The latest US trade data (for August) is out, with a deficit of $US54 billion[1]. This is about 6 per cent of GDP at an annualised rate. Also, the US budget deficit for 2003-4 came in at $413 billion.
But perhaps the most interesting story is one that arose from a relatively obscure decison of the WTO which banned a tax subsidy for US manufacturers that cost the US government around $5 billion a year. For a government in the fiscal position of the US, this ought to have been a small but valuable free gift in the attempt to wind back the deficit.
So what did the US Congress do? It passed a bill that not only replicated the effect of the prohibited subsidy, but extended it by drastically widening the class of firms classed as manufacturers. Getting support proved a little problematic, so the votes were rounded up by inviting every member of Congress to insert their own preferred piece of legislation, assisting every industry from tobacco to tackle boxes (a big tackle box manufacturer is in House Speaker Dennis Hastert’s district). The total cost is estimated at more than $140 billion over ten years[2]. As Senator Charles Grassley argues, largesse distributed as widely as this ceases to be special-interest pork-barreling and becomes more like a comprehensive industry policy
“For all the unfair carping about this bill being a special-interest bill, nearly every member raised narrow-interest provisions. So, if there’s some fault about different provisions coming up, we all share that. We all do it.”
Grassley appears to be right. On this legislation, with the usual negative, carping, exception of John McCain[3], consensus ruled the land. Liberals, centrists and rightwing Republicans all lined up to support the bill.
If I was a holder of US government debt, I’d be getting a bit worried right now. But I’m a notorious pessimist.
As various people have argued, there’s a neo-Bretton Woods system in operation in which Asian central banks (formerly Japan, now China) finance whatever trade and budet deficits the US choose to run. So, there’s no need to fret. World capitalism can safely rely on the good judgement and good will of the Chinese Communist Party.
fn1. Australia is one of a handful of countries with which the US has a bilateral trade surplus. Maybe relevant in considering the FTA.
fn2. There are various offsets from closing tax shelters, which are supposed to balance the cost. But the figures are rubbery, and this was money the government should have gone after in any case.
fn3. Why does he hate America so much?
John Quiggin 
Isn’t that budget defecit going to put upwards pressure on interest rates?
John,
Your point about the health of world capitalism relying on the good will of the Central Bank of the PRC has a precedent.
The Narodny Bank, owned and operated by the Soviet Government, invented the Eurodollar market. This had the effect of ending the fixed exchange rate Bretton Woods regime. The Narodny Bank also took a leading role in investing petrodollars back into the capital markets of the world.
Lenin’s dictum about capitalists selling the rope to hang the last priest was thereby inverted. The Commos became rope merchants.
Is it a case of second time lucky?
Nothing to worry about. As Vice President Dick Ceney reportedly said in a Cabinet meeting, “Reagan proved that deficits don’t matter”.
Historians of the future will be writing that the US empire of the early 21st century was brought down not by military defeat, but by the bond markets.
Didn’t Paddy McGuiness work in the Narodny Bank in the late 1960s? This was around the time the Eurodollar market was created.
The US’s hopes for strategic dominance are not likely to come to fruition if they rely on PRC credit to finance their over-extended military.
The only puzzling thing is the rate of US productivity increase over the past few years despite the pork-barelling orgy undertaken by both Congress and the White House. This bumblebee must crashland sometime soon.
One hopes that Howard does not succumb to this irrational and wasteful nonsense. The FTA bill is a big test. As will be demands for pork barelling from marginal rural seats disguised as environmental investment.
Howard should resort to some Peter Walsh style economic rationalism here. Pr Q it is your responsibility to speak up and denounce this mischief when it hits our shores.
John McCain hates America because he hates the American way of life.
Dear John,
Given your normally global interests I’m surprised that you describe the WTO case on the US FSC tax subsidies as ‘obscure’.
Had we a signfiicant export manufacturing sector — like most other countries of our level of income — you’d might have followed this monumenal trans-Atlantic struggle over a subsidy to US manufacturing more closely.
