Aurelio O. Angeles
Philippine Daily Inquirer

(Conclusion)

WHAT DOES it mean to the people of the United States when their economy’s current account has been on deficit not just for a year, but for 31 years?

Here are thoughts that will blow your mind.

Deficits and the American people
First, remember my statement earlier, “people make up the economy, and economics is all about people.”

The persistent current account deficit of the United States means that, on the average, Americans spend more than they earn, and they have been borrowing money from the rest of the world faster than they can earn and repay it.

The Americans–their families, government, institutions, businesses–have to work harder, earn more, be more competitive in their dealings with the rest of the world if they are to maintain their standard of living.

Or, they can live within their means.

Otherwise, their debts will catch up with them, bubbles will burst, people will default on their loans, and banks will run out of money to meet their own financial obligations.

Second, these persistent CAB can also mean the people of the United States are spending money on counterproductive projects.

Here is a good example: waging wars funded by borrowings.

If people do not provide the money for the country to go to war and its government fails to collect taxes to fund the war, there is only one way to go–the government has to borrow from the financial markets to fund these wars.

Believe it or not, with the persistent failure of the US economy to turn around its current account deficit, and of the US government to collect enough taxes to balance its budget, the wars in the last 18 years have been funded, and continue to be funded, by borrowings from the savings of the real economy within the United States and the rest of the world.

How can one repay a major financial obligation that does not pay for itself? How does one pay for a project that has become a bottomless pit of expenditures with no source of receipts?

In economics, nothing is free. In home economics, when you overcook, you burn the food.

The spectacular economic growth of the United States these past 31 years has been funded by borrowings.

Consider these figures from the IMF website, http://www.imf.org/external/pubs/ft/weo/ 2008/02/weodata/weoselgr.aspx.

The GDP of the USA has been rising from 1980 to the present: $2,789 B (in 1980), $5,803 B (1990), $9,817 B (2000) and $13,808 B (2007).

The per capita GDP of Americans is: $12,255 (in 1980), $23,208 (1990), $34,774 (2000) and $45,725 (2007).

The United States is reported to have the highest GDP and per capita GDP in the world. Right?

I tell you that expenditures for waging wars increase the nation’s GDP. People receiving income for waging wars necessarily raise the level of the nation’s per capita income.

But, because the economy is increasingly dependent on borrowing from international trade that it has no means of paying and because the government continues on its financial escapades without regard to being able to pay for them, the figures on GDP and Per Capita GDP may be truly growing as seen above, but such growth is now increasingly funded by domestic and foreign borrowings.

In such a case, the day of reckoning will come, as it does to a family which bought a grand mansion on credit without regard to the income to pay for the amortization.

Role of financial markets

Financial markets exist to do business.

It is the objective of business to look for customers, to earn money and to outdo the competition in terms of products, services, prices, distribution and frills.

So long as there are customers that buy, there will be markets that will sell. So long as business is good, there will be a growing chain of suppliers of capital that will support the industry from within and outside the economy.

If the market is free from government intervention, then the sky is the limit in offering products, services, pricing, distribution and frills.

Thus were born fixed income investments, stock markets and the “brilliant” idea of exotic derivatives, futures and options.

So, we demand: Let the government provide direction and guidelines and mandate it to intervene in the markets when necessary.

Now, why would we allow the government to interfere and provide directions in these markets when it cannot even balance its own budget for years!

People talk about recession now coming to the United States. Well, in truth, our debts have caught up with us at last.

It is the day of reckoning. It is collection time. It’s the hour for looking deep into ourselves.

Realities are simple. But our complex minds do not accept simplicity and look for reasons elsewhere.

Is there an end in sight?

Why do the financial markets continue to promote the growth of debt–or CAB deficits–in the US economy in spite of the obviousness of its inability to repay such debts from any future surplus?

First, the profit motive behind every debt paper provides the incentive. That’s free market for you. As President Bush is reported to have said: “Don’t disturb capitalism.”

Second, there is a lack of understanding among people on the impact of the chronic US CURRENT ACCOUNT DEFICIT on the world economies in general and on the financial markets in particular.

Till now, they are unable to connect these deficits with the failure of financial markets to recover in spite of massive aid.

Third, people in high places tend to equate economic prosperity with the performance of stock markets, commodities markets, futures and options markets.

If these markets are going through boom times, then there is economic growth and prosperity. If there is a bust, then the world must be in recession.

But the financial markets are just a mirror of what happens in the real economy.

