“MAPping The Future” Column in the INQUIRER – 6 April 2009
The US crisis calls for structural reforms
by Aurelio O. Angeles
On March 13, the Premier of China expressed his worries about China’s investments on US treasuries valued at
$727.4 B as of the end of last year. Wen Jiabao called on the US "to maintain its good credit, to honor its
promises and to guarantee the safety of China assets."
President Obama responded immediately with this statement: "Not just the Chinese government, but every
investor can have absolute confidence in the soundness of investments in the United States."
"There is a reason why even in the midst of this economic crisis you have seen actual increases in investment
flows here in the US."
Indeed, power is the reason
Indeed, there is a reason: it has to do with the US influence after World War II to institute the US dollar as the
medium of exchange in international trade and investment and to establish the USA as the world's financial
Unfortunately, that reason belongs to the glory of the past. The issue now is the global economic crisis that
started with the growing debts in the US economy.
This may be the point of China's Premier Wen Jiabao.
To address the growing economic crisis, the leaders of G20 representing 85% of the world's economic output
declared in their March 14th meeting in England that governments must "take whatever action is necessary until
growth is restored".
But the 8-point strategy in the G20 conference dwelt on nothing new. These points have been the program of
governments since the economic crisis erupted. (Source: http://www.ft.com/cms/s/0/3fd02aca-10ba-11de-994a-
Allow me to bring out 8 other points not taken up still which are mostly unseen undercurrents.
It's rolled-over debts, stupid!
First, what is the crisis about? It's the increasing unpaid debts of the US economy. These are debts raised and
accumulated through the years and for lack of savings they continue to be rolled over.
The US crisis first manifested in defaults in the housing sector. Then, the crisis exploded and exposed the US
dependence on complex forms of debt instruments in order to fund its economic growth.
In whatever way we view the crisis, the US growing unpaid debts will always turn up as the principal origin of
succeeding falling dominoes - foreclosures, market glut, failed institutions, bail-outs, stock market crash, credit
tightening, unemployment, recession.
There are two important sides to these debts – millions of borrowers without capacity to pay and millions of
investors with easy money to lend.
There is a third side - financial intermediaries that marry the first two sides. They are the debt masters who profit
from every debt called in another word – investment.
There would have been no crisis if there were no eager borrowers, no crisis without rich lenders so eager to part
with their money for greater returns, no crisis without debt masters so eager to make the union of the 2 parties
Here’s the clincher: Even if these 3 parties find each other as they did, still no crisis would erupt if these
borrowers were engaged in enterprises producing enough income to pay for their rolled-over debts.
The bottom line is the capability of borrowers to generate a stream of net income to pay future amortization. On a
macro level, the bottom line is the capability of the economy to produce opportunities for these borrowers who
make up the economy to generate net income to pay for their debts over time.
As it turned out, the US economy did not have such capability. And bubbles burst.
It's net income to repay debts!
This leads us to my 2nd point: the US economy does not generate net income to pay for its growing debts.
How does one determine the US economy’s capacity to generate net income and pay debts?
You would think it is GDP or Gross Domestic Product. Think again.
In the now global economy, the US economy incurs debt when the value of its exports of goods and services to
the rest of the world is less than the value of its imports from the rest of the world. (Factor incomes from
investments and work abroad also come into play.)
When the combined dollar revenues of Americans are less than their combined expenditures in their business with
the rest of the world, Exports less than Imports, then a deficit is incurred and that deficit is debt. In this case, the
rest of the world is lending dollars to the US economy.
On the other hand, when the combined dollar revenues of Americans exceed their combined expenditures,
Exports greater than Imports, then necessarily the surplus is savings. In this case, the rest of the world is
borrowing from the US economy's savings.
The term used for this account is CURRENT ACCOUNT BALANCE (CAB).
A chronic negative CAB of the USA shows that the Americans are not competitive with the rest of the world. On
the other hand, a continuous positive CAB shows that Americans are competitive in their dealings with the rest of
the world. This positive CAB of Americans generates the savings or net income that enables them to pay their
debt with the rest of the world.
