Within 48 hours of last Tuesday’s sharp and unexpected global stock market decline, Hillary Clinton was on TV labeling the event a wake-up call for the United States. According to the potential president-elect, our foreign debt threatens our very stability.
Where did that come from? I hadn’t heard any of the usual pundits blame the market decline on U.S. foreign debt. Could it be that Sen. Clinton seized the opportunity to dust off this old Democratic pet peeve? Undoubtedly. But the moment serves to again underscore the fatal flaws in the Left’s understanding of U.S. assets and liabilities.
Few politicians, especially those enamored with higher tax rates for the rich, focused on the real reason for the big market decline: the prospect of an increase in the capital-gains tax rate in China. Can you imagine Hillary Clinton, after doing her homework, coming to the media with a story that we must lower our capital-gains tax rate so as to maintain U.S. competitiveness worldwide? Of course not.
Coincidentally, Bear Stearns economist David Malpass wrote an editorial for the Wall Street Journal last Tuesday, the day of the market drop, about the tax increases being shopped by revenue-hungry U.S. politicians who aren’t happy with a $700 billion increase in tax revenues over the past four years. Putting one and one together, investors last week may have caught a foul whiff of the D.C. cabal that would drive our tax rates higher and kill the economic expansion to boot. While the Chinese authorities quickly disavowed any capital-gains tax increase, thus aiding the quick rebound of the Shanghai stock index, Hillary Clinton knocked on media doors with her favorite whipping boy: a U.S. foreign-debt crisis. U.S. markets were slow to recover from the big ’07 equity decline, and the former First Lady can take some of the credit.
So let’s dispel some of the mythology surrounding U.S. global debt. Politicians in this country would have us believe that Americans are out there, hat-in-hand, asking for money from foreigners — money that is going to have to be repaid someday. Fortunately this is a false assumption (although it still can lead to flawed economic policies). Americans buy enormous amounts of goods from abroad (assets) and pay for these goods in dollars (liabilities). Hence, world trade is a zero sum game!
An example will help explain the financial dynamics:
Assume you want to buy a car built in Japan. To finance this purchase, you go to your U.S. bank to take out a loan — a loan that will create the deposit that you will use to buy the car. Soon enough, the loan is approved: The bank has issued a new loan, Japan has its name on the deposit, and you own a new car.
But something else has occurred: Technically speaking, domestic credit has funded foreign savings. Notice there is no “imported capital” involved. In fact, there is no such thing with today’s floating exchange-rate policies. Additionally, all three parties in the transaction are happy: Japan now has dollars rather than the car, something it wanted in the first place since it put the car up for sale in the U.S.; the bank, in the business of expanding loans, has done just that; and you’re on the road in your vehicle of choice. There is no imbalance in any of this.
The time may (or may not) come when either one of two things occur: Foreign holders of dollars, or debt as measured by investments in U.S. securities, will demand products and services in the U.S. — nothing wrong with that — or they will attempt to sell these financial assets. As for the latter case, it simply means that asset prices may adjust as assets shift to parties who will either save them or spend them.
While a good many politicians and some pessimistic economists bemoan the onset of a consumer slowdown in spending, few if any of the intelligentsia recognize the power of the foreign consumer to keep the domestic economy growing at a sizeable clip. Capitalism is proliferating around the world, and growth has been accelerating in many third-world countries. As wealth and standards of living increase in these countries, the demand for U.S.-produced goods and services will increase. In this process, deposits at U.S. banks — changing hands from foreign “savers” to U.S. producers — become the payments for the goods and services that will complete this cycle . . . naturally.
Beware politicians like Hillary Clinton who promote capital controls and protectionist measures to insure our sovereignty and stability. Our sovereignty and stability are just fine without them.