As its power declines, the U.S. pays the price

April 21, 2011

Economic policy isn’t just a domestic issue anymore. That is the conclusion we should draw from the market volatility this week, including the shift by Standard & Poor’s to a negative outlook for U.S. government debt, and the meeting last weekend of the International Monetary Fund and World Bank.

This is a familiar fact for smaller countries. The emerging market nations have long understood that judgments made on Wall Street or at the IMF headquarters in Washington often had more power to shape their economic policy than the proposals of their own ministers of finance and central bankers. More recently, that is a lesson that fiscally weak Western countries like Greece, Ireland and Portugal have been learning, too.

Now, as the relative power of the United States in the global economy declines, it is a fact of life that Americans need to get used to, too. That is one of the important messages of the S&P decision at the beginning of this week to put the United States on a negative outlook – essentially a warning that the ratings agency is no longer certain the United States will maintain its AAA rating.

There are a lot of reasons the S&P call should be taken with a grain of salt. For one thing, the ratings agencies hardly covered themselves with glory in the run-up to the financial crisis, and surely no longer deserve oracular status – if they ever did.

For another, the S&P warning wasn’t new news. With a 10.6 percent budget deficit last year and with gross national debt at 91.6 percent of gross domestic product, it has been obvious for some time that the United States’ public finances are a mess. Nor has that concern been limited to the wonks. The debt and deficit have become a Main Street issue – witness the rise of the Tea Party movement – and have dominated the political debate in Washington for the past six months.
But there is one good reason the S&P’s negative outlook attracted so many headlines. It was a reminder that U.S. economic policy was no longer just about debates in Washington or what plays in the Iowa caucuses. U.S. economic policy needs to pass muster with global markets and with foreign lenders, too.

That is an old story for every other country in the world. But the United States has been accustomed to being the world’s dominant economy and to owning the printing press of its reserve currency. Both are still true, but less so than before. Moreover, for all its size, the United States’ massive debt means it is already dependent on the confidence of foreign buyers of U.S. Treasury securities, including governments running massive surpluses, like China.

That means national economic decisions, like the level of government spending, or the rate of taxation, aren’t purely national issues any more. In the proud days of the so-called Washington Consensus after the collapse of the Berlin Wall and the triumph of Western capitalism, U.S. pundits and policy-makers got used to issuing edicts from Washington about how emerging markets should run their economies. The reverse is not yet true, but the S&P move is a sign that the United States will need to start thinking about how its economic policy moves play in Beijing and Dubai, as well as in the Beltway and New Hampshire.

It is not just the debt and deficit that are making economic policy a matter of international concern. As the IMF and World Bank meetings revealed, one of the consequences of globalization has been to give national economic decisions a more powerful international wallop.

This isn’t an entirely novel notion for the United States. U.S. complaints about China’s exchange-rate policy and its strategy of export-driven growth are a vivid example of the public’s conviction that one country’s domestic economic strategy is a legitimate – indeed central – issue for international debate.

Now the rest of the world is starting to take the same view of the United States. In Washington last week, the Brazilian finance minister, Guido Mantega, complained that the policies of the Federal Reserve, designed to help the United States recover from the gravest financial crisis since the Great Depression, were having unintended and malign consequences in other parts of the world.

Low interest rates in countries like the United States, Mr. Mantega warned, were the “primary trigger of many of today’s economic woes.”

“Domestic political constraints have been too easily invoked by reserve currency-issuing countries as a reason for adopting ultra-expansionary monetary policies,” he said in a statement to the IMF’s policy steering committee. “But this does not change the fact that these policies generate spillovers that have made life difficult for other countries.”

Mr. Mantega isn’t the only one who is worried. In a panel discussion at Bretton Woods I moderated a few weeks ago, Andres Velasco, the former finance minister of Chile, warned: “So, if you are Brazil today or if you are many of these countries in the rest of the world, you look out the window and what you see is a tremendous tsunami of wealth coming your way. And this, which once upon a time might have been welcomed, I view and many of the people in these countries view as a terrifying sight indeed. Why? Because this tsunami is going to make your politics very difficult, your life if you are a minister very unpleasant and your macro trade-offs very sharp indeed.”