Far from obscure, it’s a high-stakes battle whose latest episode is the clash over Boeing-Airbus subsidies (probably the only ‘strategic subsidy’ that has ever been worthy of the name). FSC and it’s forebears are an icon of the US tax system that — like only the tax treatment of the late Roman Republic before it — holds the incomes of US firms as normally accountable to Washington, whereever they may be earned. No other modern economy does this in quite the same way.
The WTO rules, revised by the US and Europe in a bitterly fought deal struck in London in 1976 (at the end of the Tokyo Round of negotiations) have uniquely caught out the USA in a way that was, at first, a rude surprise, later a serious worry and finally a Congressional storm. We’re talking of at more than $US4bn a year in tax remissions that allow US multinationals to compete, as they see it, on a ‘level playing field”.
Of course, the US constitutional arrangements give Congress the power to fix this structural problem with the tax system, which is even less effective than putting the fox in charge of the hen house and a whole lot funnier.
The Europeans initially enjoyed the chance to pontificate, bluster and threaten retaliation (they’ve already started to retaliate) about the ‘outrageous’ US export subisidies. But after the US tried twice — and failed (see:http://www.inquit.com/article/6/tax-breaks-fracture-fsc-revision) — to fix the problem, they’re becoming seriously angry. This is not good. In its latest manifestation (see: http://www.inquit.com/article/361/a-case-for-settlement) I reckon it’s begining to threaten a lot more than trans-Atlantic commerce.
Best wishes,
Peter
So you buy from a vendor over the years by borrowing but repay him in units of currency you manage. Then what do do if the interest bill gets excessive, perhaps because of some shock? Don’t you devalue the loan you have taken out?
And apart from disruptive inflationary effects (lots of other people hold this devaluing currency) won’t the real burden of this devaluation fall on the lender?
Are the Chinese silly?
I am no macroeconomist but this fairly dramatic sort of outcome interests me. I assume the gurus in the RBA and/or Uncle Milton (whoever you are) have a story to tell that will keep us calm but this type of scenario is both interesting and fairly worrying.
Does the forthcoming arrival of the post-war baby boomers in 2010 make this issue particularly acute?
John, you probably do own US Treasuries, along with most of your readers, via super. With that sort of depth and liquidity, the contribution of the Chicoms is fairly marginal.
Thanks to the marvels of super choice, Stephen, I’ve been able to adopt a plan that avoids US shares and bonds, which has been a very good choice, particularly as regards shares. I got out a tiny bit too early in 1998, but taking account of exchange rate movements I’ve done pretty well from that choice.
The evidence appears to be that other private investors are making much the same choice, sidling towards the doors while the Japanese and Chinese central banks pick up the slack.
US Federal deficit is at present between 6 and 7 trillion dollars, and rising rapidly.
According to this article, Asian central banks owned about one trillion of this debt as of Sept 2004, and rising rapidly. The Central bank of China is a major buyer of US Treasury instruments.
http://www.iht.com/articles/111074.html
Here is the relevant extract:
“Asia’s big central banks have accumulated more than $1 trillion in U.S. Treasury notes and dollars in recent years as they have attempted to keep their own currencies weak in relation to the dollar. The Bank of Japan has nearly $500 billion in Treasury securities and has been buying at a ferocious pace over the past year. China’s central bank has about $350 billion. South Korea and Taiwan have amassed an additional $230 billion.”
This site demonstrates that foreign lenders now own more of the US Debt than private US owners.
http://bullandbearwise.com/TreasuryOwnershipChart.asp
Big budget deficits are far as the eye can see eventually must mean more inflation in the US, even with Alan Greenspan vigilantly presiding over monetary policy.
The reason is that there is a limit to investors’ appetite for US bonds. As the limit is approached, the real interest rate on bonds goes up, but it can’t in the long run be higher than the long rate of economic growth. Once the limit is reached, the interest on the bonds can only be paid for with siegnorage from money creation, and that will be inflationary.
The relevant reference is Sargent and Wallace, “Some Unpleasant Monerarist Arithmetic”. Though published in 1981, it can be found and dowmnloaded with a bit of googling.
How much appetite is there in the world for US bonds? No one knows. But even the Chinese and Japense are eventually going to go looking at other assets.
