The World s Largest Debtor Nation: What Does Debtor Nation Status Mean?

Transcription

1 The World s Largest Debtor Nation: What Does Debtor Nation Status Mean? Brittany Whetts Introduction The United States (U.S.) has been a debtor nation for many years. The purpose of this paper is to describe what it means to be a debtor nation and how the U.S. got in this position. Additionally, related issues including the trade deficit, U.S. debt history, presidential focus, China as a major holder of debt, and the current economic stimulus package are discussed and possible remedies are examined. The U.S. has been a country dependant on foreign investments for some years; this is the meaning of the designation, debtor nation. This dependency is inextricably linked to the nation s status of chronically experiencing trade deficits; it is also linked to government deficit spending. The U.S. was first considered a debtor nation 20 years ago, and has continued in this condition since; the nation currently has a trade deficit with more than 12 countries. The U.S. has implemented several strategies in hopes of stabilizing this international debt. History In the late 1700s the U.S. incurred debt through the financing of war as opposed to foreign trade. In 1776, during the American Revolutionary War, the ten founders of the American treasury funded the war through loan certificates which they borrowed from France and the Netherlands. At the end of the Revolutionary War in 1783 the U.S. had amassed a national debt of $43 million. About three decades later the War of

2 began and it was funded by borrowed funds and helped increase the debt from $45.2 million to $119.2 million. Throughout the 1800s the U.S. would see two more wars causing debt, including the War with Mexico and the Civil War. The debt caused by the War with Mexico which totaled a debt of about $63 million was soon overshadowed by the Civil War in It is estimated that by the end of the Civil war in 1865 the national debt grew to $2.2 billion (Bureau of Public Debt, n.d.). In 1907 the U.S. was in a state of panic as the New York Stock Exchange dropped 50 percent from the total of the previous year. This panic caused the U.S. to reconsider the use of a central bank. Nine years later the U.S. prepared for its entrance into World War I (WWI). The government raised taxes and borrowed an additional $300 million as well as the first liberty loan totaling $5 billion. By the end of WWI in 1919 the total debt reached more than $25 billion. Many events following WWI including the stock market crash of 1929 and World War II (WWII) in 1939 there was no real panic about the National debt. Following the wars the U.S. adopted the Keynesian theory and was no longer concerned with balancing of national budget. The Keynesian theory was set as a basis of economic policy designed to ensure economic growth and stability, the U.S. policy focus. Following the Vietnam War, which was the most expensive war to date, the U.S. showed an economy in the black for the last time until three decades later (Bureau of Public Debt, n.d.). In 1981 Ronald Reagan was elected president of the U.S. and named the National Debt one of his main priorities. During Reagan s tenure as president he entered two debt increasing ventures, the war on drugs and the funding of the Cold War, which ended in Each of these expenses carried a debt of about $3.3 trillion into 1990 increasing throughout the years (Bureau of Public Debt, n.d.). The New Millennium Throughout the new millennium the U.S. began to increase its debt based on trade rather than war. The U.S. imports almost everything 44

3 used today including crude oil, technology, and machinery. These three primary imports are essential to U.S. trade. The U.S. exports goods such as agricultural products, consumer goods, and raw materials. These imports and exports have grown the United States trade deficit tremendously. During this time period, the U.S. became trading partners with soaring economies such as India, Japan, and China. While these countries benefit from U.S. Debt, U.S. citizens feel the pressures of a lagging economy. Major Holders of American Debt There are about 12 countries that hold extensive amounts of U.S. debt. Germany holds about $56 billion (Burgess, 2009). Germany is one of the world s largest exporters and the second largest importer of goods. Taiwan holds about $73 billion in U.S. debt, while Brazil which is considered South America s economic giant, holds $134 billion in U.S. debt. The two major countries, however, holding U.S. debt are Japan at $635 billion and China at $769 billion (Burgess, 2009). Each of these countries exports everything from technology to consumer goods to the U.S. China China has been the leading exporter to the U.S. for many years. China has had the world s fastest growing economy in the past quarter century. It currently has the second largest economy in the world behind the U.S. at $8 trillion based on purchasing power parity (Burgess, 2009). The U.S. imports a majority of its goods and services from China, helping build the trade deficit. China has become the third largest supplier of agricultural products to the U.S. It supplies the U.S. with goods such as milk products, seafood, and pet supplies, in addition to technological materials and machinery (Burgess, 2009). Table 1, below, illustrates both imports, exports and the trade balance with China. 45

