In the 1992 election campaign, H. Ross Perot predicted a "giant sucking sound" of U.S. jobs heading for Mexico if the North American Free Trade Agreement passed. Perot seems to have been wrong on that - wherever U.S. jobs have gone, it's not Mexico.
Nevertheless, if you listen carefully there's still a "giant sucking sound" - but this time it's the sound of U.S. capital headed overseas.
Personal income for February was flat according to the Bureau of Economic Analysis, but personal consumption expenditure was up 0.3% -- in other words Americans were spending more money without having more income. The personal savings rate, expressed as a percentage of personal disposable income (after taxes and social security payments) dropped in the month to 3.1% from 3.4% in January.
That drop in the savings rate is worrying. The February rate is far below the 4.7% average savings rate in 2009, heading down towards the all-time low annual savings rate of 1.4% in 2005.
It had been hoped that the savings rate in the recession would rise back towards the 1965-95 average rate of about 8%. That would have provided domestic capital to finance domestic industry and at least part of the budget deficit, making the United States somewhat less dependent on foreign investors for its needs.
The United States had a very low savings rate through the 2002-07 economic cycle. It manifested itself in a number of ways: The balance of payments deficit soared to above $800 billion in 2006, and consumer borrowing broke record after record. However, if damage was done to the U.S. economy, it was beneath the surface.
This time around, we may not be so lucky. The difference is that the federal budget deficit is running at over 10% of gross domestic product (GDP). That means that foreign money not only has to help U.S. corporations finance capital expansion, since savings in the U.S. economy are lacking, but it also has to pour 10% of U.S. GDP into the maw of the federal Treasury.
This will almost certainly have two effects.
First, the U.S. payments deficit will expand far beyond $800 billion per annum, stopping only when foreigners refuse to buy more U.S. assets. Second, U.S. businesses will find it very difficult to get money, and so any plans they have for capital expansion in the domestic market will be stymied.
In the long term, a payments deficit of this size combined with an ultra-low savings rate has a pernicious effect. It starves the U.S. economy of capital.
In the past, U.S. living standards have been in the best in the world for three reasons:
- The education system was excellent - but many other systems have caught up with it.
- It was relatively un-bureaucratic, un-corrupt and low-tax - all of which appear to be changing.
- And most important, it had the most capital to support its pool of labor. That capital superiority has already been sharply diminished, owing to the low, post-1995 savings rates in the United States and the high ones in Asia; it may now be about to disappear altogether.
The solution to these problems is obvious, but frustratingly difficult to get adopted in the face of entrenched opposition. It is for U.S. interest rates to rise sharply, so that savers are assured a substantial real return on the amounts they save.
Since 2000, any saving has been penalized by an interest rate below the rate of inflation (well below, after tax has been paid) and by a stock market that has gone nowhere. Meanwhile, even excessive borrowers were hugely subsidized by the Fed at the expense of savers.
Only when interest rates are well above the level of inflation, and taxes are adjusted so that savers are not unfairly penalized (such as by the double taxation of dividends, at the corporate and individual level) will savings recover enough that the economy's domestic capital needs are funded from domestic sources.
As for the huge budget deficit, that has to go - or at least it must quickly be brought down to a level at which it can be financed domestically, without U.S. debt spiraling out of control.
Higher interest rates and a balanced budget. That's what's needed - but politicians and the Fed will fight it every inch of the way.
[Editor's Note: Martin Hutchinson has terrific foresight. He warned investors about the dangers of credit-default swaps - half a year before those deadly derivatives ignited the worldwide financial firestorm. Hutchinson even predicted where and when the U.S. stock market would bottom (a feat that won him substantial public recognition).
During the stock-market rebound that started in the middle portion of March 2009, Hutchinson's calls on gold, commodities and high-yielding dividend stocks made winners of investors who took his advice.
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News and Related Story Links:
- Bureau of Economic Analysis:
PERSONAL INCOME AND OUTLAYS: FEBRUARY 2010
- Money Morning:
Question of the Week: Is it Too Late to Stage an Intervention for Our Government's Spending Addiction?
- Money Morning:
How to Protect Yourself - And Even Profit - if Foreign Creditors "Strike" U.S. Treasuries
- Money Morning:
Will America Choke on its Own Debt?
- Money Morning:
The Truth About Inflation...
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