A little reminder about economic reality in America....:
The Middle Class in America Is Radically Shrinking. Here Are the Stats to Prove it
According to the Federal Reserve's Z.1 "flow of funds" data, Rest of World (ROW) holdings of US financial assets ended the 1980s at about US$1.9 trillion and closed the nineties at $5.6 trillion. By the end of 2009, ROW holdings had ballooned to $15.3 trillion. During the past decade, the world's holdings of our financial assets surged to 108% of US GDP from 60%.
Gigantic and unending US current account deficits were the major force behind the extraordinary foreign accumulation of our (largely debt) securities. This implies structural deficiencies in both the credit system and real economy. It would also be quite unusual for such a fundamental backdrop to support a strong currency.
To better gauge the soundness of the dollar, one must attempt some necessarily subjective assessment of underlying US financial and economic structures. Over the past 20 years, total system credit rose from $12.830 trillion to $52.328 trillion - or from a historically very high 234% of GDP to an unprecedented 367%. The important question then becomes, did this historic increase in debt correspond with an expansion of production/wealth-producing investment? Does our economy have the wherewithal to pay back our foreign creditors? When will it matter in the marketplace?
In the six years 2001-2006, total US mortgage debt doubled to $14.53 trillion. For a long time to come, the mortgage/Wall Street finance bubble will be the poster-child for pernicious non-productive credit expansion. And over the past seven quarters federal borrowings expanded $3.3 trillion, or 49%, to almost $10.0 trillion. A strong case can be made that our system's propensity for non-productive credit creation has gone from really bad to worse.
Over the years, I have argued that our intractable trade deficits - and resulting current account deficits - were the leading cause of worsening global distortions and imbalances - financial and economic. Year after year of rampant financial excess at home eventually led to the "exportation" of our credit bubble excesses to the rest of the world. I have referred to the resulting monetary disorder associated with a "massive global pool of speculative finance" - trillions of dollar financial flows commanded by the hedge funds, sovereign wealth funds and global speculating community. And there are, as well, the vast holdings of foreign reserves accumulated by (largely Asian) global central bankers. At $8.449 trillion, international reserves have surged 20% over the past year and are up 157% in six years.
I believe the Greek debt crisis marked a critical juncture for global finance. Prior to Greece unwinding, market players perceived that policymaking ensured liquid markets and a sustainable global recovery. Global reflationary forces were supposed to underpin debt across the globe. The US credit system, economy and dollar were certainly viewed as vulnerable. But amid US debt concerns, markets remained confident that years would pass before massive Treasury borrowings eventually turned problematic. Besides, US vulnerability ensured ultra-aggressive fiscal and monetary stimulus. Ongoing loose finance in the US and synchronized global stimulus seemed to ensure a reflationary backdrop favorable for global risk assets and economies.
All bets were immediately off after debt crisis engulfed European periphery markets; the credit default swap (CDS) marketplace dislocated; the euro plunged; and deleveraging and contagion erupted throughout global risk markets. Almost overnight, the world viewed structural debt problems in a different - and darker - light. Yet, with the dollar and Treasuries rallying strongly, there were visions of the US once again enjoying the fruits associated with a "king dollar" safe haven status. Markets don't tend to offer help to those that really need it.
With the yen trading to a one-year high against the dollar at the end of last week and the euro rallying back to 130, some reality is returning to the marketplace. It is unlikely the US will provide much of a safe harbor in a world of ongoing uncertainty and financial tumult. Indeed, there are indications that the markets are beginning to discount a backdrop heavily impacted by a weaker dollar and US economic fragility. And it is worth noting that the week ended with ominous declines in US financial stocks.
Earlier in the week, dollar weakness supported rallies in global risk assets - equities, commodities and the emerging markets. By week's end, the focus had shifted from the perceived benefits of a weaker dollar to fears for the US recovery. Equities were erratic; currencies were erratic; and commodities were erratic. Notably, those perceived with big exposure to the US - from Japanese exporters to the Canadian dollar to US financial and retail stocks - came under heavy selling pressure. Market concerns do appear to have turned decisively from Europe to the US
Reuters on Friday quoted China's Prime Minister Wen Jiabao: "I want to say that at this time, when some European countries are suffering sovereign debt crises, China has always held out a helping hand."
