First in the "They're Burning Your Money" Series, appearing all week on the Fox Business Network
"Our rising debt levels (pose) a national security threat."—US Secretary of State Hillary Clintonto Council on Foreign Relations, Sept. 2010
“The biggest threat we have to our national security is our debt…the interest on our debt is $571 billion in 2012 and that’s notionally about the size of the Defense Department budget. It’s not sustainable."—Admiral Michael Mullen, chairman of the Joint Chiefs of Staff, June 2010
"We've reached a point now where there's an intimate link between our solvency and our national security."—Richard Haass, president, Council on Foreign Relations
“Several months ago, a group of logistics officers at the Industrial College of the Armed Forcesdeveloped a national security strategy as a class exercise. Their No. 1 recommendation for maintaining U.S. global leadership was ‘restore fiscal responsibility.’"—Washington Post, May 2010
“The Pentagon sponsored a first-of-its-kind war game..on how hostile nations might seek to cripple the U.S. economy,” with the weapons being stocks, bonds and currencies..."it was the first time the Pentagon hosted a purely economic war game.”—Politico.com, 2009
“The Russians made a ‘top-level approach’ to the Chinese ‘that together they might sell big chunks of their GSE [Fannie Maeand Freddie Mac] holdings to force the U.S. to use its emergency authorities to prop up these companies’…the Chinese declined…‘the report was deeply troubling--heavy selling could create a sudden loss of confidence in the GSEs and shake the capital markets. I waited till I was back home and in a secure environment to inform the president.”—Former US Treasury Secretary Henry Paulsonto Congress, January 2010
"We hope that the US deficit will fall as a proportion of GDP as the economy recovers and reach a sustainable level."— China's Assistant finance minister Zhu Guangyao, May 2010
"The United States cannot force foreign governments to increase their holdings of Treasuries…The world does not have so much money to buy more US Treasuries."--Zhu Min, deputy governor of the People's Bank of China, December 2009
“We don’t have a trillion-dollar debt because we haven’t taxed enough. We have a trillion-dollar debt because we spend too much.”—former US President Ronald Reagan
A consensus is growing among national security experts inside and outside the Obama administration: To preserve national security and its standing as the world’s number one superpower, the US must rebuild its economic strength at home by cutting the federal deficit.
The US’s $13.9 trillion federal deficit, the amount of its entire debt, is now approaching the size of its entire economy. And that does not include liabilities for Social Security, Medicare and Fannie Maeand Freddie Mac. And Goldman Sachs says the Federal Reservemay print $1 trillion more in a new round of quantitative easing, essentially buying next year’s budget deficit. The Fed's balance sheet, now at around $2.3 trillion, has already doubled in size since the financial crisis began due to the central bank's rescue measures.
A debt-drenched US is vulnerable to a global run on the dollar that could begin overseas. Fears are growing, too, that governments overseas could force the US into making decisions it wouldn't have initially chosen by using their foreign Treasury holdings as leverage. Which has already happened, says former US Treasury secretary Henry Paulson.
As the US issues record amounts of debt, it is jolting our trading partners into reacting.
Chinais the largest foreign holder of US debt. A little over a year ago, after the president had a two-hour meeting with Chinese Premier Wen Jiabao, the president requested that Chinastop manipulating its currency—but the Chinese in no uncertain terms quietly pointed out how much the US owes Chinain debt.
The US faces an estimated $8.5 trillion budget deficit -- the gap between annual revenues and annual spending -- over the next decade combined.
And that’s based on rosy government assumptions from the Congressional Budget Office that the US will grow at more than 3% annually, that there will be no more recessions, and that Congress will enact even President Barack Obama's legislative proposals to cut down the debt -- and that those cuts will actually work.
Optimistic, given that the 2011 new fiscal year began in America on October 1st as it has done in five of the past seven years, without a budget, and as the US begins the new year with a budget deficit the size of Canada’s economy.
Meanwhile, the estimated $571 billion in interest costs on the US debt projected for 2012 would surpass in size the economy of Argentina, and would fund about two dozen government agencies and departments, including the entire Legislative and Judicial branches.
