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Trouble, Trouble, Debt, and Bubble

William K. Tabb taught economics at Queens College for many years, and economics, political science, and sociology at the Graduate Center of the City University of New York. His books include Economic Governance in the Age of Globalization (Columbia University Press, 2004), Unequal Partners: A Primer on Globalization (The New Press, 2002), and The Amoral Elephant: Globalization and the Struggle for Social Justice in the Twenty-First Century (Monthly Review Press, 2001). He can be reached at william.tabb [at] gmail.com.
This article is based on a presentation at the Left Forum in New York City, March 11, 2006

The questions regarding U.S. macroeconomic policy these days come down to whether the country can keep borrowing. Can consumers keep spending by increasing their debt level? Can the federal government keep running a large budget deficit without serious problems developing? Can the U.S. current account deficit keep growing? Will foreigners keep buying government bonds to cover this growing debt? If the answer is no to such questions, we can expect serious trouble and not just for the United States but for the rest of the world, which has grown used to the United States as the consumer of last resort. The United States buys 50 percent more than it sells overseas, enough to sink any other economy. In another economy, such a deficit would lead to a severe devaluation of the currency, sharply inflating the price of imports and forcing the monetary authorities to push interest rates up considerably.

The United States started to run annual trade deficits in 1976 and has done so every year since. In 1985, this country became a net debtor nation, owing more to the rest of the world than is owed to it. By 1987, it became the world’s largest net debtor nation. The debt has grown and grown since, to the point where economists Nouriel Roubini and Brad Setser suggest that “The current account deficit will continue to grow on the back of higher and higher payments of U.S. foreign debt even if the trade deficit stabilizes. That is why sustained trade deficits will set off the kind of explosive debt dynamics that will lead to financial crises.”

However it also seems to be in everybody’s interest to keep the game going. Asian countries, especially China, want to continue exporting to the United States and keep their currencies from strengthening, preferring to export to Americans and then to loan the money back to them so that they can buy more. Much of the foreign savings go into U.S. government bonds, keeping U.S. interest rates down (currently half of U.S. Treasury bonds are owned by foreigners). The cost of this debt seems manageable, in part because there is slower growth in most of the world’s countries, and so there is plenty of finance capital looking for a safe place to get positive returns. And the low interest rates allow American households to borrow more cheaply, using home equity loans on the seemingly ever-rising value of their homes.

The problem is, as Herbert Stein, Nixon’s economic adviser, famously said, “Things that can’t go on forever, don’t.” Surely a reckoning is coming. U.S. household debt has reached $11.5 trillion, an amount equal to an unprecedented 127 percent of annual disposable income. The most recent figures by the Federal Reserve show the cost of debt servicing nearing a record high of 14 percent of disposable income—and interest rates are going up. How long will Asians and others hold U.S. debt when the dollar finally starts to fall and they take losses on their holdings?

Ah, but we have the equally famous retort from Mr. Nixon’s Treasury Secretary, John Connally, “It’s our currency, but it’s your problem.” America’s creditors can’t let the dollar fall too far without serious costs to themselves (their dollar holdings will buy less the lower the exchange value of the dollar). They will be drawn to keep lending. And sure enough, recently the dollar has defied expectations and strengthened, not weakened.

The bubbles and all the debt are serious economic problems and will have political consequences. However, people have been waiting for the dollar to collapse for a while; if it does, will all the unsustainable debt really be unsustainable? Will the dollar fall this year or next? Maybe. But it is possible to argue, and many do, that in an era of financial globalization, in which productivity growth in the United States continues to outpace that in other advanced economies, the United States will continue to be the destination for investment capital. As foreigners diversify out of their own economies, the United States continues to look good. Why shouldn’t foreign investment exceed 100 percent of the U.S. GDP? Why would this be a problem? Why would anyone want their money back if returns are competitive? Why then should the dollar fall? In any case, the big buyers of U.S. treasuries are foreign governments. They are not motivated simply by financial returns. Political pressure can be exerted by Washington should their view of their own self interest change. But why should it change? As for the federal deficit, why shouldn’t the Republicans keep enlarging the national debt? This “starves the beast.” It prevents public spending they don’t want on other grounds.