Take care of the real economy, heed what the CAB has been saying for 31 years, and the financial markets will take care of themselves.

We may not grow as fast, but we will not have to kill ourselves growing.

The fourth reason for promoting debt and closing one’s eyes on the meaning of CURRENT ACCOUNT DEFICITS is hinged on the answer to this question: “Why does the US dollar appreciate in value even as the USA continues to be the center of the world’s financial crisis?”

You will read this answer from media–”The dollar remains the safest haven for the world’s currencies.” How foolish!

Why is there an increasing demand for the dollar in the various economies as the crisis engulfs the United States? Here is the first reason.

When in good times investors holding US dollars first invested funds in these economies, say the Philippines, they first converted their US dollar to peso. This brought the value of peso up in relation to the dollar. They then used the peso to engage in various forms of investments available in the Philippines.

Pinoys experienced this phenomenon when the value of the peso breached P40 to a dollar in the first quarter of 2008, after floating around P56 to a dollar in the third quarter of 2005.

Here lies the power of the volume of hot money flows.

Now with the crisis, these investors have been selling their Philippine investments in peso, converted the peso proceeds into dollars and have been repatriating their dollars to answer for their requirements in their home base.

These activities will result in a greater demand for the US dollar and the depreciation of the peso. It is the same everywhere, except in Japan where investors have to pay off their yen loans in yen.

What are some of these home-base requirements? They need to answer margin calls for their dollar investments; they need to pay their dollar loans and other obligations; they need to consolidate their dollar position.

Here is the second reason. Where is the financial center of the world? Where is the New York Stock Exchange, the New York Mercantile Exchange, the Chicago Mercantile Exchange, the Philadelphia SE, the Nasdaq? In the United States, of course!

To what currency must the peso, the dinar, the pound and ringgit be exchanged if people wish to transact business in these exchanges? The US dollar, of course!

Can we imagine the 2007 volume of equity shares traded in these exchanges? It is unbelievable but true–US$45.2 trillion! (Source: World Federation of Exchanges website, http://www.world-exchanges.org/WFE/home. asp?menu=436).

This is 3.3 times bigger than the GDP of the USA!

Here is the third reason.

What is the medium of exchange involving foreign trade transactions all over the world? What currency must a Taiwanese buy to trade with his relatives in China? The US dollar, of course. Which economy prints the US dollar? The US economy, of course.

People have no other choice in transacting international business. It is the way banks have been set up since after the Second World War, when the dollar was enthroned as king of foreign currencies.

So, it is foolish to say the value of the dollar is going up because “America, for all its problems, is still seen as the safest place to put one’s money.”

Current Account Deficit

and the US dollar

What has the universal use of the dollar as a means of exchange got to do with the growing debt of the US economy?

Take a look at the dollar bill and you will read that it is a legal tender for debts, public and private. Legally, they are liabilities of the Federal Reserve Banks and obligations of the US government.

Well, this explains why banks are tough on Argentina, Thailand and Iceland, but are patient and long suffering with the United States.

This also explains why the financial markets are adverse to the devaluation or depreciation of the US dollar.

And why is the dollar devaluation beneficial to the US economy?

It is a principal strategy for the USA to be competitive in the world market of real goods and services, to increase its net EXPORTS and turn around its CAB from negative to positive figures over time. Remember the Chinese yuan?

In short, the universal use of the dollar in finance, trade and exchange provides a massive challenge if the CURRENT ACCOUNT DEFICIT is to be turned around.

Truly a complex, interconnected world.

The leaders of the Group of 20 recently met in the United States. President Bush is reported to have offered the following list of solutions: bolstering accounting rules; setting up a central clearing house for credit default swaps; reinforcing rules for manipulation and fraud in trading of stocks and securities; enlarging the list of nations with voting power in the IMF and the World Bank.

And the Australian Prime Minister is said to have warned against rewarding executives of financial firms for high-risk investments and is said to have called this “dumb, wrong and bad.”

And more governments are providing billions of dollars to boost the liquidity of banks.

Good start. But the problem is larger than international finance, which is merely a reflection of the real economy.

The Group of 20 must address the roots of the 31-year-old international economics problem–the CURRENT ACCOUNT DEFICIT of the USA and its growing foreign debt.

The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines. The author is an entrepreneur who wrote the books “The Peso Exchange Rate: Why Are We So Poor?” and “The Philippine Economy: Do Our Leaders Have A Clue?” Feedback at map@globelines.com.ph. For previous articles, please visit map.org.ph.