One hopes Ben Bernanke and the Fed gang are reading the Drudge Report, where the top news items one day last week were: Enlarged U.S. deficits allow Switzerland to displace the United States as the world’s most competitive economy; Obama asks the Senate to raise the debt ceiling beyond its current $12.1 trillion level; the United Nations continues its push for a “global currency” to displace the U.S. dollar as the world’s go-to reserve; and — this will be no surprise, given the other headlines — the ChiComs are freaking out.
China’s role as enabler of American borrowing is often exaggerated and greeted with irrational suspicion, what Bryan Caplan probably would identify as garden-variety anti-foreign bias in American political thinking. We would be less worried, probably, if it were Canada or Britain holding vast reserves of dollars. It is worth bearing in mind, though, that the Middle Kingdom has its own robust tradition of anti-foreign bias, and that Beijing’s actions may not always follow the rational model of Homo economicus. That is why last week’s alarmed assessment of U.S. monetary policy from Cheng Siwei, a Communist-party princeling currently entrusted with China’s green-economy initiative (which is to say, he’s Beijing’s Van Jones, but less committed to Communism), deserves attention: “If [the Fed] keeps printing money to buy bonds it will lead to inflation,” he said, “and after a year or two the dollar will fall hard. Most of our foreign reserves are in U.S. bonds, and this is very difficult to change. So we will diversify incremental reserves into euros, yen, and other currencies.” Cheng added that China would like to invest in gold — which topped $1,000 an ounce as he spoke — but so heavy is China’s presence in the gold market that the price rises when Beijing buys and falls when it desists, presenting all sorts of complications to their money managers.
Cheng’s economic analysis may or may not be naïve, but naïve economics very often shapes public policy, even under undemocratic regimes. China will diversify, he says, and that is not news. The question is, How fast? Cheng’s public pronouncements suggest that Beijing may be looking to ramp up that schedule, and the government that Cheng represents controls about $2 trillion in dollar reserves, the world’s largest accumulation of same. China’s ability to move the gold market suggests a similar ability to move the dollar market. The Chinese have not much economic incentive, of course, to sink the greenback, and every economic incentive to keep it strong. But they are worried about those dollar-denominated investments, and there is a price, presumably, that they would be willing to pay in exchange for having less to worry about. Which is to say, there’s no reason for us to panic — unless they panic.
Panic is a catchy thing. First, the obligatory disclaimer: The sky is not falling, neither over Washington nor over Beijing. There is, in fact, almost no sign of inflation on the American horizon at the moment — the great worry during the financial crisis was deflation — though there are plenty of gut-level reasons to suspect that may change, and that such a change could come with brutal speed and little warning. Second, we should remind ourselves — though doing so increasingly has the character of prayer — that the size of our national debt relative to our economy, while large and worrisome, is not out of proportion when compared with that of other countries with which we are accustomed to comparing ourselves: Our national debt is 60.8 percent of GDP, Canada’s 64 percent, France’s 68 percent, Italy’s 101 percent, and Japan’s 173 percent.
About that: How much does the United States really resemble Italy? Or Switzerland? Supply-siders have traditionally minimized the importance of the U.S. debt and deficits, pointing to Japan and Europe for comparison. I myself believe that it does not make as much sense to compare the United States to, e.g., Canada as we seem to think. Canada is a sparsely populated, relatively homogeneous, relatively undynamic country with which we happen to share a border and three-fourths of a language. Likewise, the United States has much less in common with Britain, the nations of Western Europe, and Japan than we habitually assume.
In terms of population size, socio-cultural diversity, and economic dynamism, one might argue that the United States much more resembles India, or possibly China, albeit a very rich version of India or China. China and India are the two most populous countries in the world; the United States is No. 3. In our diversity and dynamism we resemble India; in our status as a world economic and military power we resemble China. What do their national debts look like? India’s is 61 percent, quite close to our own. China’s is 16 percent, i.e., basically nothing. That may not be as much an economically significant fact as a politically significant fact: An authoritarian regime with few debts, lots of assets, high growth, and lots of income from trade has very different incentives from a democratic regime with lots of debt, a politically unpopular trade deficit, and a partly lamed banking-and-finance sector — one that is vulnerable to a second financial crisis (for instance, one involving the $700 billion in securities backed by unsteady commercial mortgages that may do now what residential mortgages did last year) as well as to general consumer-price inflation and to investment bubbles.
