US debt: World Trade Challenges May Worsen Peril
The Standard & Poor (S&P) cautious downgrade of US debt may cascade into real peril if world trade challenges add to the troubles policymakers already face in cutting the devastating budget deficit and national debt.
In principle, US policymakers have up to 2013 to find credible bipartisan ways to reduce the deficit. But to get there they will also have to break the budget deadlock and create a path forward that does not repeat the deadlock. They will also have to reduce the nation’s overall debt a lot of which is caused by its world trade deficit.
The US can always avoid flat out default because the debt is denominated in dollars, which are the world’s reserve currency for trade transactions. So the Federal Reserve can always print more money. In this bottom-line sense, the S&P downgrade is not significant. But the downgrade’s importance despite the rating agency’s prudence is already clear from the negative reactions in financial markets around the world since the announcement.
A kind of panic has occurred simply because the debt outlook was moved to negative from stable despite the knowledge that US Treasuries are likely to remain triple A. Almost all markets are sending negative signals because the inflationary and other impacts of printing money are very destabilising and scary for both trade and financial flows underpinning the global economy.
World trade transactions are a major source of the dollars held by foreigners around the world. Many countries, including China, end up with surplus dollars because they export more goods and services than they import. Those surplus dollars are invested usually in US Treasuries, creating debt for the US as a country.
Prolonged inability of US policymakers to restore financially healthy footing to the nation could cause those foreigners to review their confidence in the rationality of US policies, creating confusion and additional unpredictability in global financial markets. Some parts of financial markets are speculative hedge fund money sloshing around for quick profits but most comprise stock market investments, which consist of shares in real companies giving real jobs to people. In this sense, financial markets are not virtual. They are just as concrete as money used for world trade.
One way for the US to improve its financial health is to export more to the outside world, thus earning dollars instead of printing them. Obama wants to double exports by 2015 but new world trade challenges have appeared, which he has yet to address with concentrated focus.
The main challenge is the likely failure later this year of the Doha Round of world trade negotiations after over a decade of vacillation and anguish. Almost all major sectors will be affected, including such big earners for the US as cotton and other agricultural exports, information technology services, financial and insurance services, intellectual property, manufactured exports, aircraft procurement and automobile parts.
The main reasons are the political difficulties in the US and the West in accommodating the rise in world trade of emerging economies, including China, India, Brazil, South Africa and Russia. Another trade challenge is likely to grow from the recent tragic earthquakes and tsunami in Japan. When the dust settles, Japan with typical skill and energy will start massive rebuilding programmes requiring heavy natural resource imports paid for by more exports. That Japanese export push will further undermine Obama’s plans to double US exports, already besieged by China’s export powerhouse.
Doha Round participants, which are all the major trading powers except Russia, still claim in public they will reach positive conclusion later this year but the talk behind closed doors is different. Based on the current outlook, they may declare hollow agreement by papering over differences to save face. Squabbles are many and several gaps seem unbridgeable without miraculous new political energy and economic courage.
However, politicians in the US and other democracies are not known for courageously speaking hard truths to electors or placing the public good above that of lobbies. Placating the noisiest lobbies is also more likely in the coming 18 months because Obama, Germany’s Angela Merkel and France’s Nicolas Sarkozy face elections.
S&P has a sent a signal to Capitol Hill and the White House, which some denounce as politically motivated. Whatever the truth, the issues are sharply practical. America’s budget deadlocks affect the entire world economy and come back to the US in the form of less confidence in its official paper. If that paper is downgraded further, the dollar might be edged out as a world reserve currency in favour of a basket containing China’s renminbi, the euro and the dollar. That would cut US financial clout by nearly a third, creating a loss compared with China that innovative American businesses will not be able to repair soon.