Paul Samuelson’s Ominous Message

Paul Samuelson has written a rather short and bleak article on our current economic situation.

Up until now, China has been willing to hold her recycled resources in the form of lowest-yield U.S. Treasury bills. That’s still good news. But almost certainly it cannot and will not last.

Some day — maybe even soon — China will turn pessimistic on the U.S. dollar. That means lethal troubles for the future U.S. economy. When a disorderly run against the dollar occurs, I believe a truly global financial panic is to be feared.

China, Japan and Korea now hold dollars not because they think dollars will stay safe. Why then? They do this primarily because that is a way that can prolong their export-led growth.

I am not alone in this paranoid future balance-of-payment fear. Warren Buffett, for one, has turned protectionist. Alas, protectionism may well soon become more maligned.

President Obama struggles to support free trade. But as a canny centrist president, he will be very pressed to compromise. And he will be under new chronic pressures. His experts should right now be making plans for America to become subordinate to China where world economic leadership is concerned.

The Obama team is a good one. But will they act prudently to adjust to America’s becoming the secondary global society? In the chess game of geopolitics between now and 2050, much stormy weather will take place. Now is the time to prepare for what the future will likely be.

About 4 months ago I hinted at something like this. Back then I wrote,

As I’ve noted in my last post and in comments to other posts that currently the U.S. relies to a considerable extent on foreigners to buy U.S. government debt. Further, without these foreign buyers of U.S. government debt the U.S. would likely have to offer its debt at a higher interest rate.

At the same time the current recession will likely result in a budget deficit of at least a trillion dollars this year and probably next. Further, we have TARP, the current stimulus plan and a $75 billion dollar proposal to help bailout homeowners sideways on their mortgages and talk of TARP 2.0. All of this could add close to $2.3 trillion dollars to the national debt. Adding on the deficits just due to reduced tax revenues and we are looking at $4.3 trillion dollars, at least. Currently the national debt is around $10 trillion. So in a few years we could be looking at a national debt of $14 trillion dollars. [1]

In addition as I have mentioned several times Medicare and Social Security are in actuarial imbalance to the tune of at least $40 trillion dollars. Further, the problem with Social Security and Medicare are not that far off.

All of this combined could make foreign buyers of U.S. government debt very cautious of buying even more. The U.S. could have to offer such debt at a higher interest rate. The effects of this would be to reduce potential economic growth for the foreseeable future.

Now we have this story,

Foreign demand for long-term U.S. financial assets fell in April as both China and Japan trimmed their holdings of Treasury securities.

The Treasury Department said Monday that net purchases of stocks, notes and bonds obtained by foreigners fell to $11.2 billion in April, from $55.4 billion in March.

China, the largest holder of U.S. Treasury securities, trimmed its holdings to $763.5 billion in April, from $767.9 billion in March. Japan, the second largest holder of Treasury securities, reduced its holdings to $685.9 billion, from $686.7 billion a month earlier.

Treasury Secretary Timothy Geithner traveled to Beijing earlier this month to assure the Chinese government that the Obama administration is determined to get control of an exploding U.S. budget deficit, which is projected to hit a record $1.84 trillion this year.

China’s holdings of Treasury securities represent about 10 percent of America’s publicly held debt.

The administration has said while its aggressive moves to fight the recession and a severe financial crisis will push up the budget deficit temporarily, it intends to reduce the deficit as soon as the economic situation permits.

And that final comment about reducing the deficit is just short term, the longer term picture is indeed bleak. Medicare, Social Security, Obama Care, and so forth will likely mean that the deficits will start to rise shortly after the end President Obama’s first term in office. The Chinese, Japanese, and other investors are not stupid. They have undoubtedly read the reports on Medicare, Social Security and so forth. They also likely know that pledges to reduce budget deficits are standard political cheap talk as well.

With the government’s borrowing needs soaring, there have been some concerns that foreign interest in holding U.S. debt might falter, causing interest rates to rise.

The administration contends that recent increases in the interest rates for U.S. Treasury securities were not a sign of investor unease but a reflection of improving economic conditions.

Yeah, a great economic recovery is just around the corner (ask Brad DeLong). Don’t get me wrong, I want DeLong to be right and I have to eat my words. It is just that in looking at data I have available, data Prof. Hamilton has put together, and keeping in mind the long lag time for unemployment to recover from the past two recessions I don’t think Brad DeLong is going to be right.

I think the answer to Paul Samuelson’s question is no.

FILED UNDER: Economics and Business, Government, , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Eric Florack says:

    Face it Verdon… you WANT this president to fail don’t you? Come on, admit it. You hate the USA don’t you?

    (/snark)

  2. Imagine the tools available to deal with these problems if there were no federal deficit.

    I can dream, can’t I?

  3. legion says:

    I think it will all boil down to how bad off China really is (versus their publicly-released whitewashing), and how well they think they could go on without the US as a functioning economic entity…

  4. JKB says:

    how well they think they could go on without the US as a functioning economic entity…

    I don’t think it is a case that the Chinese think they can get along without a functioning US market. It is more that they are coming around to the belief that recent administration policies and actions are likely to make the US as a functioning economic entity of a size necessary to support their foreign trade needs a doubtful proposition.