One of the great shortcomings of American political thinking has been the failure to understand bubbles — whether in the stock market or in real-estate prices — as inflation concentrated. Housing prices doubled during the boom and then nearly doubled again; if that is not inflation, what is? Homeowners, bankers, and politicians loved the boom, but politically popular inflation still is inflation. One problem is that Washington has incentives to tolerate both general inflation and narrow inflation in the form of asset bubbles. Inflation is the tax that government debtors impose on their lenders: Washington borrows dollars and repays its debts with less valuable dollars.
And it is not only a question of official government debt: As entitlement liabilities mount — Social Security, Medicare, and Medicaid already account for half of government spending — they will dwarf the present official debt. Unfunded liabilities for Social Security and Medicare over the next 75 years amount to $107 trillion dollars, about ten times the current national debt, or 700 percent of GDP. That sum will not be paid up front and probably cannot be borrowed. Washington’s choices, then, will be: (1) raise taxes to very high levels; (2) cut benefits dramatically; (3) print money; (4) some combination of (1), (2), and (3) — mostly (3), in all likelihood. Politically, the easiest thing to do is to print money, and Washington probably will tolerate a good deal of inflation if the alternative is massive tax hikes or benefit cuts. Beijing knows this, and that leaves the United States and China in a sort of prisoners’ dilemma, a Mexican standoff in the currency markets: Everybody has a short-term incentive to behave in a way destructive to everybody’s long-term interests.
So, what’s the worst-case scenario? Nobody knows. Here’s one scenario: The U.S. experiences a second round of financial crises when commercial mortgages tank, prints a lot of money and exnihilates a lot of credit to fortify the banks, and begins to experience significant inflation as a result of flooding the markets with all those dollars. Beijing decides to cut some of its losses by speeding up its already active program of reducing its exposure to the dollar and taking some losses on its remaining reserves, and more significant losses from U.S. trade, as the price China must pay to reduce that aspect of its risk portfolio. So Beijing’s dollar-green flood aggravates the effects of Washington’s, and the U.S. experiences a currency crisis of the sort Americans typically associate with quaintly impoverished vacation destinations such as Mexico or Argentina. Beijing would not be entirely displeased by that, though it, too, would pay a price.
Anybody (even an English major!) can dream up economic what-if nightmares. And that is not the point of this exercise. The point is this: Because of the size and complexity of our economy, our binary economic orbit with China, and the dollar’s role as the world’s reserve currency, U.S. deficits, one might argue, are of a different character than other nation’s deficits, and they present to us, and to the world, problems that are different from the economic problems presented to Tokyo by Japan’s deficits or to Ottawa by Canada’s deficits.
At some point, the question of American debt becomes, in an important sense, a question of sovereignty, though not in the way the Japan-bashers imagined back in the 1980s. It is a plain and unarguable fact that Ben Bernanke has to go to sleep at night asking himself, What will Beijing think about what I’m going to do tomorrow? Our debt constrains our freedom of action in a way that isn’t necessarily true for a normal country, and that is a worrisome prospect for a nation with a wobbly financial sector and $2 trillion in liabilities held by a very poor, nominally Communist, robustly authoritarian state that does not have our best interests at heart, and wouldn’t mind seeing us beat a retreat from our dominating position in world affairs. Here, the economics isn’t just about economics.
The fact that we are currently considering augmenting that problematic debt to the tune of several trillion dollars so that Barack Obama can have the pleasure of going down in history as the Lyndon Baines Johnson of the 21st century is, if not extravagantly nuts, certainly imprudent, and something that ought to be at the center of every discussion of the Obama administration’s eccentric, incoherent economic thinking.
— Kevin Williamson is a deputy managing editor of NR.