A Failed Presidency

America has borrowed on the order of a trillion dollars from abroad during the Bush years, spending that money mostly on guns and IPods, slot machines and Medicare, rather than upon railroads, factories and research labs. So what does it all mean. Quotable:

“The real danger is that the current account might change very rapidly.” [says Kenneth Rogoff.] The United States would have a harder time adjusting than did other countries cut off by foreign lending in the past, he says, because its exports are a smaller percentage of GDP. Instead of having to increase exports 10 percent to make up for the lost flow of capital, for example, exports might need to increase twice as much, implying a hefty depreciation of the dollar. Rogoff has estimated that in a sudden adjustment, the dollar might lose as much as 40 percent of its value compared to 2005 levels, with the result that “the dollar would fall like a rock and interest rates would skyrocket.”

The price of imported goods would go up almost overnight, as happened to Mexico within a few months in 1994. Gasoline, food, foreign parts for cars, tools, toys, and television sets would cost so much more that it would put an enormous strain on middle- and lower-income Americans. And even though the United States has a robust financial system, a hard landing would mean reduced economic activity. This, says Summers, “would in turn reduce confidence, lead to larger budget deficits, lead to more pressure on interest rates, and so there are a variety of vicious cycles that could kick in.” In such a situation, the Federal Reserve Board would face “a difficult dilemma,” he continues, “because on the one hand you want to provide liquidity [by reducing interest rates] at a moment when foreigners are withdrawing assets, and on the other hand you want to strengthen the currency and strengthen credibility [by raising rates], and you can’t both ease and tighten with one policy instrument.” Nor could the federal government easily help, given that it is already running annual budget deficits of about $270 billion and facing increasing interest costs ($406 billion in 2006) to service the national debt of $8.8 trillion—$2 trillion of it held by foreigners.