ivantohelpyou

Sen. Clinton (D-NY), in a Feb. 28 letter to Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke, points out:

As we have been running trade and budget deficits, [countries like China] have been buying our debt and in essence becoming our banker.

Clinton then asked the Senate:

How can we negotiate fair, pro-American trade agreements--and ensure foreign countries uphold these agreements--when we sit across the negotiating table, not only from our competitor, but from our banker as well.

What to do? Somehow, I doubt that an "alarm bell" will help:

I supported legislation by Senator Dorgan and then Congressman Cardin that sounds an alarm bell when US foreign owned debt reaches 25 percent of GDP or the trade deficit reaches 5% of GDP. It would require the Administration to develop a plan of action to address these conditions, and report their findings to Congress.

In the 2006 Berkshire Hathaway annual report, Warren Buffett has the following to say about the looming problem.*

The “investment income” account of our country – positive in every previous year since 1915 – turned negative in 2006. Foreigners now earn more on their U.S. investments than we do on our investments abroad. In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience “reverse compounding” as we pay ever-increasing amounts of interest on interest.

(Chart: Economic Policy Institute)

Here's the expected outcome:

I want to emphasize that even though our course is unwise, Americans will live better ten or twenty years from now than they do today. Per-capita wealth will increase. But our citizens will also be forced every year to ship a significant portion of their current production abroad merely to service the cost of our huge debtor position. It won’t be pleasant to work part of each day to pay for the over-consumption of your ancestors. I believe that at some point in the future U.S. workers and voters will find this annual “tribute” so onerous that there will be a severe political backlash. How that will play out in markets is impossible to predict – but to expect a “soft landing” seems like wishful thinking.

Buffett doesn't go nearly far enough in describing the potential political and economic impact of the annual "tribute." Consider all of the wonderful benefits you receive in return for the taxes you pay, and how much fun it is to help your elected officials decide how to spend government money. If instead, the government has to repay foreign debtors with those tax dollars, who's going to pay for all of the benefits and services to which we've grown accustomed? You know, like the New Food Pyramid.

Let's say the total tax burden for the US economy is 25 percent of GDP. Right now the debt payment on foreign holdings of US government securities is about 1.1 percent of GDP. That means for every dollar paid in taxes, about a nickel has to be set aside to pay interest on the debt. What happens if that nickel turns into a dime? Or a quarter? We may be tempted to think we can innovate and grow our way out of the problem, but in 10 or 20 years' time, who's to say we're going to be the top innovators?

Now you know what keeps me up at night.

Anyway, as far as Berkshire Hathaway's concerned, what'll make the headlines over the next few weeks will be coverage about the company's search for young blood. While you're reading it, here's a little Buffett-inspired drinking game: Take a shot of Cherry Coke every time you read the word "folksy" in reference to the Berkshire Hathaway annual report.

* Why do problems "loom" anyway? And what does Buffett know about looms? Well, Berkshire Hathaway started out as a textile mill and it owns Fruit of the Loom, so I'd say he qualifies as an expert. And as for the etymology, perhaps problems loom when they quietly build up big swatches of trouble as the result of small, repetitive actions, i.e., when millions of households spend more than they earn.

Labels: economics, politics