The World As I See It

Historical high US twin deficits is making headlines nowadays. Reckless government spending and low private savings lead to the huge budget deficit. And they are now mulling over the reform of the generous social security plan, especially Medicare when the baby boomers retire. But right now, these same boomers are spending like there is no tomorrow. The reform is hard, when the pockets of the government and people are empty. Nonetheless, it is still a good start - if you have to give somebody a hard medicine, do it early. On the other hand, large import over export leads to huge trade deficit. The politicians are pointing to China on the massive import of low cost products.

Given this deep hole in the current account, the shortfall must be filled by something. A constant inflow of foreign capital is the source that is feeding the US citizens. According to Paul Volcker, the former Fed Chairman, in his speech titled “US economy skating on increasingly thin ice”, the growing flow of capital from abroad is running to more than US$2 billion every working day. They have become more dependent on the foreign central banks, particularly Japan and China, and elsewhere in East Asia. Certainly it gives them a comfortable life. But as he said, “this seemingly comfortable pattern can’t go on indefinitely. I don’t know of any country that has managed to consume and invest 6% more than it produces for long”. Warren Buffett also expressed his concern in the article “America’s growing trade deficit is selling the nation” in Fortune, in which he depicted 2 islands where the whole of Squanderville is eventually bought up by Thriftville. He wanted to create an awareness that the Americans are inevitably putting an ever larger slice of America in foreign hands. The current Fed Chairman Alan Greenspan, in addressing the Congress, has often raised the issue of filling the gap of budget deficit - Speeches of Federal Reserve Board members. It seems that economists are generally more practical and objective than politicians in that they do not simply point fingers at others but will look at themselves as a starting point and the big picture.

The US is mounting pressure on China to revalue the allegedly undervalued yuan, which gives China an unfair edge. But whether it is truly undervalued or not, should China buy their argument? Obviously not. Anyway a country’s competitiveness should not, and cannot depend solely on an undervalued currency for long. Ultimately it is productivity that counts. The problem lies in the US itself, its unchecked fiscal behaviour. Until the government starts to address the budget deficit, they do not have legitimate ground to accuse other countries.

The US has let the dollar on a freefall to rescue its export industry. This has created more volatility on an already unbalanced and extremely unstable world, due to the capital fund. This is well illustrated by how the slight indication by Japan and South Korea to diversify their foreign reserves out of dollar had triggered market fear. They had to make a public clarification to calm the market. The US government tried to set up some barriers to alleviate the rate of job outsourcing to India and import from China, but this will certainly face unwelcome repercussion from other countries as well as tarnish its image as a free market, as it means backpedalling on the principle of free trade.

Now, together, Japan and China hold a large and growing portion of America in the form of Treasury Bonds. Let’s see how the new world balance will turn out to be. I believe it will have some weight which favours China on the Taiwan issue.

Source: Fortune November 10, 2003

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