The stock market has risen between 25 and 50 percent, depending on your index of choice. Foreign markets have mostly fared better than U.S. stocks. Real economic growth and corporate productivity are booming. And, strangely enough, interest rates and inflation are low. With all this good news, you would expect to see a little more exuberance after nearly three bear-market years and a mild recession. Yet there is no shortage of economic boogeymen toning down the optimism.
One of my clients recently forwarded a local newspaper editorial that would fall into the category of “Let’s scare the hell out of ‘em.” The editor relied on a recent expose produced by none other than those perennial “bullish” economists at the International Monetary Fund. According to these purveyors of outdated economic analysis, U.S. fiscal policies “threaten the financial stability of the global economy.” And according to the editorial-page writers, “the economists have a credible explanation for their worry. They warn that U.S. net financial obligations to the rest of the world, given current taxing and spending practices, could equal 40 percent of the total United States economy in just a few years. And this would bring bad consequences for the value of the dollar and play havoc with international exchange rates.”
Such warnings confirm what modern economists have known for some time now: Traditionally trained economists, especially those who populate the IMF, rely on economic theory that is tied to a gold standard. However, the world went off the gold standard in 1971 when President Nixon closed the gold window — i.e., the U.S. no longer redeems dollars for gold.
So, now that we know the economic world is round and not flat, let’s take a look at these IMF forecasts.
First of all, the warning about growing U.S. financial obligations to the rest of the world is essentially meaningless in terms of the hypothetical ability to repay. All U.S. debt is denominated in dollars. The federal government is the sole manufacturer of federal government securities. All foreigners can hope to do with their accumulation of U.S. debt is redeem it for dollars. And it’s very unlikely that they will try to take the state of Illinois in payment. They can only take goods and services.
Let’s take the analysis a step further. The accumulation of U.S. government debt by foreigners occurs because those foreigners obtained dollars by selling goods into the U.S. In other words, when a foreigner sells goods in the U.S. they have one of two choices: they can take goods and services now — reducing the trade-balance deficit — or they can take future goods in the form of holding U.S. denominated securities. Another choice — never taking any goods or services — doesn’t make too much sense. If these are the only options, then it becomes obvious that future claims on U.S. resources will be in the form of increased demand for output. By golly, that might create more jobs! Not a bad tradeoff.
Following along the IMF analysis, “a voracious U.S. borrowing appetite would drive up interest rates and slow investment and economic growth around the globe.”
Remember that old saying: “don’t confuse me with the facts?” How about this: Over the past four years, the U.S. budget deficit has risen from a surplus of $200 billion to an estimated deficit of $450 billion this year — a swing of $650 billion. Yet, interest rates over this period have actually fallen. And, as many economists know, if interest rates were to rise, it would be due to a rising demand for — you guessed it — higher investments that contribute to greater economic growth.
Then there is the diatribe about the weaker dollar. Is a weak dollar bad? Or is a strong dollar good? Let’s take a look at Japan. Here’s a country with a very strong currency — for many years — and yet their economy has been in a ten-year malaise, has a stock market that has dropped more than 75 percent, and is struggling with a banking meltdown. A strong currency didn’t help them.
And then there is the battle with China to unhinge the yuan from the dollar. Why, if a weak dollar is bad for the economy, would the Chinese want to stay linked to the dollar, and why would all these U.S. politicians want the Chinese to unhook their currency from the dollar? I guess a weak dollar isn’t all that it’s cracked down to be.
What the IMF economists want to do is raise taxes, cut spending, create a budget surplus, and manufacture a strong currency. Such policies — when dictated by IMF lending policies to third world countries — have wreaked economic havoc and political turmoil. Now the IMF is doing everything it can to push its economic theories on the U.S. Fortunately, the right guys are in Washington: The editorial stated that officials at the White House dismissed the report as being alarmist. That’s the least of this report’s problems.
— Tom Nugent is executive vice president & chief investment officer of PlanMember Advisors, Inc. and an investment consultant for Wealth Management Services of South Carolina.