U.S. debt should be downgraded to below Japan: Japan sound, U.S insolvent
By Peter Morici
web posted January 31, 2011
S&P last week downgraded Japan's long-term debt from AA to AA-, indicating the U.S. AAA rating should be taken down several notches to less than AA-.
National economies must generate foreign currency for their governments to pay foreign creditors, and national governments must be able to tax, sell bonds or print money, without causing inflation, to cover operating expenses and pay interest.
Japan's ability to pay is simply much stronger than the United States.
Japan has a strong current account surplus—thanks to a powerful manufacturing export machine—and the Bank of Japan sits on $1 trillion in foreign currency reserves. It has more than enough cash flow and adequate reserves to service the claims of foreign creditors. The United States can hardly make such a claim.
Domestically, Japan does suffer from deflation, slow growth and maintains a large budget deficit to prop up domestic demand, because Japanese citizens save so much. With prices falling, even in the face of global commodity inflation, the Japanese government has adequate latitude to sell bonds to its savers, and the BoJ has more than enough flexibility to purchase those bonds as needed—monetarize debt—without instigating domestic inflation or creating other adverse macroeconomic consequences.
The United States is a wholly different situation. The U.S. has a gapping current account deficit—on oil and with China—and policies pursued by the Bush and Obama Administrations are worsening those conditions. Owing to the large current account deficit, the United States must run a huge budget deficit, close to 10 percent of GDP, just to sustain growth at 3.5 percent and keep unemployment from flying out of control.
The large U.S. current account deficit indicates the U.S. economy as a whole is not generating adequate revenues to pay foreign creditors interest due on U.S. debt, and Washington must service the interest on externally held debt by printing more bonds and selling those abroad, but foreign private demand for those bonds is satiated. Consequently, the United States is much too dependent on the government of China to print yuan to buy dollars, and in turn, to use those dollars to buy Treasuries to finance the U.S. private economy's current account deficit and the federal budget deficit.
Beijing plays along because the resulting weak yuan and trade surplus with the United States helps deal with Chinese unemployment, but printing so many yuan requires Beijing to sterilize those extra yuan by persuading Chinese investors to purchase too many yuan-denominated government bonds—bonds the private sector does not want. The result is domestic inflation and global commodity inflation, as the Chinese private sector chases oil, commodities and food with too much liquidity.
Sterilization has not been wholly successful, and inflation domestically and globally is resulting from printing presses in overdrive at the Peoples Bank of China and the Federal Reserve. This is evidenced most vividly by rising energy and food prices globally in most countries
The government in China is like a big man sitting on the lid of a boiling pot. It is trying to regulate domestic fuel, commodity and food prices, but sooner or later all the pressure inside the pot will thrust the man off and the boiling water will scald him and all those standing close to him—including Uncle Sam.
Energy, commodity and food inflation will soon push up U.S. inflation and constrain Washington's ability to sustain even modest growth. Treasury borrowing rates will rise the second half of 2011, pushing up the federal deficit, and inflation will limit the Federal Reserve's ability to monetarize government debt through quantitative easing.
The dollar may be the reserve currency, but the global economy cannot absorb enough U.S. bonds and dollars with a U.S. federal deficit exceeding $1.5 trillion or 2.5 percent of global GDP. No one wants that much cash, and China can print and sterilize only so many yuan to buy U.S. debt without setting off a Weimar Republic inflation in the Middle Kingdom.
Even though the U.S. dollar is the reserve currency, Washington faces limits in how many bonds and dollars it can print without wrecking havoc. It is now over the limit.
The U.S government must soon dramatically cut its deficit, and correct the problems that require such a large federal deficit—huge trade deficits on oil and with China, and chronically low household savings—or face financial Armageddon.
Japan is sound, but the United States is teetering on insolvency.
Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission.
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