The US turning a debtor?

The dollar fell sharply in February when the Bank of Korea disclosed it plan to step up its purchases of securities in other currencies. Other central banks in Asia are also contemplating diversifying their holdings away from the dollar. The Finance Ministry of Japan is holding the largest portfolio of $720 billion worth of US government securities, while China remains in the second position, holding $600 billion worth. This is followed by South Korea with $235 billion and Taiwan with $193 billion.

According to the New York Times, these countries have held the bulk of their reserves in US treasury bills, notes, and bonds that has financed the US federal budget deficits for years. These countries are responsible for holding roughly 40 percent of the government of America's public debt.

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The government itself owns about 40 percent of the debt. Several government programmes, including highway, airport constructions, military and civil retirement, Medicare and social security are financed through trust funds. When the trust funds run a surplus, federal law requires that these surpluses be invested in federal securities. A second large piece of the federal debt (nine percent) is held by the Federal Reserve.

Recently oil producing countries have joined in buying US government securities. According to the US Treasury Department, 16 major oil-producing countries,

including Saudi Arabia, Iran, and Kuwait, have bought, as of September 2004, $50 billion worth of US government securities. Mexico is the largest oil-producing buyer

of US securities, with nearly $21 billion. With a $412 billion budget deficit coupled with a $600 billion trade deficit, the economy of America does not look good at all. Budget deficits are the major factor in the declining economy. There is no other way without sharing trade deficit by other investors, who would be willing to hold American dollars. And persistent budget deficits would worsen the economy further. Without bringing down the deficit, savings would be impossible. Without savings no investment is possible either.

The US federal debt has grown in the second half of the twentieth century. This total federal debt grew from $257 billion in 1950 to $900 billion in 1980. Since then it has been quintupled to $6 trillion in 2002. Defense spending has alarmingly increased, which is another factor contributing to the worsening the economy. The Republicans, by and large, are inclined to increase defense spending to make security of America stronger, and President Bush has argued that the country has no alternative but to increase defense spending.

Major industries in America are investing in Asia. Therefore, investment in America has been dwindling, but consumption remains high, which means the country has been surviving beyond its means. Savings rate in America has gone down from nine percent in the 1960s and 1970s to the lowest rate of one percent in 2000. Persistent budget deficits undermine the future well-being of Americans.

By consuming savings, the possibility of investment becomes very bleak indeed. According to the Washington Post,much of the investment in America by businesses is goingÊinto real estate, which does not generate the production of goods for export that are needed to help shrink the trade gap. According to a recent census, 45 million people are now living below poverty level. About 4 million came down to this level during President Bush's first term in office.

This being the economic scenario, the government as of now appears to be unnerved as can be seen from the action. The government is seeking approval of the Congress for increasing the debt ceiling. Jim Moran, Congressman from Virginia, whom this writer met recently, in an article gave a bleak picture of the economy in America.

He sai that in a few weeks, the current debt ceiling would be at an all time high of $8.2 trillion, and that by ignoring signs of impending crisis in the hope that markets forces would fix everything, the US is facing a looming fiscal crisis. He said that foreign governments are now America's largest creditors: "We may be the most powerful nation in the world, but China, as the largest investor, has a great deal of leverage. This poses a real threat to our sovereignty."

The dollar is down about 50 percent against the Euro since October 2000 and recently it hit its lowest level. Many analysts predict that the Euro could hit $1.40 by the middle of 2005. This trend has been accelerated since President Bush was re-elected in November 2004.

America continues to attract foreign capital. In September, foreigners purchased $63.4 billion worth of securities. Two well-known two economists, Maurice Obsfeld and Kenneth Rogoff, warned of what they called current account collapse sparked by withdrawal of funds by international investors.

The other side of the coin is that being leading importer of merchandise, including ready-made garments from third world countries, America is now buying at higher prices. If the dollar continues to dive, foreign investors would consider withdrawing investments unless the rate of interest is increased by the federal government.

On December 14, an increase of 2.5 percent was announced by the Federal Reserve, and this was the fifth such increase of interest rate that year. Some economists are of the view that the timing reflects concern that President Bush with his tax cuts would not be able to rein in record budget deficit. Another group of economists are holding the opinion that under the Bush administration there would be less concentration on tackling the two budget deficits. It would be interesting to quote from Alan Greenspan, Chairman of Federal Reserve, who said: "Foreign investors would eventually resist sending more money to the US. This could lead to a further decline in the dollar, and possibly higher interest rates." Meanwhile, the President of the European Bank has expressed concern by saying that a strong euro is making European exports more expensive

Since the dollar is sliding down, the Chinese, Indians, and South Africans are diverting from the dollar. American consumption has risen, but it has grown faster than the country's ability to produce, which has resulted in greater imports from foreign countries. Imports include cars and televisions to a wide range of clothing, toys, and other consumer commodities. This trend reflects the fact that Americans are increasingly adapting to imported products. On the other hand, foreigners are showing little interest in buying American products. The only area where America dominates in international markets relates to military equipment and computer software. This has resulted in an enormous deficit in trade.

Since foreigners are financing a large part of the increase in the national debt of America, interest payments made to foreign investors increased by almost 12 percent per year. A big chunk of America's tax revenues are in fact going abroad to pay foreign investors in the form of interest. America, as a result, has turned into a debtor country.

If the authorities intend to attract foreign capital, there is no alternative but to raise interest rates. If interest rates are increased appreciably, major problems would remain unless the budget deficit is brought down to a minimum level. An economic consultation meeting was recently held at Washington under the Bush administration's initiative, but no concrete plan has yet emerged. Let us see what pragmatic action is being taken by the administration to tackle the major economic issues of the country, i.e. its budget and trade deficits.

Mohammad Amjad Hossain, a former Bangladesh diplomat, resides in Virginia, USA.