Elephant In Exile

Winter of Our Discontent?

Those who know the elephant know that IÂ’m a boundless optimist in general and very much so when it comes to the possibilities and potential of the U.S.A. But IÂ’m finding myself increasing pessimistic about the current state of the world, our economy and just things in general. ItÂ’s not a Bush thing, or even an ideological thing. But lately I've been sensing the chilling fingers of an ill wind getting ready to blow.

First and foremost our countries current account deficit (trade and federal spending) are adding up to roughly $1 trillion dollars a year. That means $1 trillion in wealth is flowing out of the U.S. to places like China, the middle east and other places. Traditionally, the conventional wisdom was that say- unlike Argentina or other countries who experienced massive fiscal collapses as a result of spendthrift ways, the U.S. economy is so important to the world that this would never happen here. That may still hold true. The paradox is that growth in Europe and Asia are linked to our voracious demand for their products. But that demand comes at a price, with Japan, China and other countries forced to buy our bonds, equities, and currency to keep their products competitive and to do so they must purchase more than a billion dollars of U.S. assets a day to keep funding our spending. But this can only go on until 1) They get tired of doing it, 2) They find another market where they can get a higher return (think China) and 3) They stop believing that the U.S. is the best place for their money.

Recently there have been signs that our foreign creditors are becoming weary. I mean would you invest in a company, or country, that is showing an annual 'loss' of $500 billion to $1 trillion dollars. No, and I wouldn't either. Market analysts had this to say.

"As the dust settles after the U.S. elections, the one theme that is developing is the growing recognition [in the markets] of the need for more dollar depreciation," economists at J.P. Morgan told clients yesterday, citing as one major reason the likelihood that "there will be no serious new policies to trim the U.S. budget deficit."

Behind such sentiments is the belief that the U.S. economy is too dependent on foreign investors, and that they may balk at pouring money into U.S. securities if the country's debt continues to soar. Foreigners have provided much of the money the government borrows to cover its deficit, which was $413 billion in the fiscal year ended Sept. 30.

http://www.washingtonpost.com/ac2/wp-dyn/A26581-2004Nov4?language=printer

So, the dollar will continue to fall. Prices on imports will go up and the U.S. will become proportionally less economically powerful versus our rivals in Europe and China. A 25% fall in the value of the dollar per the Euro or Yaun not only makes goods from Europe or China more expensive for us, it makes Europe and China's proportional economic power roughly 25% greater.

We've seen this happen time and time again around the world. The Asian crisises of the 90s, Russia, and Argentina to name a few. What would the impact of a massive devaluation of the dollar have on the already frayed social/political fabric of the U.S.? Hard to tell. But the underlying element to all this is that deficits do matter and eventual a reckoning will happen. The severity of which can be controlled if the GOP and Democrats show leadership on spending in Washington...which may be asking for too much.

But then, the incredible thing about our country is that when threatened we pull together and usually find a way to muddle through. Let's hope that's the case here.