When we think about the thorny questions in foreign policy, we think first about the rocky intervention in Libya or the agonizing war in Afghanistan. But the really big challenge in managing relations between nations is the problem pointed to by Mr. Velasco, Mr. Mantega and S.&P.: managing a world in which my domestic economic policy solution is your foreign economic tsunami.


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That tsunami of wealth can be stopped.
But we have to restore the Balance that I talk about in this article first.

Posted by vbierschwale | Report as abusive

$600 trillion derivatives market = opportunity to reduce National Debt by an additional 1/2 $ trillion yearly

A small 0.5% transfer fee on the $600 trillion Derivatives market would pay off the debt without cuts in Social Security, Medicare or Medicaid. It would raise $500 billion per year.

Reference: How to Pay Off the National Debt by Kainz available at Barnes and Noble or

Posted by JimKainz | Report as abusive

Sorry, you lost me there. What is the expected source of the onrushing tsunami of wealth?

Posted by Ralphooo | Report as abusive

You rock on the CNN video on globalization’s affect on the middle class…thank you for a level headed and enlightening commentary. I wish there were more wise women sharing their expertise in this dark era. Next to the stuffed shirt, you shine!

Posted by papayayoga | Report as abusive

The National Security State consumes at least $1T per year. Therein lies the problem.

Cut the National Security State beast to the ex-US OECD average and tax the ultra-rich and the problem is solved.

It is that simple, but with all major politicians rented by lobbyists and owned by the ultra-rich don’t look for a solution anytime soon. Things will have to get worse before the public throws the bums out.

Posted by upstater | Report as abusive

The global impact of US escalating debt is a serious problem, but it can be put to rest by adopting a medium to long term macro policy solution. Thereby providing global money markets gurantee that US Gov & Congress are serious that they understand what type of tsunami USD is likely to create, if allowed to go unresolved.

Posted by hariknaidu | Report as abusive

Reliance on the same Wall Street, including S&P, will not get the US where it needs to be. That whole conglomerate needs to be legislated out of existence. They are not only not helping finance business growth that benefits the American people, they are hindering that growth by supporting the super-big, super-wealthy and killing off smaller business. Mergers and acquisitions by their very nature dispose of jobs at one company or the other. Derivatives are just a means of gambling, not real investment. I would definitely support a tax on these transactions as in Kainz above.

Good article, thanks, always enjoy your work.

Posted by lhathaway | Report as abusive

Hey ralphoo, the “expected source of the onrushing tsunami of wealth” is the fact that our currency is depreciating thus meaning there currencies are getting appreciated. that means your dollar isn’t going to be worth what it was 10 years ago. and it means the chinese, brazilian, whatever currency, which has been pegged to ours for the last 50, is going to appreciate in value. Which means the U.S. hopefully will be able to restore some weight to our export sector because it would be cheaper to produce goods here. and i love how these developing countries are complaining about it. I’m sure their people would love to enjoy the lifestyle us americans have enjoyed for the last 60 years. Basically, we are trying to switch the consumer culture to the developing countries and we are trying to switch back to a producing culture. Thats what they are talking about.

Posted by sweeks6833 | Report as abusive

Ralphooo – The “source” of the onrushing tsunami of wealth that is crashing against the shores of the underdeveloped markets and economies is the global investor. This guy’s wealth used to be placed almost exclusively in the U.S. and in dollar assets. NO MORE! Tons of this stuff (wealth) is flowing like tsunamis into the underdeveloped markets and economies. It carries with it huge negatives, but also some positives as well.