Is there support for such a Panglossian perspective? The “know-how” that U.S. transnationals export when they invest abroad is a major and uncounted (in the U.S. international financial accounts) export which seems to be responsible for the higher return on foreign investment enjoyed by U.S. investors compared to the return on foreign investment made in the United States. Michael Mandel, Business Week’s economics editor, argues that the United States is really doing far better than the trade and capital flow accounts indicate because of what is going on in the knowledge economy. Intangibles such as research and development (R&D) and the export of knowledge are poorly tracked by the federal government’s outmoded statistical gatherers, who still use industrial era categories. According to Business Week calculations, the ten biggest U.S. companies that report their R&D spending—firms such as ExxonMobil, General Electric, Microsoft, and Intel—have boosted R&D spending by 42 percent from 2000 to 2005, while over these years their capital spending only increased by 2 percent. What looks like less investment is really less investment in plant and equipment but not in intangible investments calculated to improve profits. America’s “knowledge-adjusted” GDP is moving right along, and that is why profits stay high. The decline in nominal investment also reflects the fact that capital goods are becoming less expensive because of productivity growth in the capital goods sector, capital deepening, and the enhanced efficiency due to improved information technology.

Even conceding that investment in the United States may be somewhat higher than official data show, it is not doing much to help the United States become more competitive. The nation’s problems are more severe, upsetting not only to its working people but to some unexpected establishment ideologues who have long celebrated globalization. Thomas Friedman, the New York Times columnist, argues that Bush is not good for America. He writes that the country “faces a huge set of challenges if it is going to retain its competitive edge. As a nation, we have a mounting educational deficit, energy deficit, budget deficit, health care deficit and ambition deficit. The administration is in denial on this, and Congress is off on Mars.” Friedman asks where are the American corporate leaders who would benefit from a serious effort to address these deficits. He can point to G.M.’s interest in health care since its benefit costs have made it noncompetitive and asks if there is any corporation in America that should not be protesting Bush’s cuts in federally sponsored basic research, a key source of innovation. But he also answers with a different voice noting that many key U.S.-based industries get most of their profits and increasingly their best talent from abroad. They are less motivated than in the past to deal with a Congress “catering to people who think ‘intelligent design’ is something done by God and not by Intel.”

There is, however, another way of looking at this. Consider that part of the higher return enjoyed by American investors results from the power of the U.S. imperial state, power that insures against bad treatment. U.S. power sets the rules on debt repayment, intellectual property rights, investor security, market access, and so on, things that no other state can insure for its investors, at least not to the same degree. The difference in the rate of return exists because foreigners are interested in a safe return and the security of their principal, while Americans investing in risky assets have some assurance that the global state economic governance institutions such as the World Bank and the International Monetary Fund, or if needed the U.S. Marines or threats by the State Department, will enforce debt collection so that their debts will be collected. U.S.-based firms charge exorbitantly for intellectual property and collect intellectual property rents, enforced by the World Trade Organization and the U.S. government, but these go to the bottom line of the companies in question. This is surely good news for those who own those U.S. assets abroad.

Sadly, working-class Americans, who are experiencing stagnant or falling real wages, do not share this satisfaction. For them, wages, shrinking benefits, and deteriorating job quality matter more than the external balance position of the United States. In the United States in which they live, income inequality grows dramatically, health care costs rise beyond the means of families, and secure retirement is a vanishing prospect. These are the real deficits for most Americans, serious shortfalls from what they have been led to expect. They are now told that to be competitive, their country must sacrifice its working people’s legitimate hopes.

In the United States where the president talks of creating an ownership society in which workers would “own” their own health care and retirement through privatized individual accounts, defined-benefit pensions, which guarantee a fixed amount of money after retirement, are replaced by defined-contribution plans, in which benefits depend upon what a worker can put in and the uncertainty of the equity market. The basic idea of social insurance, where all contribute and receive based on need, is canceled as those who can afford more not only get more but receive favored tax treatment for each dollar they set aside for their own welfare.