Clearly, it's a major development that Chinese deep pockets have come to the eurozone's aid. There are reasons for China's policymakers to see it in their country's best interest to purchase European debt. At the top of the list, euro weakness provided an opportunity to diversify some of its $2.45 trillion - and counting - of international reserves. The markets have been focused on European structural debt issues. But perhaps the Chinese, from a longer-term strategic point of view, see European investment as more favorable than accumulating additional US debt. For several years now, the Chinese have moved forcefully to diversify their holdings to include investments in raw materials, commodities and other strategic assets. As for managing their hoard of currency reserves, does it make increasing sense for the Chinese to shift their emphasis to debt obligations backed by more manufacturing and export-based economic structures?
Coming into 2010, market sentiment had turned negative on the Japanese yen. The talk was of Japan's enormous structural problems: intractable fiscal deficits; stagnant growth; political gridlock; and an aging population. Yet the yen is this year's star currency, closing on Friday not far off of the strongest level versus the dollar since 1995. Despite all of Japan's problems, are the Chinese and the marketplace now willing to pay a premium for currencies from manufacturing-oriented economies? From China's perspective - and factoring in their commitment to stimulating consumer demand and imports - accumulating debt instruments that could be exchanged in the future for consumption and capital goods makes sense. The Chinese are now the undisputed banker to the world. What's in their strategic best interest?
The markets are really struggling to come to grips with the post-Greece landscape. Structural debt issues are now a key focus - though the issues and analysis are unusually fuzzy. Is yen strength and euro recovery related to the markets reassessment of the US situation? Does the issue go beyond dimming near-term economic prospects? Not all debt problems are created equal. Are we in the early phase of heightened fears regarding US structural debt issues? Will we see these concerns manifest first in the currencies markets? Did the dollar rally - and ongoing Treasury market strength - distract the market from the crucial unfolding issue: the US structural debt predicament?
Our financial system has created an unimaginable amount of non-productive debt, with our nation owing much of it to foreign creditors. Our maladjusted bubble economy depends on uninterrupted huge quantities of credit creation. Today, this (non-productive) credit expansion/inflation originates almost entirely from our government sectors. The underlying economic structure is too services-based and ill-suited to enjoy a major beneficial ramp-up in production. This may not be a new development, except that the world is increasingly focused on structural debt issues and associated fragilities.
At the same time, there is little impetus domestically or internationally to finance US capital investment. Financial and economic power has shifted to Asia, and the global credit bubble continues to finance massive additional productive capacity throughout the region. Global imbalances - financial and economic - only worsen. Here at home, we now face a situation where our system is dependent upon ongoing confidence from both Asian central banks and the global speculating community.
To some, our recovery may look intact and stocks cheap. But our entire system is extraordinarily vulnerable to any number of potential shocks. And we'll surely face great ongoing uncertainty and market instability, as global markets struggle with the utter corruption of the US government, wall street, and the beltway bandits..., and how this all may play out.....
China Calls USA's Bluff: "The US is Insolvent and Faces Bankruptcy as a Pure Debtor Nation but [U.S.] Rating Agencies Still Give it High Rankings"
America's biggest creditor - China - has called our bluff.
As the Financial Times notes, the head of China's biggest credit rating agency has said America is insolvent and that U.S. credit ratings are a joke:
The head of China’s largest credit rating agency has slammed his western counterparts for causing the global financial crisis and said that as the world’s largest creditor nation China should have a bigger say in how governments and their debt are rated.
“The western rating agencies are politicized and highly ideological and they do not adhere to objective standards,” Guan Jianzhong, chairman of Dagong Global Credit Rating, told the Financial Times in an interview.
He specifically criticized the practice of “rating shopping” by companies who offer their business to the agency that provides the most favorable rating.