    It is not that the US won’t function at all but will it function as the consumer of the world’s goods or will barriers be placed to support government owned car companies and force domestic undesired, expensive “green” vehicles on the consumer. Or will cap ‘n trade reduce the discretionary income of American consumers forcing more of their earnings to flow to higher fuel prices and favored carbon permit holders instead of consumer goods? How long before the total “carbon” cost of a product is increased to include transportation and foreign factory carbon outputs? Necessary to raise the cost of foreign goods so that domestic producers can compete despite their high regulatory and union labor costs.

    All in all, the reduction in buying our debt is a signal that the foreign investors are expecting American buying power to be greatly impeded by government polices and not return to prior levels.

  5. odograph says:

    Tyler Cowen on Eric’s vibe:

    Matt Yglesias and Ezra Klein have a request

    Re. Charles, “Imagine the tools available to deal with these problems if there [had been] no federal deficit [riding into the downturn].”

  6. Someone explain why the Chinese would do anything to destroy the value of their own dollar reserves.

  7. odograph says:

    Re. JKB, the interesting thing is that economists and politicians have been asking China to promote internal consumption over an export economy (based on our consumption). Why did they think that China would fund our consumption while they did that?

    The unexpected shift of course, again good and bad, is that our increased savings is starting to make us a little more china-like, and more able to fund our government debut ourselves.

    I know I hold more state and federal bonds than I did a couple years ago.

  8. Dave Schuler says:

    MR above is on the right track. The Chinese authorities are very pragmatic. A lot of their national wealth is in the form of Treasuries (of various different sorts). They won’t be eager to undermine it.

    And selling off .6% of their holdings? They’ve got to pay off their own fiscal stimulus somehow. I’d say it was a good use for it.

    I sometimes wonder if economists are innumerate. China still has a long, long way to go before it assumes leadership of the world economy, if ever. To get there they’ll need to solve a host of extremely serious problems including demography, environment, and complete lack of a civil infrastructure for a major economy or even a functioning banking or equities system.

  9. odograph says:

    Someone explain why the Chinese would do anything to destroy the value of their own dollar reserves.

    Are they trapped? Is it “pay me now or pay me later?”

  10. Steve Verdon says:

    MR above is on the right track. The Chinese authorities are very pragmatic. A lot of their national wealth is in the form of Treasuries (of various different sorts). They won’t be eager to undermine it.

    I agree, in general. If you were to ask me two years ago if the Chinese owning U.S. Treasuries were a problem I’d likely say no. Then the budget out look while not fantastic wasn’t as grim as now. The economy was looking decent, perhaps getting a touch weaker.

    However, being pragmatic also means that if the Chinese think things are going to go right down the crapper they might try to get in and use it before everyone fouls it up. Of course, that could percipitate the crisis, but hey, sometimes people do things for reasons at the time seemed good, but later look bad.

    Its alot like a renewable resource extraction game. Most of the time the situation will hold that the owner of the renewable resources will manage it…well…pragmatically. However, if things get really bad then the owner might simply use up not only what he would normally use, but the “seed corn” as well.

    The Obama Administration has to be damn careful they don’t induce markets into thinking its time to eat the seed corn.

  11. Dave Schuler says:

    I think “trapped” is too strong a word, odograph. Over the years, in pursuit of their objectives, they’ve made a number of policy decisions, including the decisions effectively to peg their currency to the dollar and to purchase U. S. government debt with their current account surpluses. These are interrelated and mutually reinforcing practices.

    It will take more than a reduced ROI for them to abandon the policies.

  12. China still has a long, long way to go . . .

    Working on a location for a fictional scene led me to Google Earth to look at various areas in China. You know what you see on the roads there? A lot of buses. Cars are few and far between. For that matter, roads are few and far between.

    Last time I checked China’s economy was a little larger than Germany’s, a little smaller than Japan’s. Google Earth around Germany or Japan and you see one hell of a lot more infrastructure.

    China isn’t Shanghai and Hong Kong alone, there’s a whole lot of people still aspiring to their first bicycle out in the middle of nowhere China.

  13. odograph says:

    I agree, in general. If you were to ask me two years ago if the Chinese owning U.S. Treasuries were a problem I’d likely say no. Then the budget out look while not fantastic wasn’t as grim as now. The economy was looking decent, perhaps getting a touch weaker.

    I started hearing the same warnings two years ago, but in a sense we are in the same place today. It could be trouble or it could be fine. No one really knows.

    That’s one reason I’m comfortable with a fuzzy understanding of the China Problem. The future, the deleveraging, the unwind of the US debt, will be what it is (and probably unexpected).

    Will US savings rates climb to match those in Germany or France? No one knows, or if a new consumption cycle will begin.

  14. legion says:

    Someone explain why the Chinese would do anything to destroy the value of their own dollar reserves.

    Well, if (and it’s a big ‘if’) the Chinese are narrow-minded enough to see the US as their only major competitor on the world stage, then they might (and it’s a big ‘might’ also) be willing to knock their own economy down a rung or two in order to take ours out at the ankles.

    Frankly, I don’t think it’s a very significant threat. The old Soviet Union, if it was in China’s shoes today, might do something like that, but I believe the Chinese are, as said above, much more pragmatic about such things.