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January 14, 2009

Is America in Decline?

Paul Kennedy has a piece in today's WSJ, American Power Is on the Wane  that claims that America has begun its decline as a nation and empire.  My response is long, but I hope you find it heartening.

David Post, in his Volokh post Why I’ll Be Voting for Obama points out that "[c]ountries can descend into the ranks of the second-rate in the blink of an eye (historically speaking): it happened to Spain, and to Portugal, and to Argentina, it is now happening to Italy, and it can happen to us." You could probably add Lebanon(Remember when Beirut was Paris of the middle east?) and before WWII Eastern Europe and the Balkans were home to some of the worlds largest economies and highest per capita incomes.  I agree with that, although the details are everything.

"So while today's Russia, China, Latin America, Japan and the Middle East may be suffering setbacks, the biggest loser is understood to be Uncle Sam."

It is difficult to find an major stock market that did better than the US did this year (Stock Market 2008 - Unprecedented):
Dow Industrials - Down 33.8%
S&P 500 - Down 38.5%
Nasdaq - Down 40.5%
France CAC 40 - Down 43%
German DAX - Down 40.4%
UK FTSE 100 - Down 31.3%
Japan Nikkei - Down 42%
Hong Kong Hang Seng - Down 48%
Singapore Strait Times - Down 49%
Australia S&P/ASX - Down 41%
China Shanghai Composite - Down 65.4%

Similarly the dollar has strengthened against most major currencies. Which is astonishing when you consider that the national debt increased (The Debt to the Penny and Who Holds It)  by $1,323,842,005,473.29 last year and short term interest rates went to 0.
Daily rates

Country per $ (Today) (Year ago)  per £     per euro
Australia       1.49          1.12             2.18         1.97
Britain      0.68          0.51             -0.9
Canada      1.22          1.02             1.79        1.62
China      6.83          7.25             10.01        9.06
Euro zone      0.75          0.68            1.1          -
Hong Kong      7.76          7.81            11.38       10.27
India      49.43          39.28             72.52        65.62
Japan      89.31          108.81             30.99        118.55
Mexico      13.78          10.92             20.21        18.29
New Zealand      1.79          1.28             2.62        2.37
Norway      7.08          5.29             10.39        9.41
Singapore      1.49          1.43             2.18        1.98
South Africa      10.07          6.71             14.78        13.32
Sweden      8.21          6.35             12.05        10.83
United States      -        -        1.47        1.33

"The first reason, surely, is the U.S.'s truly exceptional budgetary and trade deficits."

The charts above show that the current budgetary deficit increases  have been met with a collective yawn by global markets.  The public perception of the trade deficit has long been an area of great frustration to economists. People are willing to take our government debt (paying something like 5% a year or less) and they will give us stuff they made. That's paper money for real stuff.  If one day they all panic and decide that they don't want our debt anymore, then our currency will crash. That's bad for us, but even worse for the people who already gave us stuff and now hold only our assets denominated in dollars. Yes, it would be a costly adjustment. But fueled by a currency collapse we would see a surge of exports, providing us with the means to payoff that external debt with cheap dollars.

"To my mind, the projected U.S. fiscal deficits for 2009 and beyond are scary, and I am amazed that so few congressmen recognize the fact as they collectively stampede towards the door entitled "fiscal stimulus.""

I actually agree with him here. The arguments for the fiscal stimulus are at best the fruits of sloppy econometrics and at worst a pipe dream of pork to fulfill everyone involved or advocating its fantasies of what government should be and what areas should receive more investment than the market currently provides.

I'd discussed my stimulus skepticism in What sort of stimulus?, but better still would be to skip it entirely.

"The third thing I'm really scared about is that we'll likely have very little money ourselves to pay for the Treasury bonds that are going to be issued, in tens of billions each month, in the years ahead. Sure, some investment firms, bruised by their irrational exuberance for equities and commodities, will take up a certain amount of Treasury issues even at a ridiculously low (or no) rate of return. But that will not cover an estimated budget deficit of $1.2 trillion in 2009."

This is possible. On the other hand, rates fell when the government issued the last 1.3 trillion, so it is hard to say whether the markets could absorb another amount of this magnitude without an increase in rates. However, if the government can borrow cheaply, and we know that that won't last forever, we may want to take advantage of that.

"Do people really think that China can buy and buy when its investments here have already been hurt, and its government can see the enormous need to invest in its own economy? If a miracle happened, and China bought most of the $1.2 trillion from us, what would our state of dependency be then?"

The alternative to China continuing to buy our bonds (given our trade deficit with them) is to let their currency appreciate. Notice in the chart above it was one of the few currencies that appreciated against the dollar last year. China is a country with terrible problems: huge governance problems, corruption, gender imbalances, rural poverty, and the first country to grow old before it grows rich. If they don't keep growing driven buy a cheap currency rendered cheap by non-convertibility, high domestic savings, and buying a lot of dollar denominated assets, they face unrest and potential social collapse. I expect them to continue to eat our debt over the next year. Herbert Haft once said, "If you owe someone several thousand dollars, you can't always sleep at night. If you owe someone several million dollars, the banker or supplier can't sleep. It's no use both of you worrying.". In time, that's evolved to saying that  "if someone owes the bank a million dollars, the bank owns him, but if someone owes the bank a billion dollars, then he owns the bank." There is truth there.

"On the other hand, the data so far suggest the economies of China and India are growing (not as fast as in the past but still growing), while America's economy shrinks in absolute terms. When the dust settles on this alarming and perhaps protracted global economic crisis, we should not expect national shares of world production to be the same as in, say, 2005. Uncle Sam may have to come down a peg or two."

Even using the PPP measures of national production which enhances the productivity of poor countries like India and China, they are still pretty far behind. Use the exchange rate measures of national production and India and china are less than half as large. PPP has its purposes, but PJ O'rourke criticized the PPP measure as saying you are richer because you live in a a bad neighborhood.

"Moreover, no three or four of those countries -- and perhaps not a dozen of them combined -- have anywhere like the staggering array of overseas military commitments and deployments that weigh upon Uncle Sam's shoulders. That brings us back, I'm sorry to say, to the "imperial overstretch" remarks I made some 20 years ago".
Well maybe. According to the SIPRI Year book (Tables of military expenditure as of 2003), China spends 2.3% of GDP on the military, Iran 3.8, Egypt 2.6, Russia 4.3 and Saudi Arabia 8.7%. The USA, far richer per capita and getting a vastly more effective military spends 3.8%. Maybe that's over reach, but it wouldn't take much reduction in health care expenditures to bring our spending in like with the UK (2.8) and France (2.6). A good defense is expensive, but we can afford it.

Therefore, while decline is always possible,  I don't see evidence of national decline in Mr. Kennedy's arguments.

Posted by OneEyedMan at January 14, 2009 10:08 AM

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