The Real Fiscal Cliff

It’s that time of year again — time to kick the can.

No prizes for guessing what investors expect Congress to do:

And 2013 seems likely to give way to can-kicking in 2014, and 2015 and 2016 and 2017 and on — the GAO estimates that by 2080 the US public could hold 8 times as much government debt as the US generates GDP. Just as Japan has never truly dealt with its debt complex — and instead chose the path of cycles of deflation, an endless liquidity trap, a soaring debt-to-GDP ratio, and mandating financial institutions into buying treasuries — so America will continue to kick the can as long as rates and nominal inflation can be kept low, and goods and energy (the real underlying economy) kept flowing. Which — going by the Japanese example — could be a very long time.

Yet America is not Japan. The key difference? The balance of trade, and the flow of goods and services. While Japan’s debt is overwhelmingly domestically held, and while Japan has long been a net-exporter, the USA imports more goods and services than any nation in history:

And more and more US debt and currency is in the hands of the nations that export the goods and services on which America’s economy functions. Here’s the total debt held by foreigners:

And here’s the dollar reserves of various Asian exporter nations:

So when the can is kicked, the Asians — and especially the Chinese — feel they are getting screwed.

As Xinhua noted the last time America faced the fiscal cliff:

The U.S. has long been facing the same problem: living beyond its means. At present, the country has debts as high as 55 trillion U.S. dollars, including more than 14 trillion U.S. dollars of treasury bonds.

And last October:

Economists agree that as the United States’ largest foreign creditor, China should contemplate ways to pull itself out of the “dollar trap,” as the U.S. economy is faltering with its debt piling up and its currency on the brink to depreciate.

China must make fuller use of the non-financial assets in its foreign reserves, as well as speed up the diversification of investing channels to resist a possible long-term weakening of the dollar, said Xia Bing, director of the Finance Research Institutes of the Development Research Center under the State Council.

Zheng Xinli, permanent vice chairman of China Center for International Economic Exchanges, has suggested that Chinese companies boost overseas investment as a way to absorb trade surpluses and fend off the dollar risk.

Now to some degree the Asians knew the bargain they were getting into in buying US treasuries. They were never buying a claim on the US economy, or on the US gold reserves. They were buying a claim on reproducible Federal Reserve notes, and since 1971 the bargain has been that this is a purely fiat currency. Ultimately, if they do not feel like the US will be solvent in the long run, they should not have started lending to it. But now they are the largest real creditor, they have no choice but to keep on buying and keep on stabilising, simply because a functional US economy and a solvent US treasury is about the only way they will see any return at all.

Yet if they don’t exert leverage on the US, then the US seems unlikely to do much at all. Without a little turmoil, legislators have very little incentive to act. If the exporter nations feel as if they are getting screwed, they are only more likely to escalate via the only real means they have — trade war. And having a monopoly on various resources including rare earth minerals (as well as various components and types of finished goods) gives them considerable leverage.

More and more Asian nations — led by China and Russia — have ditched the dollar for bilateral trade (out of fear of dollar instability). Tension rises between the United States and Asia over Syria and Iran. The Asian nations throw more and more abrasive rhetoric around — including war rhetoric.

And on the other hand, both Obama and Romney — as well as Hillary Clinton — seem dead-set on ramping up the tense rhetoric. Romney seems extremely keen to brand China a currency manipulator.

In truth, both sides have a mutual interest in sitting down and engaging in a frank discussion, and then coming out with a serious long-term plan of co-operation on trade and fiscal issues where both sides accept compromises — perhaps Asia could agree to reinvest some of its dollar hoard in the United States to create American jobs and rebuild American infrastructure in exchange for a long-term American deficit-reduction and technology-sharing agreement?

But such co-operation would require real trust and respect — and I just don’t see it. China’s leaders deeply resent the West for the opium war years, and the humiliation that came with the end of the Chinese empire — and they see America as profligate, and culturally degenerate. And America’s leaders see China as an unstable anti-democratic dictatorship, not a prospective partner.

So the future, I think, will more likely involve both sides jumping off the cliff into the uncertain seas of trade war, currency war, default-by-debasement, tariffs, proxy war and regional and global political and economic instability.