4 Table 1. Trade with China: 2009 NOTE: All figures are in millions of U.S. dollars, and not seasonally adjusted unless otherwise specified. Month Exports Imports Balance January , , ,569.9 February , , ,196.1 March , , ,617.8 April , , ,753.8 May , , ,483.8 June , , ,430.0 July , , ,416.9 August , , ,231.7 September , , ,101.2 October , , ,663.4 November , , ,223.6 December , , ,138.1 TOTAL 69, , ,826.1 Source: U.S. Census Bureau, Foreign Trade Division, Data Dissemination Branch, Washington, D.C Causes: Trade Deficit A trade deficit is a negative balance of trade in which exports are surpassed by imports. The last trade surplus (where exports exceed imports) in the U.S. was seen in 1975 (History of U.S. Trade, n.d.). Throughout the last ten years the trade deficit has risen steadily with major increases occurring in the years 2005 and Trade deficits are seen as negative because they cause loss in home jobs and also weaken the dollar. In 2001, the U.S. trade deficit was viewed as a sign of a strong economy because it was said that a trade deficit signals improving economic conditions. It has been shown that during the largest trade deficits the U.S. has been in a state of expansion. While during the smallest trade deficits it has been shown that the U.S. was in a state of recession during these periods. 46

5 One of the main worries caused by the U.S. trade deficit is that the country will incur a massive amount of foreign debt. This worry became increasingly evident within the past decade. In the past, the U.S. exported many thing including raw materials and metals. At present, the U.S. major export is its own debt (History of U.S. Trade, n.d.); this fact alone communicates the riskiness of the current economic state. Table 2 illustrates the trade balance (surplus or deficit) as a percentage of Gross Domestic Product (GDP). Table 2. Trade Balance as a Percentage of GDP U.S. Trade Balance as a Percentage of GDP 1% 0% Percent of GDP -1% -2% -3% -4% -5% Trade Balance as % of GDP Source: Data 360.org The War in Iraq The Iraq War which began on March 20, 2003 has been a major contributor to the debt of the U.S. in recent history. The events of September 11, 2001 led to the eventual invasion of Iraq, a military action which is still in progress today. Over the past nine years the Iraq and Afghanistan wars have cost the U.S. over $830 billion (Blimes, 2008). It is estimated that by the end of the war, the U.S. could spend upwards of $3 trillion (Blimes, 2008). With the election of a new 47

6 president, it was hoped that troops will be pulled from Iraq and Afghanistan at some point in the near future. Such withdrawal of the troops should minimize the loss of life as well as stabilize debt growth from that source. Current president, Barack Obama, laid out his exit plan for Iraq at the beginning of his term and plans for an exit from Afghanistan more recently. The President stated that up to 107,000 troops will be withdrawn [from Iraq] by August 2009 with 50,000 others scheduled to exit in 2011 (Blimes, 2008). It is estimated that former President George W. Bush spent nearly $2 billion per week to fund the Iraq War (Blimes, 2008). President Bush increased the national debt by $4 trillion while in office leaving the next president to inherit an economy in peril (Blimes, 2008). George W. Bush George W. Bush was elected to office in When President Bush was sworn in January 20, 2001 the national debt stood at $5.7 trillion and increased by 71.9 percent during his tenure in office. By the time George W. Bush left office on January 20, 2009 the national debt stood at $10.6 trillion (Knoller, 2008). It has been said that during two terms as president George Bush has turned in the worst economic record since the great depression. One of George Bush s favorite spending tools was offshore oil drilling which cost the U.S an enormous amount of money (Knoller, 2008). George Bush s administration was also one that saw the greatest increases in oil pricing per barrel in American history (Knoller, 2008). Table 3, below, shows the increase in crude oil prices through various wars, illustrating the relationship between war and oil. Both have had substantial impact on U.S. indebtedness. 48

