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[bob ford <bobford79 AT yahoo.com>]

This is one of the best  summations, I have yet read, on the world's economic 
crisis and how it affects and could, in the future, affect those of us in the 
U.S.  It is a long one-page commentary which I have includede, with link, 
below. This is objective, factual, scary reading. .....bobford   

exceprts:

" The US national debt as of March 2008 stands at $9.4 trillion. This equates 
to over $30,000 per person in the US population or a little over $60,000 per 
head of the US working population. The US national debt has grown by $3 
trillion (50%) since 2000, when it was $6 trillion. In 2007 alone, it grew by 
$500 billion, from $8.7 to $9.2 trillion. In 2005, it was 67% of US GDP, up 
from 51% in 1988. Prior to the current crisis, the Office of Management and 
Budget projects that total debt will rise to $12.3 trillion in 2013.

"The debt figures 'do not' include significant private sector debt (both 
corporate and consumer). It does not include “hidden” liabilities - unfunded 
public (Social Security) and private pension arrangements or unfunded medical 
and health obligations (Medicare and Medicaid)."

":In July 2008, Richard Fisher, head of the Dallas Federal Reserve Bank, 
speaking in a private rather than official capacity noted that “the unfunded 
liabilities from Medicare and Social Security...comes to $99.2 trillion over 
the infinite horizon”. This equates to $1.3 million per family of four - over 
25 times the average household's income."

"The debt figures also do not include “off-balance sheet” liabilities - the 
approximately $6 trillion plus in debt and guarantees of the government 
sponsored enterprises (“GSE”) - Fannie Mae (Federal National Mortgage 
Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). This 
is supported by modest levels of capital (about $81 billion). In mid 2008 
these obligations became de facto part of US national debt with astonishing 
speed."




Full Commentary:
---------------------------------------------------------------------------
"We interrupt regular programming to announce that the United States of 
America has defaulted"

By: Satyajit Das | Nov 11, 2008 

On 30 October 1938, the American Radio Drama series Mercury Theatre aired 
“The War of the Worlds”, directed by Orson Welles. Adapted from H.G. Welles’ 
novel, the first half of the broadcast was scripted as a series of dramatic 
news bulletins of a Martian invasion. Listeners who had missed or ignored the 
opening credits assumed that the invasion was real. People fled their homes. 
Police were swamped by panicked phone calls. Today the financial equivalent 
of this broadcast would be the announcement: “we interrupt regular 
programming to announce that the United States of America has defaulted on 
its debt!”

Pay back in devalued dollars…

Default is the failure to honour contractual obligations; in the case of 
debt, non-payment of interest or principal payments due to the lender. The 
financial impact of default is the loss suffered by the lender.

Lenders to the United States (“US”) government have already suffered 
significant losses. The losses have not been from non-payment but because 
repayments have been in a constantly debased currency – the dollar.

Assume a Japanese investor bought 30 year US Treasury bond in 1985 when the 
$/ yen exchange rate was $1 = Yen 250. Based on an exchange rate of $1 = Yen 
105, the investor has lost 58% of the investment. The investor can take 
comfort that at the low of $1=Yen 84, the investor would have lost 66%. 
European investors who bought US government bonds in recent years would have 
also suffered significant losses. Based on the highest $/ Euro exchange rate 
(Euro1 = $ 0.85) and recent trading levels (Euro1 = $ 1.56), the investor 
would have lost (up to) 46%.

Given that in a typical sovereign default the investor loses 50% to 80% of 
the value of the investment, the losses suffered are not far short of 
default. Despite “strong dollar” official policies, a case can be made that 
the US is in the process of defaulting on its obligations via a systematic 
devaluation of its currency.

Debt for all ….

US problems are evident from other indicators. The US national debt as of 
March 2008 stands at $9.4 trillion. This equates to over $30,000 per person 
in the US population or a little over $60,000 per head of the US working 
population. The US national debt has grown by $3 trillion (50%) since 2000, 
when it was $6 trillion. In 2007 alone, it grew by $500 billion, from $8.7 to 
$9.2 trillion. In 2005, it was 67% of US GDP, up from 51% in 1988. Prior to 
the current crisis, the Office of Management and Budget projects that total 
debt will rise to $12.3 trillion in 2013.