As part of the program, there are reductions in income tax (paid disproportionately by the rich), in taxation of corporations, and in capital gains and inheritance taxation that overwhelmingly benefit the rich. Government deficits created by these regressive tax cuts are partially offset by increases in payroll taxes, and proposals pour forth in support of consumption and flat-tax ideas—all new tax burdens for workers, with capital exempt.

Instead of unemployment benefits, there are to be personal reemployment and training accounts of limited size. Instead of well-funded public education, there are unfunded mandated testing and school vouchers. Consumers hurt by defective products and such are limited in their right to sue, and people who are bankrupted by personal tragedy can no longer seek bankruptcy relief as they have in the past. Government regulations to protect consumers are seen as inefficient because they increase the costs of doing business and are repealed or go unenforced, or are enforced by former industry partisans. Devolution of responsibilities from federal to state government undermines promised benefit levels, since states cannot afford such burdens and federal help is reduced.

This is the Ownership Society as envisioned by George W. Bush and those around him. It is a package of policies attacking the idea of citizenship rights and follows Margaret Thatcher’s principle that there is no such thing as society, only individuals. It stands in contrast to the principle unifying working-class movements everywhere—and at all times—solidarity. The deficits the Bush administration have created are undermining American society as we have known it. They are, however, in the narrow interests of the capitalist class.

While experts debate how long things can go on without a serious crisis, there is a structural issue of great importance to consider, namely the lack of significant domestic investment by U.S.-based transnationals and the continued expansion of their investment elsewhere. While U.S.-based corporations are earning record profits, they are investing little in the United States. For 2005, the Standard and Poor’s 500 U.S. corporations set new records, spending half a trillion dollars both to buy back their own stock and to pay dividends. Even the fund managers who profit in the short run worry that companies are underinvesting in their businesses. While profits were in many cases setting records, firms were not increasing investment; instead they were retrenching. Their profits were in fact coming from cost-cutting. This is not to say consumption was not rising. It did increase. But the majority of the increased spending was funded through debt creation, most of this due to the wealth effect of the increased value of real estate. Between 2000 and 2005, U.S. house prices increased by more than 60 percent. The market value of real estate in 2006 is about 200 percent of personal disposable income, and mortgage related assets are equal to over 60 percent of bank lending compared to 25 percent in 1970. As one investment analyst has written, “George W. Bush was re-elected president during 2004 because he presided over more housing inflation than any other American president.” That, and by scaring voters. The single-minded war on terrorism obscures stagnant and falling living standards for most of the U.S. working class.

Investment in residential construction is not the sort of investment that provides a surplus to repay foreign debt. The sectors which are growing in the United States, like health care, produce for the most part nontraded goods and services. It is only the growth of financial services, some specialized high-tech exports, and foreign investment that are showing high returns, and the firms controlling these are moving more activity offshore, following manufacturing’s lead and leaving the domestic service economy to create jobs—many low paying, temporary, and without benefits.

U.S. foreign borrowing is not significantly being used for investment to increase the productive capacity necessary to pay back the debt but for consumption, tax cuts, and military spending. From a ruling-class perspective (or at least some fraction of it), it could be argued, military spending is investment in the capacity of the U.S. state to intimidate others into accepting U.S. rules and to obtain control over valuable resources such as oil. From such a perspective, this is money well spent. However, the cost of imperialist adventure is going up and is not matched by success, so the cost/benefit ratio as seen by most ordinary Americans is not looking very good. The Persian Gulf War under the first Bush cost about $61 billion. Eighty percent of the total was paid for by American allies—Saudi Arabia, Kuwait, the United Arab Emirates, Germany, Japan, and South Korea, leaving the dollar cost of that war at only $7 billion for the United States (Japan alone contributed $13 billion). The Iraq invasion and occupation is a very different story. The United States is paying in lives and treasure, and it will continue to pay. The inflationary impact of such spending is hidden by low interest costs and the willingness of lenders to finance American profligacy.

