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President Barack Obama delivers his State of the Union address in the House Chamber at the US Capitol in Washington DC, Jan. 25, 2011.
Dr. Peter Morici: S&P has downgraded
Japan’s long-term debt from AA to AA-, indicating the US 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
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 $1trn 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 US 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% of GDP, just to sustain growth at 3.5% and keep unemployment from flying
out of control.
The large US current account deficit indicates the US economy as a whole is not
generating adequate revenues to pay foreign creditors interest due on US 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 US 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
Energy, commodity and food inflation will soon push up US 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 monetize government debt
through quantitative easing.
The dollar may be the reserve currency, but the global economy cannot absorb
enough US bonds and dollars with a US federal deficit exceeding $1.5trn or 2.5%
of global GDP. No one wants that much cash, and China can print and sterilize
only so many yuan to buy US debt without setting off a Weimar Republic inflation
in the Middle Kingdom.
Even though the US 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 US 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
Japan is sound, but the United States is teetering on insolvency.
The worry for Japan and the U.S. is not their risk of default, says Andrew Freris, senior investment strategist, Asia at BNP Paribas Wealth Management. He is more concerned that their interest rates will spike rapidly, and explains why, to CNBC's Martin Soong, Karen Tso and Sri Jegarajah:
"I think you're seeing it across the Republicans and Democrats, a realization that our tax system is broken, it was designed when America used to have all the key businesses," John Chambers, CEO of Cisco Systems told CNBC in Davos:
Professor, Robert H. Smith School of Business, University of Maryland,