Of the $4.7 trillion in private hands, $2.4 trillion (51%) is held by foreign 
investors. Japan holds around $600 billion (24%) and China holds $500 billion 
(around 20%). U.K., Brazil and the oil exporting countries own about 6%. 
Middle East and Russian holdings may be higher as Belgium, Caribbean Banking 
Centers and Luxembourg (8%) may be vehicles for investments by oil-exporting 
countries wishing to avoid disclosure. As James Fallow writing in The 
Atlantic noted: “every person in the (rich) United States has over the past 
10 years or so borrowed about $4,000 from someone in the (poor) People’s 
Republic of China.”

The debt figures do not include significant private sector debt (both 
corporate and consumer). It does not include “hidden” liabilities - unfunded 
public (Social Security) and private pension arrangements or unfunded medical 
and health obligations (Medicare and Medicaid).

In June 2008, Peter Orszag, Congressional Budget Office Director, did not 
mince words when testifying before the Senate Finance Committee: “…the US 
economy faces the long-term threat of ‘collapse’ unless major reforms on 
health care spending are instituted in the coming years.” The federal budget, 
according to Orszag, is on an “unsustainable path” with health care costs 
growing much faster than the overall economy. Unless health care spending is 
brought under control, Orszag noted that the American economy faces crippling 
problems that “would make our current economic difficulties look tiny”. In 
July 2008, Richard Fisher, head of the Dallas Federal Reserve Bank, speaking 
in a private rather than official capacity noted that “the unfunded 
liabilities from Medicare and Social Security...comes to $99.2 trillion over 
the infinite horizon”. This equates to $1.3 million per family of four - over 
25 times the average household's income.

The debt figures also do not include “off-balance sheet” liabilities - the 
approximately $6 trillion plus in debt and guarantees of the government 
sponsored enterprises (“GSE”) - Fannie Mae (Federal National Mortgage 
Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). This 
is supported by modest levels of capital (about $81 billion). In mid 2008 
these obligations became de facto part of US national debt with astonishing 
speed.

US national debt is also shortening in maturity. In December 2000, the 
average length of US public debt held by private investors was 70 months. As 
at March 2008, the average length had shortened to 53 months (a decline of 
24%). 71% of this debt is due in less than 5 years; 39% is due in less than 1 
year. In the Clinton/ Rubin years, the Treasury stopped issuing 30 year bonds 
(the decision was reversed by the Bush administration). The ostensible 
rationale was that projected US budget surpluses would allow the government 
debt to be retired. Shorter dated bonds also took advantage of lower shorter 
interest rates to reduce interest cost and boost surpluses (this was the US 
government’s version of the carry trade). The US must now “roll over” or 
refinance significant amounts of debt in the coming years.

Multiple troubles…

High levels of debt are compounded by the “twin deficits” – the 2008 budget 
deficit forecast is $400billion (3% of GDP) and the current account deficit 
is expected to exceed $ 800 billion (over 4% of GDP). The budget deficit is 
expected to rise reflecting the cost of financing recent actions to support 
the financial system, increased government spending to stimulate the economy 
and lower tax revenues from slower growth.

The US savings rate is extremely low. US consumers have relied on asset 
appreciation (primarily housing and also stocks) as saving. In recent years, 
borrowing against asset values to fund consumption has reduced even this.

One mainstay of the US economy has been its financial system – “financial” 
engineering has long overtaken “real” engineering. Lawrence Summers, a former 
Deputy Secretary of the US Treasury, proudly extolled the merits of the US 
financial system in a 2001 speech at the London Stock Exchange in the 
following terms: “… the United States is the only country in which you can 
raise your first $100 million before you buy your first suit.” He gave short 
shrift to critics who felt that US financial sophistication was synonymous 
with financial instability: “[That belief] is observed in inverse proportion 
to knowledge of these matters.”

The US financial system has been badly affected by the current credit crisis. 
Financial institutions have incurred losses in excess of $500 billion. There 
is a strong likelihood that the losses will increase.

By September 2008, the US banking system was experiencing significant 
liquidity and solvency issues. A number of major commercial banks (Washington 
Mutual; Wachovia) and broker dealers (Bear Stearns; Lehman Brothers; Merrill 
Lynch) have been forced to merge or have filed for bankruptcy. More banks are 
expected to fail in the near future.