7 Table 3. The Relationship Between War and Oil Prices 2006 $/BARREL $100 $80 $60 $40 Suez Crisis Iran / Iraq War Iranian Revolution Yom Kippur War Oil Embargo Crude Oil Prices 2007 Dollars OPEC 10 % Quota Increase Asian Econ Crisis Series of OPEC Cuts 4.2 Million Barrels Gulf War PDVSA Strike Iraq War Asian Growth Weaker Dollar $20 $0 U.S. Price Controls 9/11 U.S. 1st Purchase Price (Wellhead) 1947 MAY 2008 World Price * WTRG Economics (479) Avg. U.S. $24.98 Avg. World $27.00 Median U.S. & World $19.04 Source: Williams. WTRG Economics Barack Obama The new president Barack Obama inherited a struggling economy in Prior to his election he spoke about the U.S. budget deficit in a debate with Senator John McCain on August 14, After the debate, his economic policy director spoke about Obama s views stating that we need to change our economic policies by investing in education, new energy jobs, and technology so that we can strengthen the productivity of our workers and businesses; by enforcing our existing trade agreements and negotiating better trade agreements; and by reducing record budget deficits and raising low savings rates so that America does not have to borrow hundreds of billions of dollars annually from abroad (Steinhauser, 2009). An increase in U.S. production will reduce the nation s reliance on foreign imports, thus reducing the nation s indebtedness. Following this statement, the U.S. trade deficit did decrease to its lowest point since 1999, though the recession also would have contributed to that decline, as noted earlier. President Obama has also encouraged international investment in the U.S., which has the impact of increasing U.S. indebtedness (Steinhauser, 2009). 49

8 Causes of the Trade Deficit The U.S. trade deficit is the result of a net inflow of capital to the U.S. from the rest of the world (Griswold 1998). The U.S. currently harbors a relatively free market which is very attractive to many foreign investors; it is also true that the nation has become an importer of capital based on an inability to save domestically (Griswold 1998). Related to the import of capital, and fundamentally the cause of that import, is the volume of imports into the U.S.; an influx of capital allows for payments for imports in excess of exports. Implied by this is that, in order to reduce and ultimately reverse, the trade deficit, the U.S. must reduce imports relative to exports, and change savings and investment patterns. The U.S. has such major trade deficits with so many different countries, that it seems likely that recovery will take some time. Consumerism As has been noted throughout this paper, the trade deficit is a primary driver of foreign indebtedness. Consumerism is the belief that a high level of consumer spending is desirable and beneficial to the economy (Fong and Partners, 2006). Much of the debt incurred by the U.S. is directly related to consumerism; borrowing occurs when there is a gap between Americans incomes and their rate of consumption. The gap between income and consumption reached an astounding seven percent in 2006 (Fong and Partners, 2006). It was found that in 2006, U.S. consumers bought more goods and services than the entire output of Brazil, the tenth largest economy in the world (Fong and Partners, 2006). In spite of the magnitude of spending, consumerism is still viewed as a positive force in the economy. Consumers make up about two-thirds of the U.S. economy (Fong and Partners, 2006). Consumerism also helps create jobs and brings wealth to foreign investors, making our economy more appealing to those investors. The obvious question raised by economists, however, is what happens if consumers reach the end of their ability to borrow and spend? 50

9 Budget Deficit A budget deficit is defined as spending in excess of income and government debt is cumulative deficits. The U.S. government has carried a budget deficit since 1969 and, even in those years when the U.S. reported a surplus, there was still overspending. Budget deficits contribute to international debt in that when government debt is created some percent of that debt will be bought by international investors. Debt creates interest expense and interest, alone, forms the third largest expense in the federal budget (Cline, 2005). The top two expenses include defense and income redistribution (Cline, 2005). The Economic Stimulus Package Economic stimulus is use of fiscal policy; government spending or tax measures are used to support or revive an economy in recession. In 2009, President Obama implemented a plan that would help stimulate the American economy (Steinhauser, 2009). This plan included making the U.S. more energy efficient, providing more jobs, and supplying American citizens with tax cuts and rebate checks. This plan would help increase income to citizens allowing them to spend more, as a result revitalizing the economy (Steinhauser, 2009). This stimulus plan cost the U.S. government an additional $789 billion (Steinhauser, 2009). The plan also included aid to states for Medicaid costs, temporary increases in unemployment benefits, and public works projects to create jobs. Also included were efforts designed to improve the nation s access and use of technology by converting medical records to computer based storage and expanding internet access. While praised by many economists as a necessity during a deepest recession since the Great Depression, the stimulus package had its share of critics as well. Much of the criticism centered on the argument that a nation cannot borrow more money to spend its way back to economic greatness. Republican Cathy McMorris Rodgers stated this counter argument with the statement that instead of letting American families keep more of their hard-earned tax dollars, this plan 51

