How is the US able to spend so much more than its Income?

I had earlier promised to explain how the US has a savings rate of -7% (yes negative) and how it is funded.

The most important factors are :

1. USD as a Global Reserve Currency:

The US has a spectacular credit rating which has enabled the dollar to become the globel reserve currency, meaning that the probability of the US Govt defaulting on its loans is very low which in turn means US Dollar will be a very strong and stable currency. Every country has to hold reserves of some foreign currency/gold in order to save itself from potential political/financial crises. Hence most of rest of the world holds US dollars. Holding US dollar in terms of currency notes don’t give any returns, so they are used to buy US Treasury bonds. The bondholder has actually lent money to the US Govt.

2. Global Trade:

Most of the commodities (Oil, Gold, Silver etc.) are traded on USD globally. This means buyers and sellers of these commodities have to hold dollars. Hence there is a constant demand for dollars across the globe. Oil plays a very important role here since it is the backbone of every single economy in this world. Whichever currency in which Oil is traded, rules the world. There are theories which suggest that the reason behind Iraq attacks is that Saddam Hussein wanted to sell Oil in Euros which threatened the dollar dominance in the world. Same reason for potential attacks on Iran.

3. Artificially low interest rates:

Since the begining of the 21st century, the US has seen a period of artificially low interest rates. This was done initially to save the US Economy from the 2000-01 recession which was worsened by the 9/11 attacks. The economy made a smart bounceback because of the low interest rates. Consumption is inversely proportional to interest rates. When the interest rates are high, there is an incentive to save and when the interest rates are low, there is an incentive to borrow and spend. Hence the US consumers kept borrowing which was funded by the rest of the world.

4. Absence of an Institution called Family:

I have borrowed this point from M R Venkatesh, a noted economist from Swadeshi Jagran Manch. He says the prime difference between the saving nature among Indians and Americans is that the family culture in India is a huge deterrent to reckless spending. It is very common to see that Indians start accumulating wealth after marriage. This, he says is absent in America. The presence of Social Security and Healthcare benefits further redice incentive to save.

5. The strong consuming nature of the US:

The US is a very strong consumer in the international market. They import much more than they export, which is evident from their trade deficit year after year. The US pays dollars to exporters (Say China, Japan, Thailand, Korea, India etc.). These countries do not convert these dollars to their own currencies. Instead they are used to boost the forex reserves of the country. This in turn increases US debt.

6. Emergence of South Asia as a cheap manufacturing hub:

South asia’s emergence as a cheap manufacturing hub shifted US industries from manufacturing to services. This increased their imports massively as there was no incentive to produce the goods inland when they could be imported for a fraction of the cost. This is actually a result of the strong dollar and weak south asian currencies since weak currencies make exporting very easy.

All the points listed above are strongly inter-related and you could find a lot of cause-effect relationships. They could not have individually led to the present situation but collectively they have.

My take on Punjab Violence

Yesterday, after a gurudhwara attack in Vienna, Punjab erupted violently resulting in damage to buses, trains and an ATM , which means taxpayers money has gone down the drain. And how does our "Educated Honest PM" react? Check this link.

It doesn't matter whether crime is committed by Indians or others. The PM should have condemned the people behind these attack. Instead, he's requesting them to stop their violent behaviour.

God Save India from spineless people.

Why should the US Govt just let the recession continue rather than meddling with it?

To understand this we need to know about the history of US consumer spending. The US in the past 10-15 years has been a borrow and spend economy, evident from their evergrowing National debt. For every 100$ earned, they have been spending 107$. The remaining 7$ gap is bridged by other countries.( I shall explain this in a later article.) We all know this model is unsustainable, since one can’t keep spening more than one’s income. The house bubble burst was the trigger(not the cause) for this impending recession.

Now after the bubble burst, the US consumer has understood that he can’t keep spending more than his income and hence has cut down on his spending, which is actually good for both the US and the rest of the world. Since this cutting down has happened at a rapid pace, the recession is equally harsh and has its repurcussions in the way of Job losses and monetary losses.

What is the US Government doing now? They have cut down interest rates to almost 0% (a mistake they did in 2001 which led to the house market bubble) and are spending like crazy in the economy in the name of their stimulus plan. This is merely encouraging the consumer, who now has consciously cut down his spending, to spend more. This not only increases future recession possibilities but also increases inflation risk a lot.

My bottomline : The US Govt is again trying to interfere with the market to create skewed incentives for borrowers and is taking the economy to a yet another unstable period of growth rather than letting the economy recede and start stable growth without debt burden.

Community Blog

A few of us from IIM Calcutta have started this community blog Strat.in. I've just joined them.

Will be posting both here and Strat.in from now on.

My 2 cents on Exit Polls

Yesterday, I was looking at the Exit poll results of 2009 Elections on CNN-IBN and NDTV. They were giving all sorts of projections based on their survey.

In the CNN IBN survey, I had a look at the Bihar numbers(any state would do, I took Bihar since they had a round 40 seats which can easily divide any number). There were 1960 respondents from Bihar, which means 49 respondents per constituency. I assume each constituency as a few lac voters. How can 49 people represent these few lac voters?

I don't believe NDTV either, who have not even mentioned their sample size.

Hence I don't like to believe these numbers but would like to watch out for Saturday the 16th.