The Federal Reserve and US Treasury has been forced to undertake aggressive 
actions to support the financial system. The Fed has provided almost $1.8 
trillion in funding support to the financial system. The US government has 
also committed to financing (up to) $ 1.4 trillion of mortgage backed 
securities currently held by Fannie Mae and Freddie Mac.

The Federal Reserve and US Treasury have already entered into arrangements to 
finance JP Morgan’s acquisition of Bear Stearns. They have also directly 
supported AIG, the insurance giant, by up to $144 billion in funding.

In September US Treasury Secretary Henry Paulson introduced a plan that would 
commit the government to providing (up to) $700 billion to purchase 
mortgage-related assets from financial institutions. The plan was 
subsequently altered to encompass direct equity purchases in selected banks. 
Faced with a run on money market funds, the government also agreed to 
provided $400 billion to guarantee money-market mutual funds and an 
additional amount to purchase commercial paper. Government support for 
financial institutions in this financial crisis is already approaching 6% of 
GDP (compared to less than 4% for the 1980s Savings and Loans crisis).

The claims on the government are by no means over. The Federal Deposit 
Insurance Corporation (“FDIC”) has around $ 45 billion in funds available to 
meet its obligations. Given the expected increase in bank defaults, it is 
possible that the FDIC may need added capital and funding from the 
government. Other GSEs, including the Federal Home Loan Banks, have 
aggressively increased mortgage lending and may also require 
re-capitalisation. Non-financial industries, such as the troubled automobile 
and airline sectors, may also need government support. Congress has already 
approved a $25 billion low cost loan to the automobile sector.

Additional government borrowings (perhaps up to an additional $2-3 trillion) 
may be necessary to support to the financial system. This would mean that US 
government debt would reach a level of around 70% of GDP, a level not seen 
since 1954, when the US was repaying the costs of World War II. The 
additional debt may ultimately lead to a review of the USA’s AAA rated 
sovereign debt rating.

While the rescue boosted financial markets, the long-term impact on the US 
budget and current-account deficit and ultimately the US dollar is unlikely 
to be positive.

Financial engineering….

Confidence in US financial markets has suffered. The growth of the network of 
securitisation and off-balance sheet vehicles – the “shadow banking” system – 
without regulatory oversight to the point where it now threatens the 
financial system has perplexed foreign observers. Byzantine US accounting 
practices (especially off-balance sheet debt, mark-to-market and derivative 
accounting) and the failures of rating agencies (a substantially US 
phenomenon) have also affected confidence.

The veracity of economic information has been questioned. Bill Gross of Pimco 
and other commentators argue that the official measure of “inflation” 
significantly understates actual levels because of statistical adjustments 
made over the past 25 years. In a 1998 speech during the Asian financial 
crisis, Lawrence Summers preached the merits of American-style “transparency 
and disclosure”. It is the US that now needs “transparency and disclosure”.

Mohamed El-Erian, Pimco Co-Chief Executive of PIMCO summed it up on 25 June 
2008: “What has suffered most is the credibility of the most sophisticated 
financial systems in the world.”

There are other dimensions to the malaise. John Gapper, a columnist for the 
Financial Times observed on 8 May 2008: “If anyone doubts the problems of US 
infrastructure, I suggest he or she take a flight to John F. Kennedy airport 
(braving the landing delay), ride a taxi on the pot-holed and congested 
Brooklyn-Queens Expressway and try to make a mobile phone call en route. That 
should settle it, particularly for those who have experienced smooth flights, 
train rides and road travel, and speedy communications networks in, say, 
Beijing, Paris or Abu Dhabi recently. The gulf in public and private 
infrastructure is, to put it mildly, alarming for US competitiveness.”

The factors identified are well known. Lawrence Summers once observed: “In 
this age of electronic money investors are no longer seduced by a financial 
dance of a thousand veils. Only hard accurate information on reserves, 
current account and fiscal and monetary conditions will keep capital from 
fleeing precipitously at the first sign of trouble.” Why haven’t the 
“electronic herd” abandoned the US? Facts it seems don’t matter, at least 
until they do.

Reserve the currency….

High levels of debt are sustainable provided the borrower can continue to 
service and finance it. The US has had no trouble attracting investors to 
date. In recent years, the United States has absorbed around 85% of total 
global capital flows (about $500 billion each year) from Asia, Europe, Russia 
and the Middle East. Risk adverse foreign investors preferred high quality 
debt – US Treasury and AAA rated bonds (including asset-backed securities 
(“ABS”), including mortgage-backed securities (“MBS”)).

