Who will 'feed' the US?

The United States, the world's most developed country, is scrambling to answer the question "Who will 'feed' the US?" [Answer: “no one”] years after it had asked the most populous developing country a similar question: "Who will feed China?"

Is it sensational to ask the richest country the same question that China faced more than 10 years ago? The reply is "No." This time, it is not about "grain supply", but "capital supply" and "supply of order."

An unprecedented financial crisis that originated in the US is shattering the world, without exception to any region. In response, the US has announced massive rescue plans to revive the economy, and is ready to roll out more such plans, yet leaving a big question mark as to how it will get enough money to finance those plans.

The US Congress sanctioned a $787 billion stimulus plan submitted by the Obama administration last month, which media reports said is only a small fraction of the overall plan.

The US-based San Francisco Business Times reported on Nov 26 that the US government and the Federal Reserve is harboring a huge $8.5 trillion rescue plan, or about 60 percent of the country's GDP.

US President Barack Obama is expecting a record $1.75 trillion in federal fiscal deficit this year. The fiscal figure reached a high of $459 billion last year.

This year's deficit would account for 12.3 percent of the GDP, the highest since the World War II and far exceeding the recognized 3-percent alarm level.

In addition, Obama also foresaw an average $1 trillion in deficits each year for 2010 and 2011.

Many US experts said Obama's estimate was too optimistic [Agreed], and the actual deficit would be even bigger, as the president excluded the country's liabilities in his projection.

Where does the money come from? [Answer: “printing press”]

Who will be able to provide the financial support for the enormous fiscal deficit of the US government?

The US Treasury Department estimated the US government would issue up to $2.56 trillion of treasury bonds this year, and at least $1.14 trillion more next year. [It will be far more.]

By the end of last year, outstanding treasury bonds stood at $10.7 trillion. About 29 percent, or $2.862 trillion, is held by foreign governments or investors. That means the country's reliance on overseas investors holding treasury bonds has been raised by 10 percentage points from eight years ago.

"The world simply cannot buy any more new issuance of US treasury bonds," [Agreed] said Yu Zuyao, an honorary economist with the Chinese Academy of Social Sciences (CASS), who used to head the CASS Institute of Economics.

Many countries have their own hands full, like the US, using their capital to counter the financial crisis, consolidate their financial system, and fuel their own stimulus packages to revive the real economy, even though they have some foreign exchange reserves in US dollars.

Thanks to trade surpluses, emerging economies hold a combined $5.5 trillion in forex reserves [more when sovereign wealth funds are added in], but most of the reserves have already been used to buy US treasury bonds, said Yoko Kitazawa, an expert on international affairs, in a February issue of Sekai (The World), a Japanese monthly journal.

However, trade surpluses of these regions and countries are eroding because of a collapse in global trade.

As a result, forex reserves of these regions and countries are expanding at a slower pace, or even declining. The latest forecast from the World Trade Organization said global trade may shrink by 9 percent, or more, this year.

As the largest holder of US treasury bonds and the world's second largest exporter, China had seen exports decline since November last year, with its actual use of foreign capital falling since October.

Media reports said China's forex reserves may have decreased by more than $30 billion in the first two months. China's forex reserves stood at about $1.95 trillion at the end of last year, the largest in the world.

The Xinhua-run newspaper Economic Information Daily reported this month China had liquidity of only $300 billion to $500 billion in forex reserves, citing a report from an unidentified ministry-level research institute.

Crowding out effect of US capital pool

Yang Bin, also a CASS economist, said the US was luring capital scattered all over the world to pool in the US by floating excessive treasury bonds, which could be a threat to developing countries which are crying out for capital. [The US treasury market is sucking the life out of the world economy. Capital needed to fund economic growth in developing countries is being used to bail out doomed US financial institutions via treasury sales. The sooner the treasury market and the dollar collapse, the sooner the world can begin to heal.]

Economic development in many developing countries is, to a large extent, counting on such an influx of overseas capital.

The US-based Institute for International Finance warned in January that capital flows into emerging markets are in danger of collapsing this year as a result of the financial crisis.

The association of large banks estimates that net private sector capital flows to emerging markets will be no more than $165 billion this year, which is less than half of $466 billion in 2008 and only a fifth of $930 billion in 2007.

The crisis and a global economic recession are also aggravating the world poverty. The United Nations said in a report published this month that reduced growth this year would lead to a total income loss of around $18 billion ($46 per person) for 390 million people in Sub-Saharan Africa living in extreme poverty.

The projected loss represents 20 percent of the per capita income of the poor in Africa, far exceeding the losses of developed nations.

The majority of low-income nations, or 43 out of 48, are incapable of providing a government stimulus for the poor, according to the report.

In addition, the excessive US treasury bonds, its enormous fiscal deficit, and issuance of the dollar that far exceeds the demand of the economy would drive the world nearer to inflation and a depreciating US dollar. This could be another heavy blow to the world economy in a downturn and to developing countries in particular.

