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• The trade deficit's deep bite, 3/17/2006
• 5 ways to profit from Buffett's forecast, 3/15/2006
• Japan's gain could be your loss, 3/14/2006
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5 ways to face our nation's Wimpy mentality
Like the cartoon character who offers to pay tomorrow for the burger he wants today, our nation is addicted to borrowing -- despite the painful consequences.
By Jim Jubak
When it comes to paying our bills, the United States is a nation of Wimpys.
That's not "wimps," mind you, but "Wimpys." Wimpy, for all of you who have less gray hair (or just more hair) than I do, or who spent fewer hours in front of a TV when you were a kid, is Popeye's perennially mooching friend. He was famous for his plea, "I'd gladly pay you Tuesday for a hamburger today."
Which is why the big debts that we're running up to pay for today's consumption -- ranging from the federal budget deficit to the current-account deficit -- worry me so much. In my last column, "The trade deficit's deep bite," I argued that the record $805 billion current-account deficit that the United States ran up in 2005 was even worse than it sounded.
That's because:- The long-term trends, if left unchallenged by our politicians, would make the problem bigger year by year.
- There's very little chance that our political leaders will tackle any of our debt problems -- from the federal budget to the current account deficit -- until the handwriting on the wall is written in letters of fire six feet tall.
In this column I'm going to take a look at the way that these deferred bills are putting the squeeze on all our futures and what you and I can do about it as investors and individuals.
The global tease
In my column on the growing current-account deficit, I estimated that the period between 2010 and 2030 will see overseas investors gradually present their IOUs for payment. Right now, the world is awash in excess capital, largely the result of mind-boggling savings rates in Asia. That makes it easy for the United States to fund its twin deficits by selling bonds, equities and assets to overseas investors. And borrowing this money is cheap. A 10-year U.S. Treasury bond yields just under 4.7% right now. That's near 20-year lows for yields, which averaged 6.4% from 1986 through 2005.
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You've heard of teaser rates, the ultra low interest rates that mortgage lenders use to entice you into buying a new house or borrowing on the equity you've built up in your old one. Well, that's exactly what this low 4.7% rate -- just 1.1% after inflation -- is. It's a teaser rate being offered by global investors to U.S. consumers and taxpayers. And it has the same problem as any teaser rate. The low initial rates encourage massive borrowing because the monthly payments at the teaser rate are so low. Once that teaser rate expires, however, those monthly payments skyrocket and may indeed turn out to be more than the borrower can afford.
Why should the global teaser rate go up for the United States? Two reasons.- Overseas investors are going to need their own money back to pay for their own old age. Japan is the biggest holder of U.S. Treasurys, and, demographically, it is the oldest country in the developed world. Europe isn't far behind. The U.S. is aging, too, but at a comparatively slower rate. The real demographic story, however, is taking place in China and India. By 2020, the median age of China's huge population will be higher than that of the United States. India is further behind, but by 2050, the median age of its population will be 37.9 years, making the country as old as the United States is today. China and India are both going to get old before they get rich. Because of global demographics, we're looking at a world in transition from a period of surplus capital to a world of tight capital as aging populations go from savers to consumers of savings. Tighter capital means higher interest rates.
- Overseas investors may lose faith in our intention to pay our debts. Sovereign nations saddled with too much debt have an option that's not available to the overstretched homeowner. Instead of declaring bankruptcy, they can just roll the printing presses and create money in order to inflate their way out of the debts. But overseas investors aren't likely to sit still as the value of the dollars they hold and the dollars they receive in interest are slashed as the presses roll. As countries such as Argentina have learned, once investors have decided that the government has lost all discipline, they will demand punitive interest rates. Short-term interest rates broke 100% in Argentina in 2002, for example. Once a country has forfeited the faith of the markets, it takes a long time to earn it back. In Brazil, now lauded for its fiscal responsibility, the equivalent of the U.S. federal funds rate was above 16% in December.
Stealing from the future
Look at a recent bit of budget sleight of hand in Washington and see how much confidence you'd feel if you were a lender to the United States. The Bush administration and the Republicans want to extend the tax cut on dividends and capital-gains investment that will otherwise expire at the end of 2008. Whether you think this is a good idea or not, you'll have to agree that it's expensive. The cost of the two-year extension proposed by the House of Representatives is $51 billion, according to the Center on Budget and Policy Priorities. That's a hard sell when, even by the government's accounting, the budget deficit is set to swell to $423 billion in fiscal 2006, a new record in dollar terms.
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