- The Washington Times - Wednesday, March 22, 2006

An Indian parable about an elephant and a group of blind men tells us the same thing can seem very different, depending on which part of its anatomy you examine.

That is obviously true of the U.S. economy. Some consider its rates of growth, unemployment and inflation and declare it to be in great shape. Not too long ago, they might have said it is “as sound as the dollar.”

Others cite other statistics and paint a much darker picture. And they worry about the soundness of the dollar. Last week produced some dramatic evidence to support the naysayers.

A lot of attention was paid to the fact the federal government is spending much more than it earns. Last Wednesday, Congress had to raise the debt ceiling to $9 trillion. What may be much worse news got almost no attention: The Commerce Department announced last Tuesday we as a nation in 2005 spent almost $1 trillion more than we earned.

The federal debt has now risen 41 percent in the last four years. The Congressional Budget Office predicts the deficits this year and next will be $350 billion.

An even more intractable problem, however, is the difference between how much we as a nation, not just our government, spend compared with how much we earn.

The bad news came in the form of the annual report on the balance of payments that showed that as of the beginning of this year we were spending 7 percent more than we earn.

What’s so bad about that? We’ve been hearing about the current account deficit for so long, it’s obviously not even very newsworthy anymore. The problem, very simply, is that experience shows any good news about interest rates, unemployment, inflation and the overall economic growth rate can turn sour overnight if the value of the dollar sinks sharply.

Why should the dollar decline sharply? For years people have predicted it was about to happen, so what’s different now? The naysayers see lots of differences, none for the better.

For example: In 2000, the last year of the Clinton administration, foreigners invested twice as much money in the U.S. as we borrowed overseas. That meant dollars flowing overseas to buy oil from the Middle East and Venezuela, cars from Japan and Germany, clothing and consumer electronics from China, were being reinvested in the U.S. economy, either through direct investment in factories and other businesses or indirectly, by purchase of stock in American companies. All that helped grow the U.S. economy.

By 2004, we were borrowing 4 times as much overseas as foreigners invested here. That means foreigners are much less deeply involved in the U.S. economy as a whole. Their investments are short-term and their owners’ primary concern is the short-term return on their money: interest rates.

While the dollar has already declined 30 percent versus the euro in the last four years, it might have fallen much further and faster except for the consistent increases in interest rates by the Federal Reserve during the last almost two years. As long as those interest rates keep rising, there is hope all those foreigners will keep their trillions of dollars in dollars.

But how long can the Fed keep raising interest rates? The main justification for higher rates is that the U.S. domestic economy continues to chug along, based as ever on consumer spending. But how much longer can consumer spending continue rising?

There are three dark clouds on the horizon. The first is the price of oil and its ripple effect on all other prices, from airline tickets to lettuce.

The second is the growing perception the “housing bubble” is coming to an end. To a considerable extent, many Americans have been financing their day-to-day spending by refinancing their homes and/or by increasing consumer debt in anticipation of selling or refinancing their homes. But higher mortgage rates and the end of the spectacular increases in the value of real estate are taking huge bites out of that.

Finally, the level of consumer debt itself has got to the point where it raises serious questions.

In a speech last month at the University of California-Berkeley, International Monetary Fund Managing Director Rodrigo de Rato said the continued relative strength of the dollar is based on the strength of the U.S. economy, but the economy is based on the fact Americans keep increasing spending on everyday consumption in the face of rising personal debt. That, he said, is simply “unsustainable.” Ours is an economic house of cards.

When consumer spending slows — as it inevitably will — the Fed will find it extremely difficult, if not impossible, to continue raising interest rates. That will trigger a sale of dollars, perhaps a slow hemorrhaging, perhaps a more catastrophic one.

In 2001, the Argentine peso lost 70 percent of its value overnight, leading to horrendous inflation, 20 percent unemployment, devastation of the middle class, and food riots in a key food-producing country.

Obviously, the U.S. is not Argentina. But as Mervyn King, governor of the Bank of England, said in a recent speech in New Delhi, the U.S. balance-of-payments deficit “has raised fears of how the inevitable correction will eventually be achieved.”

We can take some comfort in the fact that when you owe your banker $100, he owns you. When you owe your banker $100 million, to at least some extent, you own him. If the dollar plummets in value, all the foreigners who own dollars will suffer. That means we can hope they will help us help ourselves.

But in the final analysis, the responsibility is ours. Do we really want to rely on “the kindness of strangers”?

George H. Lesser has reported for more than 30 years on international political and economic developments for both U.S. and European publications. He has been based in Washington, New York, London and Brussels.

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