But from the US standpoint it represents a loss of favor, loss of power, loss of wealth, loss of influence in the world at large. Of course, if we get another global investor panic and risk appetite implodes, most of that wealth is going to come crashing back to U.S. shores, mostly into short-dated Treasuries. So the “tsunami” makes its way around the globe, in all likelihood. If that happens, it will not be the solution to the U.S. problems, but rather will add to the problems both here and around the world.

This whole system is like a top that is spinning at incredible speed but that has become ever more unbalanced, and its wobbles quite literally threaten to increase dramatically, tearing it into shreds.

Posted by NukerDoggie | Report as abusive

We can try to come up with all the solutions we want. The party is over. Whole, entire economic system needs to be revamped

Posted by Dahc | Report as abusive

Time for would-be World Emperors to be ousted from US Federal Government and guardians of the American people to take over. We have had rulers who treat us as a colony rather than an independent people.

Our Government has been run solely for the convenience of tiny minority elites while the rest of us have been manipulated and gerrymandered out of any representation whatsoever. Time to look after the interests of America as a whole.

It certainly is not a time to focus less on America and more on everyone else, as this writer suggests. That is precisely how we got where we are!

Posted by txgadfly | Report as abusive

the party ain’t over. it’s just beginning 😉

Posted by sweeks6833 | Report as abusive

I don’t believe that the analysts at S&P and the other ratings agencies were so incompetent as to have missed the stark difference between a good mortgage risk and a NINA loan during the years leading up to the Collapse of 2007.

There is still good reason to, as Editor Freeland suggests, take their ratings with a grain of salt. If they weren’t incompetent, then their actions were intentional, which then makes them either manipulative, complicit and/or opportunistic.

With the federal budget deadline looming in July, foreign governments, agencies, central banks, corporations, and investors will be very closely scrutinizing America’s fiscal maladies.

It appears that agencies like S&P waited for as long as they could while America desperately tried to salvage its financial system, but they now have little choice but to begin to acknowledge reality.

Posted by breezinthru | Report as abusive

The idea of paying off American debt by playing on derivatives is not a bad idea after all.
It has been said enough that the crisis was provoked by banks taking excessive risks.
The US have also taken terrible risk with TARP, thinking that saving the banks would encourage them to loan more.
How naive that was. The banks have learned.
What do they do now with the tons of cash that they sit on?
They do not risk on loans anymore, they use that cash to trade the ups and downs of the derivatives.
They can much easier “hide” revenues from trading, then income from loans, and thus pay still less taxes.
A few very good traders and lots of extra speedy computers are less expensive that all the trouble of lending.

Small investors with little experience will most likely loose a lot on the commodity markets, but experienced and clever traders could certainly bring in a lot of profits in.

So the US treasury could do the same: playing the derivative is risky? A little less that playing the lotteries.
The gains could be formidable. And the government does not pay taxes.
To trade big, you need lots of cash. The banks have it. The government can keep printing it.

And what do we know if they have not already started doing it?
Trading the currencies is a way of trading on the different countries debts and deficits, isn’t it?

Posted by garilou | Report as abusive

For years I’ve been trying to find a description and explanation of “U.S. Government Balance Sheet”, as used by the President, Treasury, Fed, and New York Times in their public comments.

I’ve finally realized that there is no such thing. It’s just a rhetorical figure of speech, as its practitioners and everyone else but me may have known all along.

The source of my epiphany is an old OECD web page: Glossary of Statistical Terms: Government Balance Sheet, which says “. . . in practice, very few governments prepare statements of their financial position that could be described as balance sheets”.

Posted by 78wwy3Ht | Report as abusive

The only surprise here is that someone thinks that our domestic economic policy is not related to our international economic standing. This has been known for decades and has been trumpted by economists and politicians alike. So, what’s the real point here?

Posted by ptiffany | Report as abusive

the rebalancing of trades is already in motion. I am but one consumer (multiply the effects of my actions by millions of consumers). I am buying more stuff direct from the USA because of favourable exchange rates. I am curious to see if the terms of trades will get better for the USA over time.