For a details on CAB, please read my November 23rd and 30th articles on Financial Markets: Growing Unpaid
Debts, in http://business.inquirer.net/money/columns/view_article.php?article_id=173942 and in
What's the US CAB history!
What does the history of the USA on CAB show? We now proceed to my 3rd point.
The USA has been on deficit for 33 year and will continue to be so in the years to come.
Moreover, the US government under President Obama has all forms of expenditure plans funded through
borrowings which do not carry long term measures to reverse this history of CAB deficits.
So long as the US economy incurs CAB deficit through the years, it will not have any savings to pay for its past,
present and future debts to the rest of the world. That creates further instabilities.
Premier Wen Jiabao is therefore right to voice his concern on the safety of China investments in the USA.
Truly, this situation calls for an overhaul of current views on the nature of the growing US economic crisis.
It's not just GDP!
The negative US CAB for the past 33 years leads us to the fourth point.
The question is: Is the Obama administration on the right track in pumping money as fiscal stimulus?
The fiscal stimulus of the Obama administration is grounded on the belief that Keynesian economics will lead to
recovery as it did in the Great Depression.
Keynesian theory may be summed up in the formula, Gross Domestic Product = C + I + G + (X - M).
In this formula, to stir up GDP the government only has to pour money in the economy in fiscal stimulus.
Increased government expenditures would trigger the rise in consumption, investments and net exports.
In this formula, it is assumed that government may borrow without considering repayment so long as such
government borrowings result in expenditures that increase growth. Such growth is seen to take care of
increasing government revenues. A very good line from debt masters!
These may be true if the economy is relatively leak-free and most economies functioned relatively closed.
But Keynesian theories have been overrun by the now global economy starting in the 80s long after the death of
John Maynard Keynes.
With the ability of modern technology to freely move capital across national borders at an instant, the global
economy awakened the wealth of the world accumulated through centuries. This enormous wealth is now in the
busy hands of financial market operators whose expertise as debt masters is to match this wealth with needs for
debt of voracious borrowers. The debt masters soon identified these borrowers – growing economies with chronic
CAB deficits – and the biggest target of all is the USA.
The USA, the country with the world’s highest GDP and highest Per Capita Income, has become the center of the
global crisis and economic instability. Its growth in the past 3 decades has been funded mainly by grow ing
rolled-over debts in the expert hands of debt masters.
With the US crisis we now know GDP growth by itself does NOT mean stability. We now know that GDP does
not show how this growth is funded and how the debt that generated such growth can be repaid over time. We
need the economy’s CURRENT ACCOUNTS BALANCE and FLOW OF FUNDS for these, two accounts taken
for granted by most economists.
Is President Obama in the right course in pouring trillion dollars as fiscal stimulus in the economy?
Every dollar of stimulus will increase GDP and raise employment. Indeed!
But, without structural reforms in international trade and finance, every dollar of fiscal stimulus in the hands of
Americans will only result in Americans buying more cheap imports, killing US local industries, raising US
current account deficit, increasing foreign debt, the loss of employment, loan defaults. In effect, in greater risks in
the global economy.
The similarity is striking: the massive US fiscal stimulus is like drinking salt water to quench one's thirst.
Truly that calls for a radical change of views on solutions to the growing economic crisis in the USA.
It's the exchange rate!
The concept of current account deficits exposes the role of the US dollar as the medium of exchange for
international trade, investment and finance - my fifth point.
Leaders of the G20 in its March 14th conference dwell on the need for concerted fiscal stimulus, reducing interest
rates, bail-outs, the role of the IMF, World Bank, IFI and ADB, accurate credit ratings, financial markets
regulation, improvement of mark-to-market standards, etc..
But nobody will mention the US dollar’s role as the world’s medium of exchange. Why is this so critical?
One, the dollar fluctuation is the greatest source of instability and risks in the global economy. It brings
incalculable risks to international traders, lenders, investors and borrowers. It also gives worries to leaders who
invest their foreign reserves in US treasuries like Premier Wen Jiabao of China.
Two, the high value of the US dollar is also an important reason why US labor cost is high, why US products are
more expensive than China products, why cheap imports are killing US domestic industries and US exports are
finding themselves uncompetitive in the world market.
