nation can borrow endlessly from others without sooner or later forfeiting control of its destiny, and also losing the economic foundations of its general prosperity.
The world at large will be better off, in my view, when Washington is compelled to accept a less dominating role and global political power is dispersed more multilaterally. But the transition itself could be an unsettling, even dangerous time, since the declining economic power also happens to be the pre-eminent military power. In any case, an American reckoning would also have economic consequences for the rest of the world. If the United States were to tap out, the global system would lose its best customer. American consumers have propped up global trade with their open-ended purchases. Now the rest of the world is propping up American consumers, lending them the money to buy still more.
The endgame might be triggered by any number of events--including the financial exhaustion of America's overextended consumers--but the most likely venue is the global trade in capital, not the trade in goods and services. In theory, wealthy countries are expected to ship investment capital to poorer countries to build factories and infrastructure. But at present, most of the world's capital is flowing in reverse: The net inflow of foreign capital to the United States represents a staggering 75 percent of the net outflows from the rest of the world, according to economist Jane D'Arista of the Financial Markets Center. Even more abnormal is that nearly one-fourth of this lending comes from emerging-market nations, led by China, whose trade surplus with America has surpassed Japan's.
Both China and Japan are prodigious financiers of US consumption--the two largest foreign holders of US Treasury bonds--despite the weak returns they get from low US interest rates. China and Japan are willing to do this because they calculate that sustaining their own industrial output and employment is worth more than seeking stronger financial returns elsewhere.