One old but forgotten mechanism for living long and high on a deficit is to print money and use it to acquire a pool of revenue yielding assets, a “domain”. Then the people who had their currency debauched can go hang – unless they are lucky enough to get enough offsetting trickle down from genuine increases in productivity, causally connected or not.
What the USA may be unintentionally achieving is this: middlemen in industrial exporting countries take their money, then literally pass the buck, acquiring the other assets for themselves (the “bigger fool” theory). When the music stops, the middlemen don’t get hurt, just the end countries who sold the farm for by then worthless dollars, and the beginning countries who find their credit suddenly cut off.
Think of the different fates of Spain, of England and Holland, and of Poland and Turkey during and after the silver-driven inflation following the Spanish acquisition of New World bullion sources.
I don’t have enough solid evidence to amount to proof, but there are enough historical parallels to raise the question (including parallels I haven’t given).
Milton, I think you mean that the US will need a dose of inflation to reduce the principal in real terms. This is not the same thing as seignorage, although if the inflation is achieved through monetisation of the deficit there will be seignorage as well, and this will reduce the Treasury’s reliance on new debt. It’s confusing, because the term inflation tax tends to be used for both phenomena. Excuse me if I’m presumptuous: you probably know more about these things than I do.
I’ll read the article that Miltion cites but I still don’t get an answer to my original question. ‘Are the Chinese silly?’
They are holding debt denominated in US dollars and look like they will take a caning. Are they reasoning that these losses are worthwhile in terms of keeping the US currency strong so that they can continue to expand their exports.
If so then there is a certain irrationality in their actions although maybe there is political logic in it.
Or are they reasoning that the US will eventually take action to reduce the deficits?
Re Harry’s post, the Chinese might be
*buying tolerance for their gradual take over of companies in the US, which is happening
*profiting from the Bush Govt’s rejection of the Kyoto protocols, given their growing use of dirty energy
*buying tolerance for their repressive domestic regime.
I think it was JQ who made a reference to the US Free Trade Agreement. The FTA is starting to look more and more like an old-time one-sided preferential trade treaty, based on our need for a powerful ally. Like the understanding we had with the Poms in the 1920s and 30s. The Yellow Peril then, the Towel Heads now.
When you are aware of the size of the US balance of payments deficit, and the fact that banning imports is a classic response to this problem, the clock can only be ticking down before we get more animal liberationist antics kicked up to justify banning our wool and lamb, plus a reprise of the 1980s donkey burger nonsense, etc etc. All the while they will be piously heavying us over the PBS and other manifestations of Intell Property.
PS: does everyone know Bob Zoellick used to advise Enron?
Greenspan is very good on this:
http://www.federalreserve.gov/boarddocs/speeches/2004/20040302/default.htm
Greenspan refutes himself, at least in part, with this observation
As he doesn’t mention in this passage, all of this rise and more was subsequently reversed.
The implication is that, even when the implications of the fundamentals are glaringly obvious, betting on them is unwise, unless you have the resources and organisational capacity to hold out indefinitely.
there’s a neo-Bretton Woods system in operation in which Asian central banks (formerly Japan, now China) finance whatever trade and budet deficits the US choose to run
Bretton Woods eventually collapsed as foreigners proved unwilling to indefinitely fund a massive US budget and trade deficit. Not a happy precedent.
How can the US flout WTO rules like this?
How can our manufacturers compete when we come to the FTA?
Does anyone remember the US persecuting that australian company a few years ago that manufactured,what was it?
Something to do with leather or hides,the punishment was millions of dollars as I remember.
“Liberals, centrists and rightwing Republicans all lined up to support the bill.”
i’m surprised you didnt claim this was a resounding endorsement of tax and spend social democracy as you did howards latest spending spree.
Unfortunately for this line of argument, c8to, the bill consisted almost exclusively of corporate tax breaks. The current US policy consensus appears to “spend, but don’t tax”, which is great as long as the ChiComms are willing to play.
US: The twin deficits
Another day. Another coffee. More newspaper scanning. Another cake. The sun is shining, it is Friday, a weekend beckons but