This high value of the dollar is also the reason why the US current account balance has been persistently on
deficit for 33 years now. Even as that may be so, the present US government continues to maintain the desirability
of the dollar’s high value but will deny it is over-valued.
Three, under normal circumstances, an economy with chronic current account deficits will find its local currency
depreciate over time. Note the deficits of Thailand, Korea, Philippines the years before the breakout of the Asian
Crisis, Argentina before its own crisis, and now UK and Iceland in the past 3 years.
But this does not happen with the USA with its 3 decades of CAB deficits. Why not?
The world does not have a choice but to keep on buying US dollars. Why? First, trading of goods and services in
the global economy is done in US dollars. This has been instituted as a way of life since after the 2nd World War.
Second, the financial centers of the world are found in the USA - stock markets, futures and options markets and
currency markets - and the US dollar is the currency in use here. Fourth, it is the US government that prints the
US dollar. It has control over its circulation and its leaders do not want the US dollar to depreciate in value.
As a result, the US dollar remains strong and does not depreciate even if the USA has chronic CAB deficits and is
the center of the financial and economic meltdown.
Four, here is the astounding implication of these concepts.
Money spent in fiscal and monetary stimulus will end up in the hands of Americans who will buy imports made
cheap by the high value of the dollar. The competitiveness of imported products and lack of competitiveness of
US exports will weaken US domestic industries, will result in greater CAB deficit and increased US borrowings
from the rest of the world.
Foreign economies with CAB surpluses will lend their dollar savings to the US economy and foreign
governments like China will keep investing their dollar reserves in US treasuries and will keep propping up the
value of US dollars to protect the value of their ever increasing US dollar investments.
Here’s the clincher: Premier Wen Jiabao will come back with his worries about the US economy’s ability to keep
China’s investments safe and sound and ask for guarantees!
The US dollar as the international medium of exchange is the most risk-laden vicious cycle of the century! Its use
is similar to thirsty cast-aways drinking sea water to quench their thirst.
What, indeed, is the solution? We now have reached my 6th point.
I go back to the texts of the G20 communiqué: "We have taken decisive, coordinated and comprehensive action
to boost demand and jobs, and are prepared to take whatever action is necessary until growth is restored. We
commit to fight all forms of protectionism and maintain open trade and investment."
To accomplish this mission, the G20 leaders representing 85% of the world's output must now consider the
creation of one universal foreign exchange for international trading, investment and finance.
These leading economies must establish the orderly system of converting the world's present currencies to this
foreign exchange and retire the US dollar and other local currencies as medium of exchange.
The European Union successfully accomplished this type of re-structuring starting 1999 with the conversion to
the Euro of the German Marks, Italian Lira, French Francs, Spanish Peseta, etc. The world can learn from the
success of the Euro whose only deficiency as a medium of exchange till now arises from its being still only one
among the many currencies in the world.
The growing global economic crisis should impel leading economies to implement this universal foreign
exchange for the world. Call it Unitas, if you will, or another name.
The world’s leading economies in G20 must eliminate once and for all the instability, risks and non-tariff trade
barriers associated with the US dollar as the international foreign exchange.
With this universal currency, the USA is no longer saddled with the US dollar that makes its imports cheap and
exports expensive. It can now be compete with the rest of the world on trade on a level field.
Under this regime, the Obama fiscal stimulus can succeed in providing long term employment to Americans, in
boosting local industries and in enabling the USA to share the boundless reserves of its people’s technology and
innovativeness with the rest of the world through unrestricted, open trade.
Under this regime, the USA now has a chance of reversing its 33-year-old history of current account deficits.
With higher chances of attaining current account surplus, the USA now has the capacity to earn savings and repay
its foreign debt that has accumulated through decades.
There is a special group who won’t be happy with this – debt masters who make money on debt AND on the
world’s numerous currencies! May I refer you to my other article on Doctors Healing Themselves in US
Economic Crisis: Barriers to Problem Solving?
Truly, this calls for a structural change and a united action among the leading economies of the world.
It's the wealth of nations!
This universal medium of exchange now leads me to the 7th point - the wealth of nations dating back to the times
of kings and queens to the present.
