Impending Destruction of the U.S. Economy

Editor's Note: EconomyInCrisis.org is not a partisan advocate for any particular party or candidate. However, the following article speaks to many causes of our current situation that an increasing number of Americans feel are critical for future voters and leaders to consider.

Hubris and arrogance are too ensconced in Washington for policymakers to be aware of the economic policy trap in which they have placed the U.S. economy. If the subprime mortgage meltdown is half as bad as predicted, low U.S. interest rates will be required in order to contain the crisis. But if the dollar's plight is half as bad as predicted, high U.S. interest rates will be required if foreigners are to continue to hold dollars and to finance U.S. budget and trade deficits.

Which will Washington sacrifice, the domestic financial system and overextended homeowners or its ability to finance deficits?

The answer seems obvious. Everything will be sacrificed in order to protect Washington's ability to borrow abroad. Without the ability to borrow abroad, Washington cannot conduct its wars of aggression and Americans cannot continue to consume $800 billion dollars more each year than the economy produces.

A few years ago, the euro was worth 85 cents. Today, it is worth $1.48. This is an enormous decline in the exchange value of the U.S. dollar. Foreigners who finance the U.S. budget and trade deficits have experienced a huge drop in the value of their dollar holdings. The interest rate on U.S. Treasury bonds does not come close to compensating foreigners for the decline in the value of the dollar against other traded currencies. Investment returns from real estate and equities do not offset the losses from the decline in the dollar's value.

China holds over $1 trillion, and Japan almost $1 trillion, in dollar-denominated assets. Other countries have lesser but still substantial amounts. As the U.S. dollar is the reserve currency, the entire world's investment portfolio is overweighted in dollars.

No country wants to hold a depreciating asset, and no country wants to acquire more depreciating assets. In order to reassure itself, Wall Street claims that foreign countries are locked into accumulating dollars in order to protect the value of their existing dollar holdings. But this is utter nonsense. The U.S. dollar has lost 60 percent of its value during the current administration. Obviously, countries are not locked into accumulating dollars.

The reason the dollar has not completely collapsed is that there is no clear alternative as reserve currency. The euro is a currency without a country. It is the monetary unit of the European Union, but the countries of Europe have not surrendered their sovereignty to the EU. Moreover, the United Kingdom, a member of the EU, retains the British pound. The fact that a currency as politically exposed as the euro can rise in value so rapidly against the U.S. dollar is powerful evidence of the weakness of the U.S. dollar.

Japan and China have willingly accumulated dollars as the counterpart of their penetration and capture of U.S. domestic markets. Japan and China have viewed the productive capacity and wealth created in their domestic economies by the success of their exports as compensation for the decline in the value of their dollar holdings.

Both countries have seen the writing on the wall, ignored by Washington and American economists, however: By offshoring production for U.S. markets, the United States has no prospect of closing its trade deficit. The offshored production of U.S. firms counts as imports when it returns to the United States to be marketed. The more U.S. production moves abroad, the less there is to export and the higher imports rise.

Japan and China -- indeed, the entire world -- realize that they cannot continue forever to give Americans real goods and services in exchange for depreciating paper dollars. China is endeavoring to turn its development inward and rely on its potentially huge domestic market. Japan is pinning hopes on participating in Asia's economic development.

The dollar's decline has resulted from foreigners accumulating new dollars at a lower rate. They still accumulate dollars, but fewer. As new dollars are still being produced at high rates, their value has dropped.

If foreigners were to stop accumulating new dollars, the dollar's value would plummet. If foreigners were to reduce their existing holdings of dollars, superpower America would instantly disappear.

Foreigners have continued to accumulate dollars in the expectation that sooner or later Washington would address its trade and budget deficits. Now these deficits seem to have passed the point of no return, however.

The sharp decline in the dollar has not closed the trade deficit by increasing exports and decreasing imports. Offshoring prevents the possibility of exports reducing the trade deficit, and Americans are now dependent on imports (including offshored production) for which there are no longer any domestically produced alternatives. The U.S. trade deficit will close when foreigners cease to finance it.

The budget deficit cannot be closed by taxation without driving up unemployment and poverty. American median family incomes have experienced no real increase during the 21st century. Moreover, if the huge bonuses paid to CEOs for offshoring their corporations' production and to Wall Street for marketing subprime derivatives are removed from the income figures, Americans have experienced a decline in real income.

Some studies, such as the Economic Mobility Project, find long-term declines in the real median incomes of some U.S. population groups and a decline in upward mobility.

The situation may be even more dire. Recent work by Susan Houseman concludes that U.S. statistical data systems, which were set in place prior to the development of offshoring, are counting some foreign production as part of U.S. productivity and GDP growth, thus overstating the actual performance of the U.S. economy.

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