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What Happens with Deficit Spending? Get Ready

Econ101

Well-known member
Press Release

For Immediate Release
November 02, 2006
Contact: Afshin Mohamadi (Maloney)
202-225-7944
Nan Gibson (JEC)
202-224-0377
Steve Adamske (Frank)
202-225-7141
Bush Administration Increasingly Relies on China and OPEC to Finance U.S. Debt, Report Shows
WASHINGTON, DC - The Bush Administration has allowed the United States to become increasingly dependent on foreign purchases of U.S. Treasury securities to finance the federal budget deficit, and future U.S. national income will be depressed by payments to foreign holders of U.S. debt, according to a new study by Democrats on the Joint Economic Committee (JEC) and the House Committee on Financial Services.

“If the United States does not begin to take steps to reduce its unsustainable dependence on foreign borrowing in an orderly way, there could be a run on the dollar and that could precipitate an international financial crisis and a sharp increase in interest rates,” the report warned.

Sen. Jack Reed (D-RI), Ranking Democrat on the JEC, Rep. Carolyn Maloney (D-NY), Senior House Democrat on the JEC, and Rep. Barney Frank (D-MA), Ranking Democrat on the House Financial Services Committee, today released the report, Relying on the Kindness of Strangers: Foreign Purchases of U.S. Treasury Debt. Key findings from the study include the following:

* At the end of fiscal year 2005, 42.1 percent of the public debt of the United States was held by foreigners, including foreign governments. That foreign ownership share rose by 11.8 percentage points just since 2001 and will be higher still when the data for 2006 are released.
* Foreign ownership of Treasury securities more than doubled from $1.0 trillion in January 2001 to $2.2 trillion in August 2006. China’s holdings rose 450 percent, from $61.5 billion to $339 billion. The OPEC nations have doubled their holdings to over $100 billion in the past two years.
* The fiscal discipline of the 1990s put a halt to rising federal debt and rising foreign-ownership, but both have grown since 2001, with foreign holdings growing faster than the overall public debt.
* Since 2001, foreign purchases of U.S. Treasury debt have almost certainly contributed to keeping interest rates lower than they otherwise would have been in the face of large federal budget deficits, but the United States must reduce its heavy dependence on foreign borrowing in order to avoid a run on the dollar and a steep rise in interest rates.
* Even without a run on the dollar, the need to pay interest of $100 billion or more per year on foreign holdings of Treasury securities will reduce U.S. national income.

“Our reliance on China and other nations to finance our debt is the result of a deliberate policy by the Bush administration, one that reversed course from the Clinton administration and has favored deficit financing of tax cuts and federal spending over a prudent fiscal policy. It will take years of sound fiscal policy to reduce our reliance on foreign lenders and return the federal debt to a prudent level,” the report concludes.

Report link: http://jec.senate.gov/democrats/Documents/Reports/foreigndebtkindnessofstrangers.pdf
 

cedardell

Well-known member
I can see by the lack of comments that none of you econimic gurroes out there comprehends financing the twin deficits with our trade deficits. Kind of takes the wind out of our bargining power don't it?
 

Econ101

Well-known member
America, the Debtor Nation
Peter Morici

The United States is a debtor nation, just like the poorest states in Africa, Latin America and Asia. Since the fourth quarter of last year, U.S. citizens and businesses have paid more dividends, interest and the like to foreigners than they have received from abroad.
How Americans entered a debtor’s life is hardly a puzzle but what it means is even more troubling.

For most of the last 30 years the United States has been piling up large trade deficits. The current account, which includes net exports of goods, services and income payments, has now reached 6 percent of GDP, and must be financed by capital inflows. Foreigners must purchase large amounts of U.S. property, stocks, bonds, bank deposits, and currency, or the current account deficit cannot be financed.

The U.S. appetite for foreign goods and services moves up in a fairly steady fashion, other things remaining the same, but the private sector appetite for U.S. assets is erratic. When foreign purchases of U.S. assets dip and do not finance the current account deficit, the supply of U.S. dollars in foreign exchange markets should exceed the demand, and the dollar should fall in value against other major currencies. U.S. exports should become more competitive and imports more expensive. In turn, the trade deficit should shrink to an amount foreign creditors wish to finance.
However, for decades, Asian nations, led first by Japan and now China, have prosecuted a mercantilist development strategy. They consistently buy U.S. dollars and securities to keep their currencies and products cheap.

Regardless of the level of private demand for U.S. assets, these governments have consistently entered foreign exchange markets, sold their currencies for U.S. dollars and converted the proceeds into U.S. bonds and bank deposits.

When private purchases of U.S. assets slack off, those governments rev up purchases to keep their currencies and their products artificially cheap on U.S. markets. To support these policies they erect arcane barriers to U.S. exports—automobiles and parts, heavy machinery, electronics, and software have been particular targets for their protectionist industrial policies.
This process has escalated during the recent economic expansion to dangerous proportions. Each year, China spends more than $200 billion, or 9 percent of its GDP, purchasing dollars and other foreign currencies and converting those into debt instruments. This provides an off budget export subsidy of about 25 percent of the value of China’s exports.

The debt Americans are incurring is massive. Direct investment in U.S. productive assets provides only about 11 percent of the needed funds, and the balance is obtained through the sale of Treasury securities, corporate bonds, bank accounts, and other paper assets. Americans borrow nearly $60 billion each month to consume more than they produce. The total debt will exceed $6 trillion by the end of 2006.

At the same time, our ability to finance this debt is shrinking, and with it our economic security. By running such massive deficits, the United States is shifting resources in record amounts out of export and import-competing industries, like autoparts and software, where worker productivity and investments in R&D are high, into non-trade competing activities, like restaurants and retirement homes. This lowers GDP immediately and cripples future growth.

Over the past five years, the process has accelerated, as Americans, financed by China and other Asian governments, over-invested in large houses and shopping malls instead of R&D, plants, equipment, and software that drive productivity growth and product innovation. JPMorgan estimates that potential U.S. GDP growth has declined from 3.5 percent 1996 to 2002, to 2.7 percent in the years since. Going forward it estimates potential growth to be even lower.

Rising debt and falling growth are prescriptions for calamity.

The Bush Administration urgently needs to persuade China and other Asian countries to significantly revalue their currencies and to stop intervening in foreign exchange markets.
So far China has balked at meaningful action. It has permitted the yuan to appreciate by about 4.5 percent over 15 months. That is hardly enough to have any meaningful effects.
At the conclusion of his recent trip to Asia, Treasury Secretary Henry Paulson announced the initiation of a U.S.-China Strategic Dialogue. We have had years of talk, now we need strong action to combat Chinese and broader Asian protectionism.

Unfortunately, many U.S. multinationals, like GE, Caterpillar and GM are making huge profits in the protected Chinese market, and President Bush is reluctant to disappoint his strongest supporters.

Branding his critics protectionists, instead of the Chinese, the President appeases his domestic allies and foreign powers to the peril of the nation.
Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission

Peter Morici
Professor
Robert H. Smith School of Business
University of Maryland
College Park, MD 20742-1815
703 549 4338
cell 703 618 4338
[email protected]
www.smith.umd.edu/lbpp/faculty/morici.html
www.smith.umd.edu/faculty/pmorici/cv_pmorici.htm
 
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