This wealth is enormous and their values are seen from investments managed by hedge funds, mutual funds,
private equity funds, pension funds and insurance conglomerates.
To appreciate the enormity of these savings, kindly access my November article, Financial Markets - How Large
Are They? in http://business.inquirer.net/money/columns/view_article.php?article_id=171190 .
I have three comments on this wealth.
One, if interests are reduced to near zero by central banks, what incentives can banking institutions provide the
world’s savers and wealth accumulators? Don't they deserve returns for providing the capital to mobilize the
cash-starved real economy!
These rates must not be too low, otherwise central banks will be driving savers in the arms of Bernard Madoff and
of debt masters who will compete with one another in providing exotic derivatives.
These rates must not be too high, otherwise the real economy will stagnate.
Central banks must now set a balance between this incentive to wealth accumulators and the borrowing cost of the
real economy. This is the principal goal of managing interest rates - providing incentives for savers and producers
in order that aggregate supply can match aggregate demand and as a result price stability is maintained. Interest
rates, taxes and regulations must also be managed to control speculative demand coming from financial market
Two, the management of interest rates must protect savers and producers. Monetary policy must NOT protect
the interests of financial market operators at the expense of savers and producers. Eventually what is good for
savers and producers will result in the benefit of financial market operators.
Three, monetary and fiscal policy must provide priority to the development of the real sector of the economy
representing production of goods and services in the present and future over the interests of the wealth
accumulators representing the production of goods and services of the past. In the end, what’s good for the real
economy will benefit wealth accumulators.
The rationale for this position is discussed in my October 12th article, Financial Markets: Where To Now?
Four, there is irony in the accumulation of trillions of these savings in the hands of financial market operators
whose view of investments are limited to the opportunities existing in exchanges. I would like to quote my
November 9th article:
"The world of exchanges are awash with money accumulated through centuries of mankind working in the real
economy and that money has no place to go."
"The abundance of capital in the world of exchanges today also explains why derivatives must be invented. If
derivatives were not around, financial engineers would create another medium by which the wealth of nations
could be attracted, channeled and yield higher incomes."
"How ironic it is that the rich and the powerful must lose money for having so much of it in the financial
That situation calls for an overhaul of economic policy thinking and implementation.
It's the remaining frontiers of growth!
The wealth of nations brings us to my final point - the irony of wealth in stock and futures exchanges in the midst
of so much economic opportunities in the remaining frontiers of growth in the world.
Let me quote my November 9th article:
"How difficult it is to comprehend that while this abundant wealth has no place to go but in an endless spiral of
speculative transactions, billions of people in third world countries and underdeveloped economies are wanting of
food, clothing, housing, medicine, hospitals, roads, bridges, airports, clean air, clear water and capital to build
Let me quote my October 12th article, Financial Markets: Where To Now?.
"And this is the irony of being rich.
When a man gets to be one, he loses his sight of the fact that he became rich by serving people, by making his
customers number one and by exploring unchartered frontiers where other customers abound.
As he masters the time value of money, he figures he will make faster money in the exchange rather than in the
exchange of real goods and services in the real economy.
He loses his touch of the opportunities that abound in the teaming population of Third World countries and
underdeveloped economies where the demand for f ood, clothing, housing, education, infrastructure,
transportation, information and communication technology, health and science facilities are boundless.
But people create demand. A billion people mean a billion-people demand.
What is needed is to trigger the supply to satisfy this demand. The process of matching supply with demand
creates opportunities, employment, income and purchasing power. These are created not just in underdeveloped
economies but in the advanced markets where this capital—money, technology and education, machinery—
That calls for the recasting of the goal of investment banking as an agent of worldwide economic development,
an overhaul of economic structures and the cooperation of the world’s leading economies.
(The article reflects the personal opinion of the author and not the official stand of the Management Association
of the Philippines. The author is an entrepreneur, a member of MAP who wrote the books The Peso Exchange
Rate: Why Are We So Poor? and The Philippine Economy: Do Our Leaders Have A Clue?" Feedback
at email@example.com. For previous articles, please visit map.org.ph.)
G:\mapping\mapping - rangeles - 6April2009.doc:mel