Still MORE dangers of debt...

Proverbs 22:7 The rich ruleth over the poor, and the borrower [is] servant to the lender.

Our government cannot borrow enough money from American investors to cover its budget. Remember, there is a limited amount of money and credit available. One reason the government cannot get enough money from American institutions and investors is that Americans have, in recent decades, spent everything they earned instead of saving and investing it. In fact, until the recent financial crisis, Americans spent MORE than we earned. We had what is called a negative rate of savings. This is not good for individuals, and it is not good for the country.

Think about it this way. Banks can only loan out a certain amount of money based on their holdings. The more of people’s savings they have, the more they can loan out. Less savings means less money available for investing in economic growth. Of course, this is offset to some degree by the fact that our spending also leads to economic growth. The more we consume, the more factories will sell and the more they will produce. The point is, both saving and spending are important for our economic well-being, so we need a good balance of both.

As an interesting aside, for the first time in a long time, we are saving too much! Americans are worried about the future of our economy, and they are worried about their jobs. Logically, they are holding on to their money. This is the smart thing for individuals to do, but it is not helping end this recession. The government would like very much for us to go on a spending spree! (Don’t do it, though – you may be sacrificing your own well-being for the economy. Frankly, I don’t think ANYONE’S job is safe!)

OK, back to my original topic: the government needs more money than it can get from American investors. So what does it do? It turns to foreign investors. That is why China holds over 700 billion in U.S. securities, and Japan holds over 600 billion. Many other countries have invested in America as well. This has been a good thing so far. It has helped hold interest rates down and it has financed our ever-growing deficits. However, some economists and government officials worry that there is a danger involved, especially where China is concerned. Although we are heavily entwined with China from a trade and financial point of view, no one would say that our governments are the best of friends! In fact, China is a major competitor and one of the few remaining Communist countries. China is growing at a remarkable rate, and would no doubt like to dominate the world stage much as we have in modern history. You have to wonder, how much leverage do we want to give a nation like that?

How, you may ask, have we given them leverage? Well, as best as I can understand, the danger is that China could suddenly sell off a large amount of its U.S. holdings, in other words, dump them on the world market. With dollars flooding the market, their value would go down. (The more there is of something, the less it is worth. Grains of sand are plentiful and worth very little; diamonds are a whole different story!) If the value of the dollar depreciates (declines), we would have to pay more for all those goods we import from China and other nations. The clothes you buy at Kohl’s would cost more. So would a lot of other things, so we would probably experience inflation and, as a result, a lower standard of living – at least in the short run. In the long run, it might actually be good for American industries, as they would get more of our business. That could be good for our economy.

ON THE OTHER HAND – if foreign countries are no longer buying U.S. securities, how will we finance our government? In order for our govt. to entice new buyers, they will have to pay them higher interest rates. That means EVERYONE who borrows money will pay higher interest rates, including businesses that want to invest in new factories and growth, and you and me. So that could be bad for the economy! Pretty confusing, huh?

At any rate, the very possibility or threat that China could do this gives them leverage over us. They have threatened to dump securities if we come up with trade policies they don’t like. In a recent interview, officials from two Chinese government think tanks stated that China has the power make the U.S. dollar collapse. While it is doubtful they would actually do that, they don’t mind reminding us that they could. Does this have an effect? Yes. In a recent visit to China, Secretary of State Hillary Clinton did not make an issue of their human rights violations, in part because “How do you get tough on your banker?”

Most experts believe that China would not suddenly dump U.S. securities because our economies are so intertwined that we rise and fall together. Anything they do to hurt us would ultimately hurt them. That makes sense to me, so I am not terribly worried about our foreign debt from that standpoint. What does concern me is that this source of revenue might eventually dry up. Especially with our economy in trouble, other countries might lose confidence in us and the value of our assets. Then how we would finance our deficit? Furthermore, I don’t like being dependent on other countries!

There are other options for dealing with our deficits, but big problems exist with those options as well. I’ll look at those in my next post.