But market analysts say this is not a problem just yet, because bond markets are not signaling any issues now with US debt issuance, as Treasury yields remain at historic lows. For now.
However, the US faces severe dollar devaluation, as the US is devaluing its way out of the crisis. The Federal Reserve’s quantitative easing and the Treasury’s massive borrowing has already dropped the US dollar to 15 year lows versus the yen, which is why commodities and gold are rising inexorably higher.
But the question is, would Chinadump its holdings in retaliation?
Paul Bracken, a professor and expert in private equity at the Yale School of Management who attended the economic war games sessions last year told Politico that he questions whether the Chinese would dump dollars on the global market to attack the US economy. Reason: Because it would harm their own holdings at the same time.
But Bracken added that the Chinese could take a middle way—they could sell dollars in increments.
Already, Chinahas steadily rotated out of its US Treasury holdings, which officially now stand at $846.7 billion, down from $939.9 billion in July of 2009 (market watchers believe Chinacontinues to own US debt via intermediaries in London and Hong Kong). Chinacould also simply threaten to roll over a slug of its $846.7 billion in US debt at faster intervals, to, say, a month from 90 days, which would roil the stock, commodities and currency markets.
Look at what happened with Fannie Mae and Freddie Mac. Although they are not on the official US budget books, the US had to take them over. What went on behind the scenes? Fears that Chinawould join Russia in dumping Fannie and Freddie debt caused the US to take these two insolvent companies into conservatorship. Russia reportedly dumpedits Fannie and Freddie debt in 2008, after holding $65.6 billion of their debt, according to central bank data.
Much of the US deficit is being financed by China, which is selling the US hundreds of billions of dollars of goods, then lending the US those dollars back. Overall China’s currency reserves amount to nearly a quarter of its purchasing power parity. And by suppressing its exchange rate, and underpaying its workers, Chinaeffectively subsidizes production of its exports.
However, Chinais not the biggest holder of US debt—the US is, through government agencies, households and nonprofits (see listing below).
We are funding ourselves sick. Which is why the US dollar is taking a beating.
If a US publicly traded company tried this “vendor financing style” of roundtripping of US money printing to buy US government debt, back to more demands at the Fed to print more, that would get a civil lawsuit from the Securities and Exchange Commission, says Fox Business news director Ray Hennessey.
Tech and telecom companies were slapped around for this accounting shenanigan by the SEC during the dotcom bubble. It essentially involved companies lending other companies money to buy their products, which goosed the revenue line higher—and subsequently stock prices.
So, who should we worry about more? Derek Scissors of the conservative Heritage Foundation in the US says the irony is: “The biggest force undermining the dollar is the US Federal Reserve, and the dollar’s biggest defender is the People’s Bank of China.”
Which is why the midterm elections are once again a rejection of Washington and a vote for gridlock, just when the US needs compromise in the halls of Congress, as the debt grows, as entitlement spending mounts and urgent action is needed now.
“It undermines our capacity to act in our own interest, and it does constrain us where constraint may be undesirable. And it also sends a message of weakness internationally...So I don’t think we have a choice–it is a question of how we decide to deal with this debt and deficit….There is no free lunch, and we cannot pretend that there is without doing grave harm to our country and our future generations.”--US Secretary of State Hillary Clinton
Top holders of US Treasury securities (as of June 30, 2010)
Source: US Treasury Dept.
1. US government: $4.6 trillion in intergovernmental holdings
2. US households and non-profits: $1.1 trillion
3. China: $843.7 billion
4. Japan: $803.6 billion
5. State and local governments: $511.8 billion
6. Private pension funds: $407.4 billion
7. United Kingdom $362.2 billion
8. Money market mutual funds: $351.2 billion
9. Other mutual funds: $281.6 billion
10. Commercial banks: $246.2 billion
1. Treasury Dept., "Debt to the Penny"
2. Treasury Department, TIC data, Major Foreign Holders of US Treasury Securities
3. Federal Reserve, Flow of Funds Accounts, L.209 Treasury Securities, September 17, 2010