Monday, November 14, 2005

Are we living in a financial fantasyland?

The dollar is appreciating, despite the fact that the U.S. notched up a record trade deficit of $66.1bn last week (equivalent to roughly 6% of its gross domestic product). The US is financing that trade deficit by flooding the global markets with dollar-denominated assets that are snapped up by its creditors.

When you get down to it, there are only two reasons for an appreciating dollar. One is that it is going up because it is going up; the herd mentality of markets means that you do what everybody else is doing even if you think they are wrong. The second is that the markets have deluded themselves into thinking that a country that is spending one dollar and six cents for every dollar that it is earning doesn't have a problem.

The fact that the Chinese, the Japanese and the other big exporting nations of Asia are colluding in this financial fantasy should come as no surprise. A strong dollar is wonderful for these countries since it helps them to build up their industrial - and, in China's case, political -power even as American manufacturing is hollowed out.

It would be misguided of the US to believe that all sides gain equally from this arrangement; the Asians are getting by far the better of the deal, owning enough US dollar assets to buy a controlling interest in every company listed on the Dow Jones Index. As a new book by Bill Bonner and Addison Wiggin (Empire of Debt: The Rise of an Epic Financial Crisis; published by John Wiley) notes: "They [the Asians] have enough Treasury bonds to destroy the US economy on a whim."

Bonner and Wiggins argue that Americans believe they can go on spending more than they make indefinitely. "They go deeper and deeper in debt, believing they will never have to settle up. They buy houses and then mortgage them out, room by room, until they have almost nothing left. They invade foreign countries in the belief that they are spreading freedom and democracy, and depend on lending from communist China to pay for it. The imperial people choose to spend rather than to save, and to hallucinate, rather than think hard. They demand bread and circuses at home; let the Asians sweat abroad."

At some point, as Bonner and Wiggin note, the shopkeeper who keeps extending credit to a customer having problems paying the bills in the hope that he will eventually straighten himself out can end up sharing the pain. Until the crunch comes, however, it's easy to keep believing the fantasy.

Larry Elliott, The Guardian, Monday November 14, 2005
Bill Bonner and Addison Wiggin, Empire of Debt: The Rise of an Epic Financial Crisis; published by John Wiley

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