What about the countries that are lending the United States all this money? Much of the so-called savings glut is coming from Asia. It is not the result of increased saving by households or private corporations. Rather it is fed by public sector saving as governments have cut back and increased their surpluses. Since the 1997 Asian financial crisis, which the Asian governments understand to have been a liquidity crisis, they have taken precautionary steps to dramatically increase their reserves to prevent a replay. Between 1996 and 2003, developing countries as a whole moved from a collective deficit of $88 billion to a surplus of $205 billion, a net change of $293 billion, a vast increase in global savings. The Federal Reserve estimates that this surplus increased by $60 billion in 2004. Figures for 2005 will show further increase. It is also the case that since the crisis, investment rates have fallen in the region (except for China) by more than 10 percent from the mid-1990s peak, as excess capacity is still being worked off and adjusted to the China impact. Because all of this saving is not being absorbed in productive investment, interest rates have fallen. Low interest rates have fueled the real estate bubble in the United States and some other places and allowed the cashing-out of the home equity loans that have fueled U.S. consumer spending.

Government-generated liquidity is also the engine of the other great motor of the contemporary global economy, China. China’s incredible investment rate, about 45 percent of its GDP, is also being driven by liquidity and not necessarily by expected profitability, raising the potential that China is growing too fast for its own good. State-owned banks are lending money to state-owned companies. In the case of enterprises owned by provincial authorities, borrowing and investment often seem to be uncorrelated with profitability, but rather are politically driven. Saving rates in China remain high in part because of an aging population worried about life in a free-market economy in which the provision of pensions, housing, education, and health care are not provided as a right by the state. At the same time, the significance of the U.S. current account deficit with China is complicated by a number of factors. First, most of China’s exports are controlled by foreign companies. These companies receive the profit when, say, a Barbie doll made for thirty-five cents in China sells for twenty dollars in a rich country’s market. Second, many of the products exported from China are not made there but assembled there from high-value components produced elsewhere. China’s value added is a fraction of the value of exports.

In 2005, China was the dominant Asian exporter, while exports from Asia as a whole were 36 percent of all world exports. In 1990, when Japan was the dominant exporter and we worried about Korea, Taiwan, Singapore, and Hong Kong, total exports from Asia were 38 percent of world exports. Much of what comes from China used to come from someplace else in Asia. Today Sony, Toshiba, and Panasonic, among others, send their products to the United States from China. Korea’s Samsung has twenty-three factories in China employing 50,000 workers. Taiwan may still control the market for computer components, but they are assembled in China by low-wage workers. Locals get only a small part of the profits generated. So while it is true that the U.S. deficit with China rose by 25 percent (to over $200 billion in 2005, and this is the largest debt the United States has ever run with any country), it is also the case that China’s deficit with the rest of Asia was more than two-thirds the size of its surplus with the United States. All together, the U.S. deficit with Asia has changed very little in recent years. It is the total value of oil and other energy sources that has been rising dramatically, thanks to the demand of a United States which refuses to conserve energy, causing it to run an increasingly large deficit when oil prices rise.

Importantly, on a global scale, saving and investment rates have both gone down, trends mainly reflecting developments in the industrial countries where both saving and investment have been trending downward since the 1970s even as saving has been increasing in the oil-producing countries and in Asia. The industrial countries still account for 70 percent of world saving, but this is down from 85 percent in 1970. Together, global savings and investment are near historic lows, having fallen markedly since the late 1990s. The even more telling figure is for the rate of growth of the global economy, which has been falling since the 1960s, when it was 5.4 percent to 4.1 percent in the 1970s, to 3.0 percent in the 1980s, to 2.3 percent in the 1990s. While mainstream economists dismiss any idea of a race to the bottom, there is an unquestionable slowing of growth and an emergent underconsumptionist, or rather overaccumulationist, trend. While global growth has slowed, the reach of transnational capital has dramatically increased, and its power to seek out lower costs and play workers in one place against workers elsewhere has grown. What we are seeing is a process of redistributional growth, in which over the ups and downs of the business cycle, capital’s share of the social product is increasing and labor’s share is diminishing.