In the aftermath of the financial crisis “rating shopping” has been one of the key complaints from western regulators , who have heavily criticized the big three agencies for handing top ratings to mortgage-linked securities that turned toxic when the US housing market collapsed in 2007.
“The financial crisis was caused because rating agencies didn’t properly disclose risk and this brought the entire US financial system to the verge of collapse, causing huge damage to the US and its strategic interests,” Mr Guan said.
Recently, the rating agencies have been criticized for being too slow to downgrade some of the heavily indebted peripheral euro-zone economies, most notably Spain, which still holds triple A ratings from Moody’s.
There is also a view among many investors that the agencies would shy away from withdrawing triple A ratings to countries such as the US and UK because of the political pressure that would bear down on them in the event of such actions.
Last week, privately-owned Dagong published its own sovereign credit ranking in what it said was a first for a non-western credit rating agency.
The results were very different from those published by Moody’s, Standard & Poor’s and Fitch, with China ranking higher than the United States, Britain, Japan, France and most other major economies, reflecting Dagong’s belief that China is more politically and economically stable than all of these countries.
Mr Guan said his company’s methodology has been developed over the last five years and reflects a more objective assessment of a government’s fiscal position, ability to govern, economic power, foreign reserves, debt burden and ability to create future wealth.
“The US is insolvent and faces bankruptcy as a pure debtor nation but the rating agencies still give it high rankings ,” Mr Guan said.
A wildly enthusiastic editorial published by Xinhua , China’s official state newswire, lauded Dagong’s report as a significant step toward breaking the monopoly of western rating agencies of which it said China has long been a “victim”.
“Compared with the US’ conquest of the world by means of force, Moody’s has controlled the world through its dominance in credit ratings,” the editorial said...
China is not shy about reminding the U.S. who's got the biggest pockets. As the Financial Times quotes Mr. Guan:
“China is the biggest creditor nation in the world and with the rise and national rejuvenation of China we should have our say in how the credit risks of states are judged.”Might Makes
Indeed, Guan is even dissing America's military prowess:
“Actually, the huge military expenditure of the US is not created by themselves but comes from borrowed money, which is not sustainable.”As I've repeatedly shown, borrowing money to fund our huge military expenditures are - paradoxically - weakening our national security:
Indeed, as I pointed out in 2008:
As I've previously pointed out, America's military-industrial complex is ruining our economy.
The fact that America spends more than the rest of the world combined on our military means that we can keep an artificially high credit rating. But ironically, all the money we're spending on our military means that we become less and less credit-worthy ... and that we'll no longer be able to fund our military.
So why hasn't America's credit rating been downgraded?Well, a report by Moody's in September states:
"In superficially similar circumstances, the ratings of Japan and some Scandinavian countries were downgraded in the 1990s.
For reasons that take their roots into the large size and wealth of the economy and, ultimately, the US military power, the US government faces very little liquidity risk — its debt remains a safe heaven. There is a large market for even a significant increase in debt issuance."
So Japan and Scandinavia have wimpy militaries, so they got downgraded, but the U.S. has lots of bombs, so we don't? In any event, American cannot remain a hyper-power if it is broke.
The Scary Part
I chatted with the head of a small investment brokerage about the China credit rating story.
Because he gives his clients very bullish, status quo advice, I assumed that he would say that China was wrong.
To my surprise, he simply responded:
They're right. What's scary is that China knows it.In other words, everyone who pays any attention knows that we're broke. What's scary is that our biggest creditor knows it.
Tricks Up Their Sleeves?
China has been threatening for many months to replace the dollar as the world's reserve currency (and see this). And China, Russia and other countries have made a lot of noises about replacing the dollar with the SDR. See this and this.
Gordon T. Long argues that the much talked about gold swaps are part and parcel of the plan to replace the dollar with the SDR. Time will tell if he's right.
China, of course, is not without its own problems. See this and this.
In related news, Germany's biggest companies are starting to shun Wall Street as too risky and utterly corrupt beyond redemption....