Economic Armageddon: Why?

Two scary predictions about the economic crisis looming over the USA as a result of our trade deficit.

Robert Reich on the declining dollar:

American exporters are cheering because a lower dollar makes everything they sell abroad cheaper. But it’s bad for the rest of us because as the dollar drops everything we buy from abroad — including oil — becomes that much more expensive. And these higher prices will ripple through the economy, threatening inflation and higher interest rates — and, ultimately, reducing our living standards.

Investment banker Steven Roach predicts armageddon. Brett Arends reports:

To finance its current account deficit with the rest of the world, he said, America has to import $2.6 billion in cash. Every working day.
That is an amazing 80 percent of the entire world’s net savings.
Sustainable? Hardly.
Meanwhile, he notes that household debt is at record levels.
Twenty years ago the total debt of U.S. households was equal to half the size of the economy.
Today the figure is 85 percent.

I expect the conservative economists will eventually weigh in on this armageddon scenario, but it’s making a lot of sense to me. There really doesn’t seem to be any signs of a healthy economy in the US, aside from the improving unemployment rate and rise in GDP and productivity (although not income). Normally those are positive signs, but one wonders how much of a bubble is hidden underneath these indicators.

Think optimistically. I finally paid off my lingering debt from my days of unemployment and plan to keep spending down as much as possible for the near term. If Americans used the taxcut windfall to reduce their debt burden rather than buy more things, that could work to the nation’s benefit.

The question becomes: is George W. Bush responsible for this mess? Yes, to the extent that public spending (and deficits) have increased significantly over the last 4 years. But honestly, the deficit as a percent of GDP is not unusually high. Granted, the war campaigns have been expensive and are a drag on the US economy (especially because they involve long term investments unlikely to help our own country). This “American empire” mentality only lowers investor confidence and to doubt our financial stability. If the bond market or Japan forex traders are looking for a stable place to plop its investments, should it choose the war-happy/interventionist USA or the multilateralist/consensus-based EU? Our new emphasis on national security and border control also creates the perception that foreigners are unwelcome, and the 2004 election only fanned the flames of xenophobia (about jobs going overseas, etc.). Richard Florida’s argument that economic vitality depends on region’s ability to create tolerance and diversity applies here. Is America still a cool place to be?

True, our regulation environment is outstanding, and so is unencumbered trade (relatively speaking), but is it cool? International polls indicate that the American government is despised worldwide, (fairly or unfairly), and that surely has some impact on American brands overseas. I always remember when in Ukraine, I came across a hilarious billboard touting Chesterton cigarettes. It included several models pretending to be movie stars or business execs lounging on the top of a skyscraper, laughing and living it up. The billboard slogan said, “Chesterton’s–The American Taste”. Never mind the fact that Chesterton’s aren’t particularly popular here; the real interesting thing is that a company would so openly identify itself with a nation. Nowadays, it seems practically inconceivable that a MNC would want to do this.

So I blame Bush on the perception problems as well as the government deficit (although I have to admit the taxcuts kicked in at almost the perfect time after 9/11). However, consumer debt seems to be a byproduct not of Bush’s policies (or even Clinton’s) but Greenspan’s commitment to keep interest rates low. Consumption is not a problem per se, but consumer debt never concerned Greenspan enough to raise interest rates. Perhaps consumer debt is not as bad as alleged, but we need to watch out for multiplier effects: adjustable rate mortgages can increase the debt burden on consumers when economic times are bad; credit card fees and interest rates multiply when customers fall behind. These factors pass risk away from the company or banks to the consumer; is this bad or good?

I tend to be philosophical when it comes to debt and credit cards. While in Albania and Ukraine, I was shocked to hear how little credit consumers and businessmen had access to. (Contrast this with USA where students receive all sorts of credit card offers). Debt can be very helpful and even lead to greater earnings potential if it can be paid off within a year or so. During financial hard times, I frequently put myself in hock to learn about computers, take classes, buy books on programming. That is a sensible investment. On the other hand, it’s sometimes hard to put pricetags on intangible benefits; if I buy Photoshop, how much will it add to my income potential? If I buy an expensive PDA, it may organize my life and make me more productive in my personal life, but couldn’t I easily do without it? I can say I need a camcorder to make movies, but am I doing that for genuine work (and skill-building) or just for recreation? And even those who spend money on lavish home mortgages, they can justify it by saying that this is a financial asset which can be leveraged later on (with the potential for appreciation).

Finally, playing devil’s advocate for a moment, but how real are the dangers of inflation? Many technology products and service are stupefyingly cheap anyway, and if they are expensive, just wait a year, and they will be affordable. Ok, sure my mp3 player cost $450 in January, 2004. Now you can buy the same product for $350. Even if we assume that imported products will become more expensive (let’s say 20% more expensive), that still does not forestall the rapid falling of price over time. In this economy, although I have several big ticket items to buy, the strategy of procrastinating these purchases as long as possible is beneficial. Not only does waiting reduce your debt load, it also means that the price of the new gadget will be cheaper as well.



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