43 thoughts on “The Real Fiscal Cliff

  1. Pingback: Guest Post: The Real Fiscal Cliff » A Taoistmonk's Life

  2. “…the GAO estimates that by 2080 the US public could hold 8 times as much government debt as the US generates GDP.”

    The fact that the GAO would even put an idea like this [project 70 years into the future] to print demonstrates that they are living on some other planet.

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  6. People from different races, cultures and value philosophies get together to plan a mutually aggreable plan to resolve the issues at hand ? Yeah right!

    Maybe the communist party of USA and China agreeing at a weekend retreat but not in real world politics.

    The democratic system in the USA is designed to implode. The fact that Government spending as a percentage of GDP is growing is like a car with its handbrake off and parked on a hill. It gathers momentum towards its crash.

    But I agree with John. This will play out over a few years. Trade protectionism will be the end game, before total collapse. Politics dictate this. It is the 30’s all over again.

  7. AZIZ: While I am not knowledgeable enough to judge, my guess is that you are on target. Two “sidebars”:

    1) We are reminded that, with all our deliberations about the USA, EU, UK, Russia, Japan, Muslims, etc., it is really CHINA that is going to lead (rule?) the world economically and, to the extent that they wish, militarily.

    2) Meantime, how in hell should the individual citizen invest his savings or plan a career?

    • “Meantime, how in hell should the individual citizen invest his savings or plan a career?”

      During times like these, continue to build your “inner-wealth” and take what the system is willing to give you.

      It’s about survival.

  8. Here’s a great example of how are elected crooks operate:

    “The United States on Thursday announced the imposition of antidumping tariffs of more than 31 percent on solar panels from China.”

    So……China’s willing to sell us devices to make us energy independent at incredibly low prices and we’ve got a problem with that???

    Fucking insane. That’s like Saudi Arabia dropping oil to ten bucks a barrel (which would make it even cheaper on a BTU basis than US-produced nat. gas), but instead of celebrating, we bitch. This government wants us at the mercy of the elites so badly it is threatened by anything that could empower the individual.

    I track solar panel prices and by my calculations, the latest Chinese solar panels would pay for themselves in less than three years. It’s getting tempting for me, and I’ll bet a lot of other people as well. I can think of nothing that I would rather have “dumped” on the market than energy independence, Can you?

    I assure you, a “trade war” with China will just be another attack on what’s left of our middle class by our own government.

    • Australia lead solar tech, but our big business lobbied Government to focus on Coal.

      Now we buy from the Chinese, and can’t sell Coal without Carbon Taxes.

      Idiots I say.

      • Carbon tax in Australia: if it is justified by MAN-caused global warming, it is indeed idiotic. While coal often has sulfur pollutants, climate change because of carbon dioxide from burning fossil fuel is a total FRAUD.

  9. Just a thought.

    An ancient military axiom says don’t speculate on the enemy’s INTENTIONS; prepare against his CAPABILITIES. Even though the current threats may not be deliberate attacks, following that admonition with respect to energy, trade war, debt, default, etc. might be smart. If the game theory intellectuals have a rational plan, our governments haven’t heard about it.

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  11. Thanks for another interesting post, Aziz. America is still getting by on her “good looks.” By that I mean the relative, (if decreasing,) freedom still found here, and things like the still spacious feel of most places, and having far more usable land per capita than perhaps anyplace else. America is still cool, people still want to come here. Nobody wants to move to China and I doubt they ever will.

    But those good looks under assault as never before. Just like smoking, drinking and other bad habits never fail to leave their marks on the human body, no matter how good looking someone starts out, so too with America. How long will the old girl keep turning heads? Lotta bad habits, and no sign of straightening up and trying to get healthy before it’s too late. The clock keeps ticking…

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  23. For an exceptionally comprehensive overview of this subject, go to for the July 14, 2012 weekly edition of the (free) John Mauldin’s “Thoughts from the Frontline”. This article, titled “The Beginning of the Endgame”, touches on Scandinavia, Canada, Australia, China, UK, Japan, Spain, Germany, Italy, Belgium, and of course the EU* and US**. You can get an idea about Mauldin’s influence if you take a look at this week’s sample of his speaking gigs.

    My paraphrases:

    * EU — “It’s not clear whether or not the EU will break up, but it should.”

    ** US — If, after the election, the US avoids its debt/deficit issues, “we will turn into Spain quicker than you can say ‘spit’!”

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