Worries over dollar-denominated assets

"The immense 'US treasury bonds bubble' has not only badly weakened new demand among investors, but also put foreign investors in danger of seeing their dollar-denominated assets shrink in value," [Agreed] said Yu.

The US Treasury Department said the US government bonds held by foreign countries were down by $4.7 billion at the end of January from a month ago.

This is the first time for other countries to sell US treasury bonds since March 2007.

China's purchase of US treasury bonds decelerated. The country purchased $12.2 billion in treasury bonds in January, the smallest monthly increase since the second half of last year.

Capital is fleeing the US in January, foreign investors sold $43 billion of long-term US bonds, compared with an inflow of $34.7 billion into the country.

The US is facing a capital account deficit of $148.9 billion, if short-term bonds are included, as foreign governments and institutions became reluctant to buy more US bonds. The deficit compares to $609.9 billion in surplus for the whole of 2008.

Returns on US government bonds will be down by 2.69 percent in 2009, according to the Caijing Magazine, citing a treasury bonds index of Lehman Brothers. In 2008, returns on US government bonds were almost 14 percent.

China held US treasury bonds worth $740 billion by the end of January, about 7 percent of the total of US government bonds. In all, the country holds $1.2 trillion of dollar-denominated assets, including institutional bonds and equity investment as well.

Chinese Premier Wen Jiabao on March 13 expressed worries over the safety of these assets and called on the US to keep to its commitments and ensure the safety of such assets.

More than a week ago, however, US Federal Reserve chairman Ben Bernanke, dubbed "Helicopter Ben" for his speech about using a "helicopter drop" of money into the economy to fight deflation, actualized his threat to print more greenbacks.

He said on March 18 the Fed would purchase up to $300 billion of longer-term Treasury securities over the next six months, along with an additional $750 billion in mortgage-backed securities.

It is the first time since World War II that the Fed has bought long-term government bonds.

The Fed's decision to print more money to finance the purchase immediately led the greenback to fall against all other major currencies.

The San Francisco Business Times reported the Fed's printing press is financing about two thirds, or $5.5 trillion, of the $8.5 trillion of the US rescue money. The Fed needs no approval from the Congress to start the printing press.

Analysts said the Fed is left with no other option but to print, with the key interest rate staying at a record low of zero to 0.25 percent.

"The US is indeed capable of paying off its government bonds, but, what is the real value of bunches of dollars by the time the bonds are due," said Yang.

In a move to dispel concerns over the US extravagance in spending, the Obama administration said it aimed to halve the country's fiscal deficit to $533 billion in 2013. The goal is based, however, on optimistic estimation of a strong rebound in the US economy.

"People have every reason to doubt whether this could be possible," Yang said.

Over the next 10 years, the federal fiscal deficit is bound to swell as the government will have to address the structural problems of the US social insurance and medical insurance plans.

US economists believe that a ballooning deficit would be inevitable, regardless of the status of the US economy.

Finding a way out

China's central bank governor Zhou Xiaochuan last week suggested the creation of a super-sovereign reserve currency that is disconnected from individual nations and is able to remain stable in the long run, to avoid inherent deficiencies caused by using credit-based national currencies.

The repeated and escalating financial crisis since the collapse in 1971 of the Bretton Woods system showed the whole world may be paying more than what it gained from the current currency system, he wrote in an article.

As the world's reserve currency, about two thirds of the international trade and financial transactions are priced and settled in the US dollar. [That is a disaster waiting to happen.]

At the core of the ongoing financial crisis that started in the US are the fundamental flaws of the US economic systems and the neo-liberal economic policies of US that led to tremendous trade deficit, fiscal deficit and personal credit deficit, Yu Zuyao said.

"It is not in the least a problem in US financial regulation," Yu said. "What is needed is to overhaul the US neo-liberalist system, reform the current international financial system and restore the world's economic order, otherwise, such crises will be repeated." [Agreed]

A currency is intended to serve the economy; however, Wall Street took the lead in creating a currency-focused economy that is parallel to the real economy.

The market value of US financial assets is $40 trillion to $50 trillion, but market capital has been indulged to operate in away that makes financial derivative products spiral up to more than $600 trillion in value, about 50 times the 2007 US GDP.

More than 97.5 percent of the world's capital in circulation is speculative capital and only 2.5 percent is enough to meet the demand of the real economy, said Yoko Kitazawa.

In the meantime, the US has long been a supreme power in the world.

The US-led developed countries are actually receiving $3.5 from developing countries for every dollar in aid that goes to the developing countries, Yoko Kitazawa said.

Paradoxically, as the world's largest debtor with more than 20 years of consecutive years of trade deficit, the US is witnessing, at the same time, a surplus in capital account and in capital inflows. This is a testimony to the unfairness in the international financial system and the global economic order.

"It's time to have the resolution to change it," Yang said. "It is what the financial and economic crisis has told us."