Debt and hegemony:

[Robert Lancaster-2]

Interesting analysis, I thought.  (Sorry about the format.  It's a
small part of a site that needs registration--Dow
Theory Letters.)



   What's Likely to Bring it All Down
by Marshall Auerback


"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":


  "[T]hat 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


Bob