Outlook 2010: Is America really insolvent?

The decline of U.S. financial and moral clout is grim news for Canada.

Recent American history affords plenty of fodder for Edward Gibbon wannabes. Costly, protracted conflicts in Afghanistan and Iraq seem far from resolution. The U.S. financial system is a shambles, and nationalization of crucial parts of it vandalized the long-standing free market credo of American capitalism. “I grew up in a world in which American leadership was important and, I thought, constructive,” Paul Volcker, chair of President Barack Obama’s Recovery Advisory Board, told German newsmagazine Der Spiegel recently. “It’s more difficult now because we are not as relatively strong as we used to be.” Could the latest flood of Decline and Fall of the American Empire tomes be correct?

Mounting debt tops America’s jeremiad; the nation is busily paving a 12-lane expressway to serfdom. When he took office in early 2009, Obama inherited a burdensome yet manageable national debt totalling US$5.8 trillion. Seeking to buy America out of recession, he has greatly increased it. The Congressional Budget Office predicts that for fiscal 2009 the deficit will be US$1.6 trillion, or 11.2% of GDP — a crippling magnitude last witnessed during the Second World War. The CBO expects deficits to continue for the next decade, bringing total debt to more than $14 trillion in 2019. Bond rating services now warn the U.S. to get its books in order or face potential downgrades, which would make financing its obligations more costly.

The U.S. needs foreign capital to continue financing this behaviour. It increasingly answers to China, now its largest creditor. And DBRS, the bond rating agency, detects change in this relationship. “Now, it is the Chinese who ask the tough questions, whereas in the past it was American officials who usually drove the discussions,” noted its recent report. “The reality is that, longer term, China’s opinion about the creditworthiness of the U.S. government is virtually the only one that really matters.”

Ascendant superpowers are creditors, not debtors. Britain’s relatively rapid loss of its superpower status reached its logical conclusion during the Suez Crisis, when U.S. President Dwight Eisenhower persuaded Britain to withdraw by threatening to sell America’s reserves of the pound — a move that would have sent the British currency into free fall. China’s leaders seem unlikely to play the Eisenhower card anytime soon, as they continue to benefit from selling goods to Americans. The point is that they could.

If America’s government courts insolvency, so do its citizens. U.S. consumers, seemingly indefatigable for so many years, have truly overdone it. Egged on by low interest rates and lax lending standards, they’ve acquired massive debt — 165% of their disposable incomes, on average. The housing bust destroyed their finances. And unemployment now stands above 10%. Household credit has been in retreat since 2008, but an extended era of deleveraging has just begun.

That means Americans are nowhere near ready to resume spending — which is precisely what they must do before Washington can return to balanced budgets. Peter Schiff, a prominent investment strategist (who is also running as a Republican for a Senate seat in Connecticut this fall), believes the U.S. economy must remain on life support indefinitely. “Based on the distortive effect of stimuli and bailouts, our economy has adapted to a climate where cheap credit is plentiful,” Schiff told clients recently. “Our economy is less able than ever to survive in a world in which stimulus is removed.” Yet if policy-makers can somehow coax Americans back into automotive showrooms and furniture stores, it could merely assure an even greater disaster.

None of America’s problems are irreversible or insurmountable. And one should also not lose sight of its still formidable position. Though overstretched, the military primacy of the United States remains uncontested. Many of the world’s greatest universities remain on American soil, and it continues to secure more patents than any other country. It is still widely regarded as one of the world’s most productive, competitive economies. An era of relative American decline, however, seems likely. In an essay published in Foreign Affairs, former U.S. deputy Treasury secretary and investment banker Roger Altman said that although weaknesses will eventually be repaired, “in the interim, they will accelerate trends that are shifting the world’s center of gravity away from the United States.”

That shift no doubt creates opportunity for competitors. “For some emerging markets,” University of Chicago professor Raghuram Rajan argued during a speech last year, “especially those that can rely on their own, or regional demand, this crisis could result in a dramatic improvement in relative economic power.” China and India, which are among the apparent front-runners in what is increasingly a multipolar world, continue their rapid growth. China is increasingly assertive in international forums such as the G20, and at negotiations such as the recent Copenhagen climate-change summit. Rising powers will have less patience for American lecturing on how to structure their financial sectors or how to behave in their own backyards. But the continued success of the emerging economic powers (which is by no means assured) may depend in no small measure on recognizing the virtues that made America great, while avoiding the pitfalls that brought it to this unhappy moment.

As for Canada, the decline of the United States is unequivocally grim. The two economies are closely integrated, and the vast majority of Canada’s exports are still headed south. We share (and squabble over) numerous resources, including air, water and oil. In the name of harmonization with our largest trading partner, Ottawa increasingly looks to Washington to establish a tone for regulatory systems, commercial practices, environmental standards and the like. This symbiotic relationship long proved beneficial for both parties — and particularly so for Canadians, to such an extent that we seldom looked elsewhere for new friends. We have many reasons to hope for America’s return to economic health. And henceforth, we may have many reasons to regret Canada’s lacklustre performance in building stronger relationships and markets outside North America.