Supposedly, Congress and the incoming Bush Administration are under immense pressure from friendly nations to reach agreement on a deficit-reduction deal. If the federal budget deficit stays high, according to this view, the dollar and the economy could suffer a hard landing.
But there is an even worse prospect. It's just possible that foreign creditors could decide that they like the status quo. And the economy could keep chugging along as it has for much of the Reagan Administration, with foreign capital keeping America on life-support, as the real productive strength of our economy continues to erode.
Despite the famous "twin deficits"--the $155-billion annual federal budget deficit and the $150-billion to $200-billion trade imbalance--foreigners have found it expedient to pump capital into the United States. Because the dollar continues to be the world's unofficial currency, the United States remains the only debtor nation that gets to borrow from foreign creditors in its own currency.
As the value of the dollar slowly declines, this is the equivalent of writing off small portions of our foreign debt. Poor Brazil doesn't get to borrow in its own currency. As the value of its cruzado keeps declining, Brazil has to pay the debt back in dollars, which are even more expensive.
But why do the European and Japanese keep indulging our appetite for ever greater borrowing, despite the fact that we repay them in a debased currency?
The answer to that question has several parts, and each is very sobering.
First, as America goes deeper and deeper into debt to foreigners, we are paying for some of that credit addiction by selling off real assets, too cheaply.
In 1987 the United States had a total national savings rate of just 2% of gross national product, but domestic investment was 5.8% of GNP. The missing 3.8%--almost $200 billion--came from foreign capital. Some of it went to buy U.S. Treasury debt, and some of it went to buy real estate, factories and entire companies.
There is nothing wrong with foreigners investing in United States--as long as the flow of capital doesn't become a one-way street. But because of the twin deficits and the pitifully low domestic rate of savings, the inflow of foreign capital has been dwarfing the outflow of U.S. investments. If this continues for a couple of decades, we will become a kind of economic colony.
The second reason why European and Japanese investors keep financing our deficits is the same reason why department stores give you a credit card even though they know you're already deeply in hock. They want you to keep buying their products.
Germany and Japan today have strong currencies, productive industries and big trade surpluses. They recycle that capital into loans to profligate Americans. We turn around and use the money to keep indulging our taste for Mercedes cars and Sony VCRs.
On balance, the Germans and Japanese don't mind that their dollars gradually decline in value, because their economies get richer and stronger in the process. And the American office buildings, hotels, factories, etc. that they buy with the play-money dollars are real assets.
In theory the cheaper dollar was supposed to make foreign products more expensive and U.S. products cheaper in world markets. But it hasn't quite worked out that way. The Germans and the Japanese have managed to adapt to a cheaper dollar by becoming ever more productive and ever richer. Instead of making American products more attractive, the main result has been to put American assets on sale.
It may turn out that the international economy doesn't force the United States to exercise greater fiscal discipline, but only allows us greater profligacy and greater dependency. Consider an all-purpose expression frequently used by the Japanese: "administrative guidance."
When the Japanese government tells Toyota that it had better voluntarily limit its exports in order to appease Congress, or when the Ministry of International Trade and Industry advises Japanese banks to bail out Mazda, or when the Ministry of Finance urges Japanese pension funds to keep buying dollar bonds, this is discreetly termed "administrative guidance."
Although we Americans may believe that Adam Smith's invisible hand rules the market, in reality our ability to keep the U.S. economy humming along on foreign capital partly reflects the unseen hand of the Japanese government. Administrative guidance is one more Japanese export on which America has become dependent. And the more we depend on it, the more it guides us as well as the Japanese.
This, unfortunately, could go on for quite some time. If there is one thing more dangerous than a wasting disease with painful symptoms, it is one with painless symptoms.