Warren Buffett in his 2006 annual letter to shareholders noted that the US 
can fund its budget and trade deficits as it is still a wealthy country with 
lots of stock, bonds, real estate and companies to sell. In reality, a 
significant portion of the money flowing into the US was not used to finance 
productive investments but funded government spending, (sometimes 
speculative) property and consumption.

The real reason that the US actually has not experienced a sovereign debt 
crisis is that it finances itself in it own currency. This means that the US 
can literally print dollars to service and repay it obligations.

In February 1988, Thomas Moore, a member of the Presidents’ Council of 
Economic Advisors recognised this: “We can pay anybody off by running a 
printing press, frankly… so it is not clear to be how bad [the transition to 
net debtor status] is.” In other words, the dollar printing presses could be 
run to service debt. In fairness, Mr. Moore was not advocating this as “sound 
policy”.

The special status of the US derives, in part, from the fact that the dollar 
is the world’s major reserve and trade currency. The dollar’s status derives, 
in part, from the gold standard that once pegged the dollar to the value of 
gold. The peg and full exchangeability is long gone. The aura of stability 
and a safe store of value based on the perceived strength of US economy and 
American military power has continued to support the dollar. In 2003, Saddam 
Hussein, when captured, had $750,000 with him – all in $100 bills.

The dollar's favoured position in trade and as a reserve currency is based on 
complex network effects. Many global currencies are pegged to the dollar. The 
link, sometimes at an artificially low rate, like the Chinese Renminbi, is 
used to maintain export competitiveness.

This creates an outflow of dollars (via the trade deficit that is driven by 
excess US demand for imports based on an overvalued dollar). Foreign central 
bankers are forced to purchase US debt with dollars to mitigate upward 
pressure on their domestic currency. The recycled dollars flow back to the US 
to finance the spending. This merry-go-round is a significant source of 
liquidity creation in financial markets. Large, liquid markets in dollars and 
dollar investments are both a result and facilitator of the process and 
assist in maintaining the dollar’s status as the world’s primary reserve 
currency.

The dollar’s dominance may be coming to an end. Recently, Wen Jiabao, the 
Prime Minister of China identified the need to “diversify” the global 
currency system. This is a subtle way of suggesting that the dollar’s 
dominant role as a reserve currency should be reduced.

There is increasing discussion of re-denominating trade flows in currencies 
other than $. Exporters are beginning to invoice in Euro or Yen. In the early 
1970s Japanese exports were invoiced almost exclusively in dollars. Today 
only 50% of Japanese exports are invoiced in dollars. Around 40% of Japanese 
exports are invoiced in yen, an increase from 34% in 2001. The decline in 
dollars held outside the US from 1.83% of world trade in 2002 to 1.22% in 
2006 may reflect changes in its role in global trade.

The Taj Mahal now does not accept payment of its entrance fee in dollars 
preferring the “strong” Rupee. Apparently super models and even drug dealers 
now prefer Euros to dollars.

There are proposals to price commodities, such as oil and agricultural goods, 
in currencies other than dollars. Some countries have abandoned or loosened 
the linkage of their domestic currency to the dollar. Others are considering 
such a move.

Foreign investors, including central banks, have reduced investment 
allocations to the dollar. The dollar’s share of reserves has fallen from a 
high of 72% to around 60%.

Foreign investor demand for US Treasury bonds has weakened in recent times. 
Recent auctions of Treasury bonds have been characterised by poor 
“bid-to-cover” ratios (the level of demand relative to the amount offered for 
sale) and “long tails” (the difference between the average accepted rate and 
highest rate on the bonds issues). Low nominal (negative real) rates on 
interest and bouts of dollar weakness are key factors. Secondary market 
liquidity for Treasury bonds has also weakened evidenced by high levels of 
“failed trades” (settlement or delivery failures). Foreign investors are also 
beginning to question the credibility of the Federal Reserve and US Treasury.

For example, the debt of Fannie Mae and Freddie Mac had long been regarded as 
“implicitly” backed by the US government despite the absence of any explicit 
guarantee. Foreign investors, including more than 60 global central banks, 
hold over $1,400 billion in securities of US agencies including Fannie Mae 
and Freddie Mac.