10 proposes to spend additional money on such programs as new government cars, global warming studies and a billion extra dollars for the U.S. Census. Further, the counter argument goes that in order to balance the budget enacting tax cuts are central to moving our economy forward (Steinhauser, 2009). The implication of this argument is that tax cuts created by the stimulus were either not deep enough, or went to the wrong people, to create enough stimulus effect. The argument for balancing the budget during recession is a political one, not an economic one. Balancing a budget during recession could only result in a deeper recession. The Table that follows, Table 4, illustrates where the economic stimulus package dollars are being spent, by functional area. This package allocates billions of dollars in both tax cuts and spending in a Keynesian style fiscal stimulus plan. Table 4. Allocation of The American Recovery and Reinvestment Act of 2009 Entire Stimulus Package, Billions of Dollars state and local law enforcement, 4???, 31.3 temporary increase in the Medicaid matching rate, 87 food stamps, 20 tax cuts, 275 healthcare for newly unemployed, 39 increased unemployment benefits and job training, 43 preventative care, 4.1 health I.T., 20 higher education modernization, 6 Pell grant, 15.6 state fiscal relief, 79 local school districts, 41 transit and rail, 10 clean water, flood control, and environmental restoration investments, 19 highway construction, 30 modernize federal and other public infrastructure, 31 transform the nation s energy transmission, distribution, and production systems, 32 repair public housing and make key energy efficiency retrofits, 16 weatherize modest-income homes, 6 science facilities, research, and instrumentation, 10 expand broadband internet access, 6 Source: Rampell. New York Times. Stimulus Pie Chart. 52

11 Consequences of Borrowing A consequence of borrowing extremely large amounts of money from abroad is the potential damage done to the American standard of living, in the present as well as the future. In 2004 it was predicted that by 2014, foreign debt would consume 1.7 percent of gross domestic product in the U.S. (Shostak, 2004).Citizens of the U.S. must also look to their own behavior as it contributes to the nation s debtor status, as has been discussed, the huge trade deficit is the current driver of increasing international indebtedness (Bivens, 2004). If Americans do not begin to decrease the trade deficit, there may come a period when foreigner investors will no longer be willing to put their resources into investment in American assets. Should this happen, the dollar will weaken internationally and interest rates will have to rise to attract foreign investment. Other consequences of extensive borrowing could include job loss for working class Americans as more production is done abroad and imported into the country, a crash in the housing market as foreign investors sell off their U.S. assets, and much higher prices for products not made in America. Table 5 shows the estimated debt in the next five years. Table 5. Projected Foreign Debt as a Percent of U.S. GDP 2.0% 1.5% 1.0% 0.5% 0.0% Projected increase in international debt service burden, % 1.5% 1.4% 1.3% 1.1% 0.8% 0.9% 0.6% 0.4% 0.2% 0.0% Source: Bivens,

12 The Dollar The interpretation of the impact of a weakening dollar is mixed. In recent months the dollar has lost ground to the Euro, Canadian Dollar, and the Pound. The weak dollar has made U.S. exports more attractive and imports less so; it encourages investment in American industries because dollars are cheap and assets that can be bought with dollars that are relatively less expensive. Investments from China and Russia help keep interest rates down, offsetting to some extent continued U.S. imports from China and oil purchases from Russia (Delfeld, 2007). Conversely, there are negative effects from a weak dollar. Delfeld outlined a series of reasons why a weak dollar is bad for the economy (Delfeld, 2007). First, he notes that a weaker dollar translates into a cut in the real spending power of American consumers in effect, a reduction in real income. Also, a weaker dollar weakens the role of the U.S. dollar as the world's reserve currency. Why should investors and central banks around the world invest in U.S. assets when their value is steadily declining? Another reason to fear a weaker dollar, writes Delfield, is that the chances of a weaker dollar leading to a sharp reduction in America's trade deficit is highly unlikely since 40 percent of the current balance is due to oil imports that are denominated in U.S. dollars. An additional 20 percent is due to trade with China, which is, of course, controlling the value of its own currency. Also, a weaker dollar is inflationary since it increases the cost of imports. Delfield also states that business leaders know that discounting prices may bump near-term revenue and profits but at a real cost to long-term profitability and what a weaker dollar really does is to encourage American and international investors to invest in non-american markets. The more the dollar drops, the more global equities rise. Many Asian currencies are hitting record highs against the U.S. dollar (Delfeld, 2007). Both positive and negative arguments are valid; what is not known is which effects will be stronger. 54

