China a major buyer of US treasuries is reported to be losing its interest in buying more US debts. For the US economy which has exhausted all options and now looking at deficit spending as the last hope this could spell more trouble. First a brief background.
President Elect Obama announced that the US deficit could reach $1 trillion for years to come. He has said that he will be passing multi-billion dollar fiscal stimulus packages to stop the free fall of the US economy. Fiscal policy is now the only available lever to pull given that the only other major lever, Monetary policy has been exhausted. The Fed had already reduced the target interest rate to 0-0.25%, there is no further room for the monetary policy. Even now the lax monetary policy did not stop the fall and is proving to be impotent. The only hope is fiscal stimulus.
But with any fiscal spending the first question to ask is, “How is the Government going to fund the spending?”. In other words, what gives? The only revenue source to the Government is the Tax collection. When the Government spendings exactly match the tax revenues collected we will have a balanced budget. Otherwise we get surpluses or deficits.
The Government does deficit spending by issuing debts, in the form of US treasuries. Any individual, institution or Sovereign funds from around the world can buy these. Until now a biggest buyer of US debt has been China. But with its slowing economy and its posed $1 trillion fiscal stimulus it is losing interest in buying US debt.
What does this mean?
The US Government has to find other buyers from locally or from EU. It may have to spice up the bonds issue by increasing the rate it offers on these bonds, but this means the interest rate for all US credits will go up. For an economy struggling under credit crisis, this will further staunch credit available to businesses and individuals and the effects may negate the positive effect from Government spending.
The net is, without a buyer for US debts at current rates, getting out of the economic crisis through deficit spending is not going to work.
The New York Times story on Black Friday sales has this quote from a non-shopper,
At Westfield Century City Shopping Center in California, Harper Mance, 31, said: “I’m looking around, thinking, ‘If there are discounts on everything now, what’s it going to be like after Christmas?’ You know it’s going to go down further.”
Speculators were an easy target for the Congress that wanted to show the people that they are doing something about the oil prices. A simple explanation of demand and supply was not enough, it was too complex for most to comprehend.
Every story needs a villain, a damsel in distress and a knight in shining armor. Arguably, the speculator are the real knights but they are not up for reelection nor are they good at pitching their side. So the lawmakers took the opportunity to pitch the plausible story of oil speculators driving up prices.
But as the demand fell due to consumers adjusting their behavior, the oil prices fell back 13% from its highs. The Nightly Business Report’s Suzanne Pratt said this nicely:
PRATT: So what happened to all the speculators that were supposedly driving up prices and ignoring fundamentals? Today, futures regulators said an inter-agency task force has found that supply-demand fundamentals are the best explanation for the recent run-up in oil prices, not excessive speculation, as some lawmakers believe. Many economists and analysts agree that fundamentals, mostly strong demand from India and China, have been the primary price driver, as well as stagnant supplies. But those fundamentals may be changing. Economist Carey Leahy says investors are waking up to the idea that slowing U.S. growth and other global factors could result in a big drop in demand.
Of course there is enough room in this for lawmakers to tell a different story, the mere mention of curbing speculation was enough to slay the dragon.
Greg Manikw, the author of my favorite Macroeconomics book, writes in his blog a series on Cross-Price Elasticity of Demand.
The New York Times reports that shoppers are doing more online shopping than driving to the stores. While the demand for the products has not shifted to their substitutions, the channels through which people buy has.
Online shopping is gaining at a time when simply filling up a gas tank to head to the mall can seem like a spending spree.
A number of retailers — including Gap, Victoria’s Secret and J. C. Penney — are experiencing double-digit sales growth at their shopping Web sites, creating a surprising bright spot during an otherwise gloomy time for sales in brick-and-mortar stores.
Down the line this means drop in incentives to the employees who work in the shops and it is bound to cause shift in their consuming patterns.
If I can make predictions about other economic and consumer behavior changes we should expect in the future, these are in my short list:
1. People brown-bagging lunch
2. Product unbundling in restaurants. No more free bread, chips-salsa or worse no more free napkins or water.
3. 4 day work week, with 10 hours a day
4. US Mail stopping Saturday delivery
5. Newspapers adding a higher delivery surcharge, causing a shift to their online version.
Last March I had to answer an analysis question on whether or not India can keep up its 8.5-10% growth. With inflation then raching 7.5%, its deficit 6% of GDP, its national debt close to 80% of GDP, the Government’s lack of infrastructure spending, excessive transfer payments for populist schemes and with a vast majority of the population earning less than $2 a day, I took a stand that the current growth was not sustainable and expected a slowdown. I compared it with China which despite its high inflation could control it by letting its currency float freely and with its National Debt just 15% of its GDP had lots of room to fund its growth.
Business Week writes
Most economic forecasts expect growth to slow to 7%—a big drop for a country that needs to accelerate growth, not reduce it. “India has gone from hero to zero in six months,” says Andrew Holland, head of proprietary trading at Merrill Lynch India (MER) in Mumbai.
The Oil price shock once again hastened what would have been a gradual slowdown process. Inlation is a big concern hitting 14%. So far this has not lead to labors demanding higher salary but once that happens, the inflation is bound to spiral out of control. The Government has been subsidizing Petrol and Diesel prices artificially. With its deficit mounting and rupee falling, and the higher import prices of the Oil, the subsidies have to go. This will lead further price increases and further strain the population that lives on less than $2 a day.
Just like the shock is sudden, India’s growth came at a fast pace without any strategic action by the Government. There is infrastructure to support this growth, no even wealth allocation, no investment in primary education and labor training. An year ago the Business Week wrote about India as “Bursting at the Seam
s”. Now the global macroeconomic conditions have placed a considerable roadblock in India’s path.
A Goldman Sachs report released in June a report on India’s potential to grow 40 times by 2050 and the 10 things it needs to do to get there. For the record that would be 3-4 times current US economy. Those are steps the Government should have taken 5-10 years ago, when the economy was still healthy. Now we are in a ER room and looking at triage. Let alone quadrupling, if India wants to prevent social unrest and save its millions from starving, it needs some drastic steps now.
I would start with improving tax collection and re-purposing Government spending. But with elections around the corner, the Government may not have the courage to act. The problem is inaction is not enough in the ER room when the patient is bleeding.
Larry Summers believes we could possibly at the most dangerous moment since the financial crisis began. There are calls from others for another stimulus package. I do not like another stimulus package because it a transfer payment that is just a band-aid. Larry, calls for several options, one of which is makes for propping up the economy through infrastructure investment. The idea is that it will spur new job growh (especially in construction sector).
I like the idea of infrastructure investment, and to be specific the Federal Government should invest in public transport infrastructure (trains, subways, mono-rails) across cities. With as prices on the rise and existing public transit not designed to handle the increased traffic, the secondary effects of improving or install mass transit systems are much more than any other infrastructure projects. There is precedence to such investment, it is the Interstate Highway network that propped up the economy in the past.
The problems with any Government investment is, one how to fund it and second the risk of inflation. To first one can be addressed by increasing the gas tax (which is bound to have secondary negative effects on the economy and inflation). But in the long run we would have effectively addressed the energy crisis, reduced urban sprawl, and changed people behavior.
So if the Government wants to help the economy, put it on a train (an electric one).