On 23 July 2008, the Financial Times, reported that the US embassy called the 
Kuwait Investment Authority (“KIA”), the world’s sixth-biggest sovereign 
wealth fund, to reassure them about the “soundness” of bonds issued by Fannie 
Mae and Freddie Mac after Kuwait’s minister of finance announced that the KIA 
was not planning to invest in their debt in future. Yu Yongding, a Chinese 
economist and former advisor to China’s central bank, recently warned that: 
“If the US government allows Fannie and Freddie to fail and international 
investors are not compensated adequately, the consequences will be 
catastrophic. If it’s not the end of the world, it is the end of the current 
international financial system.”

Following the announcement of the US government’s $700 billion plan to 
restore confidence to the financial system, Kwag Dae Hwan, head of global 
investment… with South Korea’s $220 billion National Pension Fund noted: “The 
image of US Treasuries as a safe haven has been tainted by the ongoing 
financial debacle … A big question mark hangs over whether the US can deal 
with an unprecedented amount of debt. That is unnerving all the investors, 
including me.”

A mere United States security …

Investors around the world are now faced with deterioration in the 
creditworthiness of the world’s largest borrower. Scrooge’s nightmare, 
described by Charles Dickens, in which “solid” British assets are changed 
into “a mere United States security” may become a reality.

On 28 October 2008, Anthony Ryan, the Treasury's acting undersecretary for 
domestic finance speaking at a conference in New York noted that: “[The US. 
Treasury’s] financing needs will be unprecedented”. Market estimates suggest 
that issuance of Treasury securities will rise to about $1.15 trillion in 
2009 from around $724 billion in 2008.

Ryan also acknowledged explicitly that the US government was “effectively 
guaranteeing” debt issued by Fannie Mae and Freddie Mac: “The US government 
stands behind these enterprises, their debt and the mortgage-backed 
securities they guarantee” Ryan said. The US Treasury is looking at selling a 
wider range of securities – 3 year notes and also longer term debt – to meet 
its requirements.

The need for additional financing comes at a time when other governments also 
need to raise large amounts of funding, in part to finance support of their 
banking sectors. For example, European government will need to issues bonds 
totalling around Euro 1 trillion ($1.25 trillion) in 2009 (See Table below). 
The US will need to compete with these issuers to meet its funding 
requirements.



Foreign investors may not continue to finance the US. Wen Jiabao, the Prime 
Minister, indicated that China’s “greatest contribution to the world” would 
be to keep it’s own economy running smoothly. This may signal a shift whereby 
China uses its savings to invest in the domestic economy rather than to 
finance US needs.

At a minimum, the US will at some stage have to pay higher rates to finance 
its borrowing requirements.

The credit default swap (“CDS”) market for sovereign debt is increasingly 
pricing in increased funding costs for the US. The fee for hedging against 
losses on $10 million of Treasuries was about 0.40% pa for 10 years 
(equivalent to $40,000 annually) in October 2008. This is an increase from 
0.01% pa ($1,000) in 2007. The equivalent CDS fee for German government bonds 
has also increased from 0.02% pa to 0.37% pa $37,000 from $2,000.

Ultimately, the US may be forced to finance itself in foreign currency. This 
would expose the US to currency risk but most importantly it would not be 
able to service its debt by printing money. The US, like all borrowers, would 
become subject to the discipline of creditors.

For the moment, the dollar is hanging on. This reflects structural weakness 
in the Euro and Yen based on deep-seated problems in the respective 
economies. The artificial nature of the Euro and its long term survival is 
also problematic. Substantial European bank lending to emerging markets, 
especially in Eastern Europe, remains a concern.

The dollar is also a beneficiary of the “too big to fail” syndrome. Foreign 
investors, especially central banks and sovereign investors in East and South 
Asia, Russia and the Gulf, have substantial dollar investments that would 
show catastrophic losses if the US were to default or its currency devalue. 
The International Monetary Fund (“IMF”) estimated that Gulf Cooperation 
Council (Saudi Arabia, the United Arab Emirates, Qatar and other Gulf States) 
might lose $400 billion if they decide to stop pegging their currencies to 
the dollar.

Every lender knows Keynes’ famous observation: “If I owe you a pound, I have 
a problem; but if I owe you a million, the problem is yours.” In history’s 
largest Ponzi scheme, foreign creditors must keep supporting the US. As the 
old observation goes: “The only man who sticks closer to you in adversity 
than a friend is a creditor.”