13 Conclusion The U.S. is in a very complex economic situation. The term, debtor nation, refers to a nation with a cumulative balance of payments deficit and a negative net investment after recording all financial transactions completed worldwide. For many, the implication of this status is a country with a weak economy. Other analysts and economists view the U.S. debtor nation status as more of a benefit than a problem. It is true however, that a huge international debt has the potential to scare off international investors in the U.S. economy and government debt, and put upward pressure on domestic interest rates. It is also certain that government interest payments take an increasingly large portion of the Federal budget, though much of this interest is paid to Americans holding government debt, meaning that the debt is an income transfer from American taxpayers to American treasury securities holders. The current recession makes management of U.S. debt far more complicated. The necessity of the economic stimulus package is not questioned by most economists; neither is it questioned that the stimulus must drive up government debt. Throughout the history of this country, the U.S. has relied on debt, including foreign debt to finance its activities. It seems unlikely that the nation will be able to become a net lender as opposed to a borrower. There is a great deal of discussion about Federal Government debt, but that is not sufficient to address the problem of the international debtor status of the U.S.; complicating this is the need to stabilize the economy as it emerges from the Great Recession, as some have termed it. Stabilization of the economy can only occur through creation of jobs, improving education and our energy base, and increasing exports. The trade deficit that occurs each year, generally at an increasing dollar amount is the primary driver of U.S. international debt. The relationship the between the U.S. and China is a complex one that creates an interdependency between two very different countries. 55

14 A complicating feature of this relationship is the Chinese insistence on tying the value of their currency to that of the dollar, artificially reducing the price of Chinese imports into the U.S. The result is that China continues to purchase U.S. debt, though recently at a decreasing rate, and Americans continue to import low cost Chinese goods. This cycle illustrates the great difficulty resolving the issue of the world s largest debtor nation. References Bureau of Public Debt: Non Fiction. (n.d.). Retrieved April 17, 2009, from Bureau of the Public Debt The 18th Century.mht. Bivens J. (2004, December 14). Debt and the dollar. Economy Policy. Retrieved April 21, 2009, from Debt and the dollar The United States damages future living standards by borrowing itself into a de.mht. Blimes L. (2009, March 9). Iraq war will cost. The Washington Post. Retrieved April 21, 2009, from The Iraq War Will Cost Us $3 Trillion, and Much More washingtonpost_com.mht. Burgess L. (2009, April 7). U.S. national debt. Gold World. Retrieved April 21, From Google Image Result for http--images_angelpub_com _us_national_debtpng_png.mht. Cline W. (2005, September 17). United States as a debtor nation. Peterson. Retrieved April 21, 2009 from United States as a Debtor Nation William R_ Cline, Peter G_ Peterson Institute for International Economics.mht. Delfeld C. (2007, October 17). Weak dollar is bad for economy. Forbes. Retrieved April 21, 2009 from A Weak Dollar Is Bad For America Forbes_com.mht. Griswold D. (2001, February 21). America s record trade deficit. CATO. Retrieved April 21, 2009 from America's Record Trade Deficit A Symbol of Strength by Daniel Griswold (Cato Institute Daily Commentary).mht. History of U.S. Trade. (n.d.). Retrieved April 17, 2009, from History of the U_S_ Trade Deficit.mht. 56

15 Knoller M. (2008, September 9). Bush administration. CBS News. Retrieved April 21, 2009, from Bush Administration Adds $4 Trillion To National Debt CBS News.mht. Rampell, C. (2009, January 15). Stimulus pie chart. Economix: explaining the science of everyday life. The New York Times. Retrieved April 10, 2009 from Shostack F. (2006, February 2). Widening U.S. trade deficit. Ludwig. Retrieved April 21, 2009, from Does the widening US trade deficit pose a threat to the economy Frank Shostak Mises Institute.mht. Steinhauser P. (2009, April 10). President pushes stimulus package. CNN Politics. Retrieved April 21, 2009, from President pushes economic stimulus package -CNN_com.mht. U.S. Census Bureau. (n.d.). Trade in goods (imports, exports and trade balance) with China Foreign Trade Statistics. Retrieved February 15, 2010, from U.S. trade balance as a percent of GDP. (n.d.) Data 360.org. Retrieved April 10, 2009, from 70_500_350.jpg&imgrefurl= Williams, J.L. (2009). Oil price history and analysis. WTRG Economics. Retrieved April 20, 2009, from 57