Remember when you were a kid and you thought if you could dig a hole deep enough you'd get all the way to China? Well, that's exactly what we're doing now -- financially speaking. We're digging a huge hole of debt -- and it won't be surprising if the next generation finds itself at the mercy of the Chinese, who will be our creditors.
Headline: U.S. Records $199.8 Billion Second Quarter Current Account Deficit!
This week's report on the current account deficit might have seemed just another one of those huge MEGO numbers. (MEGO stands for My Eyes Glaze Over.) But the $190.8
deficit for just the second quarter of this year means that we are even more indebted to foreigners who accept our dollars -- and then make choices about what to do with all that money we are sending them in exchange for imported goods.
The biggest use of those dollars is to lend us money -- buying our Treasury securities and corporate bonds. Only a small portion -- about 12% -- goes into buying U.S. productive assets. The Chinese have a third use for the dollars we send them; they buy things like petroleum, or even Venezuelan oil wells.
Although the current account statistic includes services and investments, the imbalance is mostly about cheap imports. And mostly that means imports from China. Sure, we import a lot of other things -- notably oil, which is costing us ever more. But oil is a freely traded global commodity. Stuff made in China, by contrast, is priced artificially low because the Chinese currency -- the yuan -- is "tied" to the dollar.
If allowed to float freely, the Chinese currency would rise in value compared to the dollar. That would make prices of Chinese exports more expensive in the U.S., slowing their exports and leveling off the trade imbalance. But instead, the Chinese central bank keeps buying dollars in the world currency markets -- and selling yuan -- to depress the value of their currency and help their exports. According to the Bank for International Settlements, the Chinese central bank does about $250 billion a year in interventions.
Free Trade and Presumed Bargains
It's dangerous to mess with free trade. America learned that lesson with the Smoot Hawley tariff in 1930, which many argue exacerbated the collapse in the American economy into a global depression. When trade stops, profits stop, and all sides lose.
And it's also dangerous to mess with the American consumer. I'm one of the many millions who enjoy buying cheap stuff -- clothing, towels, household goods and more. The ability to pay a lot less for lots of stuff has made Americans feel they are better off. But are we really getting bargains?
Peter Morici, economist and professor at the University of Maryland, makes a compelling case that these cheap imports are not true bargains for Americans. First, he notes that the Chinese are notoriously inefficient users of energy in manufacturing, so their purchases of oil drive up the price for everyone -- costing Americans more to fill up their tanks. And, the Chinese are notorious polluters, destroying the global airspace. So the low prices of these goods don't reflect their true costs.
But worst of all, when Americans buy those bargains, we pay by borrowing from others. The dollars we send abroad are used by foreign central banks and companies to buy U.S. Treasury notes and bills and bonds. Morici calculates that U.S. foreign debt now exceeds $6 trillion -- and that the interest payments come to about $2,000 a year for every working American.
In other words, we're mortgaging our future to pay for today's "cheap" purchases! By using the dollars they collect to buy our debt, the Chinese are putting themselves in position to exert significant control over our economy.
Morici has a solution -- albeit a controversial one. He suggests a tariff -- wait, don't panic -- a tariff that would be equivalent to the Chinese level of manipulation of their currency. As the Chinese reduce their manipulation -- purchase of dollars in the global marketplace -- the tariff would diminish.
Is this protectionism? Not at all, claims Morici. He calls it "taking back the sovereign right to set the value of our currency." There can only be free trade in goods, he says, if there is also "free trade in money."
Americans can never resist a bargain. It's human nature to keep making those purchases of cheap imported goods. And, like the housing market, few are aware of the potential long-term cost of those bargains. And the cost will rise exponentially if and when interest rates rise. Or if the lenders
higher rates of return.
The foreign debt we owe is insidious, covered up in huge MEGO-numbers, seemingly trivialized by the billions and trillions we read about every time a new government statistic is reported. But we
digging a deep financial hole for our future -- all the way to China! And that's the Savage Truth.
Terry Savage is an expert on personal finance and also appears as a commentator on national television on issues related to investing and the financial markets. Savage's personal finance column in the Chicago Sun-Times is nationally syndicated, and she released her fourth book,
The Savage Number: How Much Money Do You Need?
in June 2005. Savage was the first woman trader on the Chicago Board Options Exchange and is a registered investment adviser for stocks and futures. A Phi Beta Kappa graduate of the University of Michigan, Savage currently serves as a director of the Chicago Mercantile Exchange Corp. She also has served on the boards of McDonald's and Pennzoil.