Traders have a saying: “Don’t panic but if you are going to panic, panic 
first.” The present MAD (mutually assured destruction) pact that binds the US 
and its creditors is fragile. Dollar holders are acting like a cartel. A 
break in the cartel - a major investor deciding to exit in the belief that it 
can get out – could be extremely disruptive.

Does any of this matter? Walter Wriston, then chairman of Citigroup, opined 
that: “Countries don't go broke”. In 1982, shortly after this statement, 
Mexico, Brazil and Argentina defaulted inflicting near mortal losses on 
Citibank.

Sovereign debt crisis, especially in emerging markets, are characterised by 
high levels of debt, especially foreign borrowings, poor fiscal policies, 
persistent trade deficits, a fragile financial system, over-investment in 
unproductive assets and a sclerotic political system. Arturo Porzecanski (in 
Sovereign Debt at the Crossroads (2006)) noted that: “Governments tend to 
default specifically when they must increase spending quickly (for instance, 
to prosecute a war), experience a sudden shortfall in revenues (because of a 
severe economic contraction), or face an abrupt curtailment of access to bond 
and loan financing (e.g. because of political instability). He further 
observed that: “governments with large exposures to currency mismatches and 
interest rate or maturity risks are, of course, particularly vulnerable.”

Can the status quo continue? The US must ultimately pay the piper. Max 
Winkler, who had warned against the excesses of the boom that culminated in 
the Great Depression, in his book Foreign Bonds: An Autopsy (1933) noted: 
“The history of government borrowing is really the history of government 
defaults.”

Taking the cure …

So what must the US do to remedy the problem? In 1989, John Williamson 
described certain economic prescriptions - the Washington Consensus – that 
became a “standard” reform package promoted for crisis-wracked countries by 
the IMF. The controversial, much criticised package includes: fiscal policy 
discipline; redirection of public spending from subsidies; tax reform; market 
determined and positive real interest rates; competitive exchange rates; 
trade liberalization; liberalization of inward foreign direct investment; 
privatization of state enterprises; and deregulation. Resolution of the 
problems facing the US requires adopting many elements of the standard IMF 
economic reform package for emerging markets.

Some elements, such as fiscal and monetary discipline, are politically 
difficult if inevitable. Reform of farm subsidies must overcome deep-seated 
resistance.

Markets are restless for action and do not wait. The US dollar has weakened 
and is likely to fall further. This helps exporters, tourism and will 
ultimately attract inwards foreign investment.

Foreign investment has been slow. Weak economic growth and concerns about the 
US financial system have offset the effects of a lower dollar. The “closing 
down sale” of US assets - real estate, companies and infrastructure assets - 
has begun. InBev, a Belgian based brewer has launched an unsolicited bid of 
$46 billion for Anheuser-Busch, the brewer of Budweiser, the quintessential 
American beer. Abertis Infraestructuras, a Spanish infrastructure company 
teamed with Citigroup, submitted $12.8 billion, the largest bid, for the 
right to lease the Pennsylvania Turnpike for the next 75 years. Foreign 
investors have provided a substantial amount of the capital needed to 
re-capitalise the US financial system.

Increasing foreign investment is politically sensitive in America. Surveys 
show that most American would prefer key businesses to remain in American 
hands. Public concern about investment by Sovereign Wealth Funds (“SWF”) 
reflects this financial xenophobia.

Political considerations led to the failure of two foreign takeovers – China 
National Offshore Oil Corporation’s (“CNOOC”) bid for Unocal and Dubai Ports 
World acquisition of a company that managed container terminals in the US. In 
2008, the Government Accounting Office’s (“GAO”) overturned the $35 billion 
contract awarded to a combination of an American corporation Northrop Grumman 
and European EADS for US military mid-air refueling aircraft after a 
challenge by Boeing. Foreign investors view the decisions as a sign of 
implicit resistance to foreign investment in sensitive and strategic areas of 
the economy.

Business leaders have spoken out in favour of foreign investment. In his 2007 
letter to shareholders Warren Buffett noted that foreign investment was a 
function of misguided US policies and not “some nefarious plot by foreign 
governments”. Stephen Schwarzman (the head of private equity firm Blackstone) 
struck a shriller note in an opinion piece in the Financial Times in June 
2008: “… hostility is dangerous … The US is the world’s largest debtor nation 
and we are now in an uneasy relationship with our creditors. … If we were 
forced to rely mostly on domestic borrowing, we would have to pay very high 
interest rates. The consequences would be increased inflation, a dollar 
falling even faster and very slow (or negative) economic growth. If the 
investment climate for SWFs is poor in the US, the countries with large 
dollar reserves (which are the owners of most of the SWFs) could … look for 
alternatives.”

