Updated: May 3, 2013 12:14PM
Remember when you were a kid and you thought if you could dig a hole deep enough, you'd get to China? Well, that's what we're doing now -- financially speaking. We're digging a hole of debt -- and it won't be surprising if the next generation finds itself at the mercy of the Chinese, who will be our creditors.
Headline: U.S. records $199.8 billion second-quarter current account deficit.Not just another MEGO figure
Last week's report might have seemed just another one of those huge MEGO numbers (MEGO stands for My Eyes Glaze Over), but the $190.8 billion deficit for just the second quarter means that we are even more indebted to foreigners who accept our dollars -- and then make choices about what to do with all that money we are sending them in exchange for imported goods.
The biggest use of those dollars is to lend us money -- buying our Treasury securities and corporate bonds. Only a small portion -- about 12 percent -- goes into buying U.S. productive assets.
Although the current account statistic includes services and investments, the imbalance is mostly about cheap imports to the United States. And mostly that means imports from China. Sure, we import a lot of other things -- notably oil, which is costing us ever more -- but oil is a freely traded global commodity. Stuff made in China, by contrast, is priced artificially low because the Chinese currency -- the yuan -- is "tied" to the U.S. dollar.
If allowed to float freely, the Chinese currency would rise in value compared with the dollar. That would make prices of Chinese exports more expensive in the U.S., slowing Chinese imports here, and leveling off the trade imbalance. But instead, the Chinese central bank keeps buying dollars in the world currency markets -- and selling yuan -- to depress the value of their currency, and help their exports. According to the Bank for International Settlements, the Chinese central bank does about $250 billion a year in interventions.
It's dangerous to mess with free trade. America learned that lesson with the Smoot Hawley tariff in 1930, which many argue exacerbated the collapse in the American economy into a global depression. When trade stops, profits stop, and all sides lose.
It's also dangerous to mess with the American consumer. I'm one of the many millions who enjoy buying cheap stuff -- clothing, towels, household goods and more. The ability to pay a lot less for lots of stuff has made Americans feel they are better off. But are we really getting bargains?
Peter Morici, economist and professor at the University of Maryland, makes a compelling case that these cheap imports are not true bargains for Americans. First, he notes that the Chinese are notoriously inefficient users of energy in manufacturing, so their purchases of oil drive up the price for everyone -- costing Americans more to fill up their tanks.
Worst of all, when Americans buy those bargains, we pay by borrowing from others. The dollars we send abroad are used by foreign central banks and companies to buy U.S. Treasury notes and bills and bonds. Morici calculates that U.S. foreign debt now exceeds $6 trillion -- and that the interest payments come to about $2,000 a year for every working American. Mortgaging the future
In other words, we're mortgaging our future to pay for today's "cheap" purchases! By using the dollars they collect to buy our debt, the Chinese are putting themselves in position to exert significant control over our economy.
Judging by recent headlines, Americans have learned of the dangers of debt when it comes to financing their homes. If interest rates rise, the burden of servicing that debt becomes intolerable.
The foreign debt we owe is insidious, covered up in huge MEGO-numbers, seemingly trivialized by the billions and trillions we read about every time a new government statistic is reported. But we are digging a deep financial hole for our future -- all the way to China! And that's the Savage Truth.
Terry Savage is a registered investment adviser.