Dust Bowl: ACL 2005
Festival Etiquette

A Coming Meltdown?

Over the weekend, I read "Countdown to a Meltdown" in the July/August issue of The Atlantic Monthly. It presents a scary picture of a possible future for the United States economy. A future played out only over the next eleven years.

I had hoped when reading it that Katrina had awakened us to many of the issues raised in the essay. Though I believe it has, it appears that in the early-going, Katrina has actually made matters worse.

What the Atlantic essay considers is "How will the United States handle a sudden economic collapse?" Its conclusion is "not very well." There is currently no wiggle room in the economy and will be even less so in the next decade. If we were to have a sudden collapse it would have dramatic effects. Industry is currently in decline. Look at the airlines, many of which are currently going bankrupt. The auto industry hasn't actually made money on the sell of cars since 2002. We are in a housing bubble, where many people, especially in cities and growth areas, have paid more for their homes than they are worth. With a depression, property values would drop and folks mortgages would be higher than the value of their homes (this is one of the things that happened in the '30's). Consumer spending is still suffering, and continues to with rising oil prices. Governments local, state, and federal don't have any saved money currently when the economy is doing well, and it would be difficult to raise new revenues if there was an economic collapse. American families aren't saving anymore, either, and would have no cushion. As the article states:

The evaporation of personal savings was marveled at by all economists but explained by few. Americans saved about eight percent of their disposable income through the 1950's and 1960's, slightly more in the 1970's and 1980's, slightly less and then a lot less in the 1990's. At the beginning of this century they were saving, on average, just about nothing.

This essay bases its conclusions and projections on a series of studies done in recent years. It is the kind of "what if" thinking that we expect out of think tanks, the governement, and academics.

So, then, could America be suddenly throw into a financial depression? Do the circumstances exist in the world currently to make that happen? With a lot of interesting, but reasonbaly possible, speculation, the article answers "yes."

The series of circumstances it finds likely centers on one sobering fact that is gaining commentary in recent months -- our growing indebtedness to China. The current GOP philosophy is to cut taxes, spend heavily, and borrow to pay for it all. Government spending has increased dramatically under this administration. Instead of the expected surpluses, we've ended up with increased debt. Though 9/11 explains an increase in some spending, according to the Congressional Budget Office the largest percentage increase in the debt was due to tax cuts (48%) with only 37% coming from increased spending post-9/11 on warfare and security. According to the article what mattered was that since 2001 the government was taking in a smaller share of taxes as a percentage of GDP than at any point since the late 50's just as government commitments were growing dramatically (war, new Medicare prescription drug benefits, the highway bill, aging Baby Boomers, now Katrina). If the Bush tax cuts are made permanent, which the GOP is still insisting on, and tax revenue remains at the same level as a percentage of GDP, then by 2015 that means that interest, social security, Medicare and Medicaid will take up almost all government revenue and that we'll have to borrow to fund everything from the Pentagon to Education. Awareness of this situation led David M. Walker, comptroller general of the US government to say in 2003 about adding the prescription drug benefit that that year was "the most reckless fiscal year in the history of teh Republic."

How does China figure in? To fund our deficit spending, we have to borrow. But since Americans are not saving, they are not the ones privately funding the government's deficit spending. To fund it, we must look abroad. Though other foreign governments, companies, and individuals have purchased American securities, China has increased its funding the most.

In China there is a mass migration of rural workers into the cities. In order to find jobs for these workers, China has determined to keep the price of its currency, the yuan, low. If the yuan is low, it encourages investment in China by foreign and domestic companies, thus the surprising economic growth of China in recent years. How has China kept the yuan low when it should have been rising as part of standard economic forces? The central bank of China has fixed the yuan-dollar exchange rate, instead of allowing it fluxuate. As Americans (and others) bought cheap Chinese goods in dollars, the Chinese banks piled up huge amounts of dollars. But, they didn't exchange them back into their own currency. Instead, they used the dollars to buy U. S. Treasury notes. Here is the problem:

If any one of hte Asian countries piling up dollars (and most were doing so) began to suspect that any other was about to unload them, all the countries would have an incentive to sell dollars as fast as possible, before they got stuck with the worthless currency.

In effect we've seen this happen before. Lawrence Summers, former Treasury Secretary and now Harvard President, said in 2004, "Fixed exchange rates with heavy intervention have enormous capacity to create an illusory sense of stability that could be shattered very quickly. That is the lesson of Britain in 1992, of Mexico in 1994, of emerging Asia in 1997, of Russia in 1998, and of Brazil in 1998." These various currency and, thus, economic collapses (and other potential ones) were usually bailed out by other countries, mainly the United State riding its 1990's economic boom (remember Time magazine's cover after the 1997-98 crises that called Greenspan, Rubin, and Summers "the committee that saved the world" by keeping U. S. interests rates unreasonably low in order to bail out these collapsed economies?).

So, one potential for throwing the US into a financial depression, is if China ever has any reason to stop funding our indebtedness and start selling off its holdings in dollars. It would cause our currency to collapse, then our over all financial picture, then our industry, ultimately affecting American individuals who are deeply in debt, not saving, mortgaged above their means, and unwilling to be taxed to fund government programs that provide a social safety net. It is unreasonable, and poor thinking, to rule out such as move which might be in China's strategic interests at some point, especially if provoked by some action of America that it opposes. (the article itself hinges the episode on our over-consumption of oil and angering of the governments that control oil production, particularly Venezuela, who could work out an agreement with China that would hobble the United States).

In essence, a number of our current practices are bringing us very near the edge, with little to no wiggle room in case there is a crisis. And some of those practices are making it such that another country and potential strategic competitor could flip the switch. And some of those practices seem hell-bent on creating situations that would anger foreign countries into flipping the switch.

Now, I understand that this is all speculation. We've had doom and gloom images before over the federal finances, especially in the early 90's. That time we were saved by the economic growth that resulted from the burgeoning new technologies associated with the internet and computing. So, it is not for certain that we are headed down a dark path, but we seem to be playing a risky game of chance, quite close to the edge.

I recommend HIGHLY that you read this very long, informative, and ultimately quite scary essay.


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