The “adjustment” may be under way. The dry measured economic prose of the 
Washington Consensus does not capture its human elements. It will require 
reductions in US real wages and living standards on a scale that those who 
have not experienced it first hand cannot understand. Just ask the average 
citizen of many Asian countries (post the 1997/ 1998 monetary crisis), 
Argentina and any other country that has taken the IMF’s “cure”.

A character in Siri Hustvedt’s novel The Sorrows of an American (2008) 
records the following diary entry at the time of the Great Depression: “A 
depression entails more than economic hardship, more than making do with 
less. That may be the least of it. People with pride find themselves beset by 
misfortunes they did not create; yet because of this pride, they still feel a 
pervasive sense of failure… People become powerless.”

In the twentieth century, the US and the dollar overtook Great Britain and 
the Pound Sterling as the pre-eminent global economic power and currency. A 
similar epochal tectonic shift in the global economic order may be commencing.

The shift is not inevitable. There is much to admire about the US. It remains 
wealthier than other nations including the new titans - China and India. 
America remains a science and technology powerhouse. It accounts for 40% of 
total world spending on research and development, and outperforms Europe and 
Japan. For example, between 1993-2003 America’s growth rate in patents 
averaged 6.6% a year compared with 5.1% for the European Union and 4.1% for 
Japan. America’s economy with its growing population, secure legal and 
property rights and well-developed financial markets has been attractive to 
investors.

However as Warren Buffett in his 2006 annual letter to shareholders observed: 
“Foreigners now earn more on their US 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 US will now 
experience ‘reverse compounding’ as we pay ever-increasing amounts of 
interest on interest. …. no matter how rich you are, borrowing on top of 
borrowing is not a great long-term financial plan. I believe that at some 
point in the future, US workers and voters will find this annual 'tribute' 
(of interest payment on the debt) 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.”

The Economist magazine wrote that: “…public credit depends on public 
confidence…The financial crisis in America is really a moral crisis, caused 
by the series of proofs …that the leading financiers who control banks, trust 
companies and industrial corporations are often imprudent, and not seldom 
dishonest. They have mismanaged…funds and used them freely for speculative 
purposes. Hence the alarm of depositors and a general collapse of credit…” 
The words appeared over 100 years agoon 2 November 1907 during the 1907 crash.

The US faces a challenge to reestablish its economic credentials. Without 
drastic and radical action, America’s ability to continue to borrow from 
foreign investors to meet its financing requirement is likely to become 
increasingly difficult.

The mass hysteria and panic that followed the broadcast of Orson Welles The 
War of the World played on fears about an attack by Germans. It is 
interesting to speculate whether a broadcast on a default by the US on its 
sovereign debt would play on the secret fears of global markets triggering a 
similar panic.

“We interrupt regular programming to announce that the United States of 
America has defaulted on its debt!”


--------------------------------------------------------------------------------

© 2008 Satyajit Das All Rights reserved.

Satyajit Das works in the area of financial derivatives and risk management. 
He is the author of a number of key reference works on derivatives and risk 
management include Swaps/ Financial Derivatives Library – Third Edition 
(2005, John Wiley & Sons) (a 4 volume 4,200 page reference work for 
practitioners on derivatives) and Credit Derivatives, CDOs and Structured 
Credit Products –Third Edition (2005, John Wiley & Sons). He is the author of 
Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of 
Derivatives (2006, FT-Prentice Hall), described by the Financial Times, 
London as " fascinating reading … explaining not only the high-minded theory 
behind the business and its various products but the sometimes sordid reality 
of the industry". He is also the author (with Jade Novakovic) of In Search of 
the Pangolin: The Accidental Eco-Tourist (2006, New Holland).

At the time of publication the author or his firm did not own any direct 
investments in securities mentioned in this article although he may be an 
owner indirectly as an investor in a fund. 
http://www.rgemonitor.com/financemarkets-monitor/254332/we_interrupt_regular_programming_to_announce_that_the_united_states_of_america_has_defaulted