If we take the long view of history the much-discussed $600 billion U.S. current-account deficit should come as no surprise. Some things never change, and one of those is the perennial American desire to live beyond our means - and make someone else pay the bill.
In 1626, Dutch colonists swindled the island of Manhattan out of a local Indian tribe for a paltry sum of 60 guilders. In 1862, the government was selling homesteaders 160-acre parcels of land, cleared of its native occupants, for just $18 each. From slavery to Nike sweatshops, the American Dream has been someone else's burden.
So forget everything you've heard about Wal-Mart and unfair Chinese competition. The deficit is a statement about the American lifestyle: We're buying more than we can actually pay for.
The proof is in the numbers. To maintain our spending habits, we borrow a whopping $2 billion from abroad - every single day. Bit by multi-billion dollar bit, it adds up: Foreigners now hold over $7 trillion in U.S. debt. According to September's figures, instead of saving up money to pay them back, we're blowing 99.8 percent of our income on the biggest spending spree in recorded history.
Under normal circumstances, the market would punish us for our excessive borrowing. We'd start having to pay higher and higher interest rates on its debt, if not because lenders don't trust us to repay them, then because their simply isn't enough capital out there to satisfy our voracious appetite for it.
Instead of spiraling upward, however, American lending rates have plunged to historic lows. Adjusted for inflation, interest rates on many loans remain close to 0 percent, meaning our profligate borrowing habits cost us virtually nothing. It also means the foreigners who lend us money aren't making a good return, yet they keep on lending anyway.
Who is this foreign fairy godmother that is underwriting the U.S. consumption binge? You can look towards Asia's central bankers, who have bought up hundreds of billions of dollars in American bonds, leaving Americans awash in cheap money.
Thanks to insufficient domestic demand, Asian economies are highly dependent on U.S. export markets, and a strong dollar is necessary to keep their goods cheap for American consumers. The recent weakness of the dollar against the euro, for example, has sent economic growth in Europe screeching to a virtual halt - a fate that Asian central bankers are bent on avoiding. Japan, in particular, has only just begun exporting its way out of a decade-long deflationary spiral, and without strong American demand for its products, its fragile recovery could end overnight.
Hence, to maintain a strong dollar, Asia's central banks have purchased U.S. debt at a feverish pace, and, crucially, at bargain exchange rates. The Bank of Japan, for example, has purchased more dollars than any other central bank in history.
This lending frenzy has allowed Americans to live magnificently - and unsustainably - beyond their means. Current demand for dollars, economists agree, is untenable, supported only by the intervention of Asian monetary authorities. And even that won't last forever. Federal Reserve Chairman Alan Greenspan, in a moment of brutal clarity, recently remarked, "Given the size of the current-account deficit, a diminished appetite for adding to dollar balances must occur at some point."
Peter Schiff, the head of Euro Pacific Capital, told the San Diego Union-Tribune, "I can't tell anybody to make a long-term investment in the U.S. dollar, in the same way I tried to keep my clients out of dot-com investments in the late 1990s. It's even more important to get out of the dollar now than it was to get out of Nasdaq in 1999."
The numbers indicate that the market is getting the message: The private sector is increasingly reluctant to finance American borrowing, and futures prices forecast a significant depreciation of the dollar against the price of gold in coming months. Meanwhile, the dollar has slid dramatically against the euro.
The question, as the dollar drifts downward, is how many economies it will take with it. Unfortunately, the coffers of Asia's central banks, which are now replete with $2 trillion of U.S. debt, and the international financial system, are exposed to great risk.
For example, if the dollar falls moderately against the Singapore dollar, Singapore would suffer a capital loss equal to 10 percent of its gross domestic product. For a country like China, whose banking system is already burdened by hundreds of billions of dollars of bad loans, losses of that magnitude could set off a financial crisis.
Asian governments could continue to prop up the dollar by purchasing even more U.S. debt, but accumulating additional dollars exposes them to even greater losses down the road, when the house of cards finally collapses. The longer the game goes on, the riskier it gets. On Friday, China indicated that it might be the first to cut its losses and start unl oading its dollar reserves.
Americans, meanwhile, have become increasingly sensitive to changes in interest rates as they continue to accumulate near-record levels of debt. So what happens when Asia's central banks, seeking to make the best of a bad situation, finally jump ship? As foreign lending dries up, we would face a dramatic and unexpected rise in interest rates. Business investment and consumer demand would evaporate as higher borrowing costs squeeze budgets. The United States and Japan, both heavily dependent on U.S. consumers, could slide back into recession, bringing the world economy with them. The Eurozone is already on the brink.
Many economists are optimistic that the dollar will make a "soft landing" that gives banks and households time to adjust, but one thing is certain: As interest rates rise, the United States will have to significantly moderate its addiction to borrowing. That's a lesson that Washington would be wise to learn, and soon.
Nate Goralnik '06 is a suburban tease.