There is a clear thread that connects domestic developments in the U.S. income distribution, debt-funded growth, the increased dominance of the rentier capitalists who profit from these developments, and global ambitions and the projection of imperial dominance. A century ago John A. Hobson argued that as the power of rentiers grows and taxation becomes more dramatically regressive, a hegemonic power (then Great Britain) is tempted to engage in imperialism. Hobson urged higher taxation of incomes generated as a result of financial speculation and government favoritism to produce a more equal distribution of income and higher working-class and middle-income spending, which would encourage domestic investment and make imperialism less attractive. He wrote,

The issue in a word, is between external expansion of markets and of territory on the one hand, and internal social and industrial reforms upon the other; between a militant imperialism animated by the lust for quantitative growth as a means by which the governing and possessing classes may retain their monopoly of political power and industrial supremacy, and a peaceful democracy engaged upon the development of its national resources in order to secure for all members the conditions of improved comfort, security, and leisure essential for a worthy national life. (John A. Hobson, “Free Trade and Foreign Policy,” Contemporary Review 64 [1898]: 179, quoted in Leonard Seabrooke, “The Economic Taproot of US Imperialism: The Bush Rentier Shift,” International Politics 41, no. 3 (September 2004): 293–318.

Today the “rentier shift” produces the very conditions Hobson warned of in the context of Great Britain a century ago. The growth of the rentier economy and the drive for external expansion long evident in U.S. history (and surely under both Clinton and Bush, albeit with a different policy mix) has been fed by an investor politics that has favored the very rich disproportionately in both taxation and government spending priorities. The dramatic increases in the upward redistribution of income have contributed to driving the investor class to look for opportunities abroad as the slower growth, and indeed saturation, of domestic markets pushes them to do. And this is taking place even as their increased class dominance—with trade unions and working-class power weakening, and real wages stagnating—allows them to push for a greater degree of regressive taxation and less progressive redistributive state spending.

Along Hobsonian lines, Arjay Kapur, a Citigroup strategist, argues that the rich are responsible for the low saving rate in Anglo-Saxon economies, which he describes as “plutonomies”—economies driven primarily by the wealthy as compared to the more egalitarian Japanese and European economies. In the plutonomies, above all the United States, it makes little sense to speak of the average consumer, since the top one percent of all households has 20 percent of the income, about the same as the bottom 60 percent.

Spending in the United States is driven by the asset inflation of the equity and real estate holdings of the top 10 percent of the income distribution. The wealth effect of such holdings allows debt- financed spending and results in the negative saving rate. Kapur finds that throughout our history there has been a strong negative correlation between the share of U.S. income going to the top 1 percent and the overall saving rate—the higher the share, the lower the saving rate. Economies with low saving rates tend to show current account deficits and the need for foreign borrowing.

To this analysis one might add that the power of the United States to command foreign credit depends in some measure on the power of the U.S. state, the continued use of the dollar as the reserve currency, and other factors which ultimately rest on U.S. imperial power. This relation is two-way. Harvard’s Linda Bilmes and Columbia’s Joseph Stiglitz estimate that the eventual cost of the war in Iraq will be more than a trillion dollars and possibly closer to two trillion dollars. So far the Bush administration has borrowed the money and underestimated the cost, but its policies raise the specter of imperial overstretch and the need for further coercion to keep the American economy afloat.

Past empires have followed the path that the United States seems to be going down, a movement from manufacturing production as the core activity to financialization and rentier income, and then finally bankruptcy from a loss of competitiveness and the cost of maintaining empire. For the elite there seems no better alternative, even if this is finally a negative-sum result. Any more positive strategy from the perspective of a democratic majority would require policies that would weaken the power of the ruling elite. It appears to this elite that it is better to continue to get rich and maintain power through the period of national decline. To the extent that this class can obtain rents from the familiar sources of state handouts, corrupt dealings, and tax policies, it stands to gain.

In conclusion, the concern over debt levels and bubbles is certainly appropriate. What is essentially a regional and sectoral disproportionality crisis leading to imbalance in capital flows and the high debt position of the United States is deserving of the attention it is receiving from all points on the ideological compass. What must be central to such discussions, however, is the class dimension of the accompanying redistribution of wealth and power and the resultant impact on members of the world’s working classes. Disproportionalities are more than matters of technical economics. They are manifestations of class struggle. Understood in this way, analysis enables more clear-sighted mobilization addressed at real enemies and demands for real solutions. Imperialist adventurism today serves the U.S. ruling class. It comes at the expense of working people everywhere.