Posted by kilosubtorra | Report as abusive

Sell sell sell.
When the buble bursts buy buy buy.
It’s the Amerikan way

Posted by LAMO1213 | Report as abusive

I really don’t understand why Chrystia and other financial writers do not ask S&P to explain their possible downgrading of GOVUS debt.
The ratings criteria for S&P and Moodys relate to the potential and likelihood of a default(failure to pay when due) on a debt-instrument.
The GOVUS, being monetarily sovereign and issuing its debts ONLY in its own currency, cannot default on its debts except on purpose.
So there is NO potential for default.
There is a potential for a lengthy currency devaluation, a.k.a. monetary inflation, but we have seen none of that to date.
The great financialists – and I include the rating agencies in that crew – are totally responsible for the financial-economic crisis that has CAUSED the economic downturn and resulting government deficits.
Given the old adage that a good offense is your best defense – in this case – it is not surprising that S&P attempts to place blame on the government for these failings.
But that this issue is so unintelligently discussed here at Reuters does little good, and provides little hope, for an honest money solution.

Posted by joebhed | Report as abusive

The US owes the money it borrowed. To duck that obligation with derivatives, inflation or other shirking method is not fair to those who have put faith in the US enough to invest in its debt. Inflation as a debt shrinking tool is also bad for retirees living on savings.

The fundamental issue for the US is productivity. Enough technology exists right now for everyone to live like royalty. Instead we are limping along trying to avoid getting flushed down the tubes, economically. Perhaps the US economy is showing signs that it is recuperating, but only in marginal terms. What we need is a quantum leap forward, and this can be achieved if we choose to align our efforts to get there.

As companies have off-shored and laid off workers, the US as a whole has shifted the jobs producing stuff to other countries, which has good and bad elements. Bad in that income once earned here is now earned elsewhere. Good in that as people in other countries earn more, they establish themselves as consumers for goods produced anywhere, theoretically including the US (if we’d just get back to making stuff everyone wants).

We have clung to obsolescent capital productivity here because we fear ponying up to buy the latest and greatest means of production or spend enough on R&D to make the next better mousetrap. And Japan, then Korea, then Viet Nam, India, China and other countries, just starting out with their industrialization, invest in the new best way to make whatever, coupled with a workforce happy to receive a tenth or less of the wages of US workers.

The US is left with fewer, lower paying, service type jobs that yield less income. And because the US economy is now smaller, it wields less power globally. It is no longer the shiny engine at the front pulling the economy.

How do we burnish the rust and decay? There are lots of high paying jobs available, but they are specialized. This requires training, but most workers are behind the eight ball because now that they have had to take lower paying jobs they have to work more yet earn less, and working more means there’s less time available for family (which is very important for social and civil stability), and even less time for training.

So first thing to do is make training cheap and readily available for the specialized jobs that will recoup the earning ability the US used to have.

Next the US needs to address the mix of goods. As people have less money now, they have fewer economic votes in their pocket to guide the economy as to what should be produced. Saving TBTF banks was far less worthwhile than simply putting that money in the general public’s hands to spend. Of course dumping infusions the size of the TARP, QE1 and QE2 directly into economic demand would lead directly to inflation if there is no preparation on the business end to be able to increase production to supply the increased demand.

So business needs to know what we would buy if we all had boatloads of money. And then they have to be given incentives to act like the demand already exists – invest in capacity, hire the (already self-trained) folks at good wages, and things will blossom. Except that what is being made now is not necessarily what people would actually buy if they had a lot of money.

So the other piece of the solution is for businesses to know this latter missing element – exactly what would we buy with lots of money? Well the only way to know for sure is to find ways for people to expose their desires. Market research has the flaw that it evaluates what people would buy based on what money they have, not what they would buy if they had a LOT more money.

What we need is a way for people to present virtually, with no actual cost, what they would buy if they did have money. Apps like Farmville are exactly the kind of virtual existence that could provide this crystal ball view into people’s real wants and desires.

And we might be surprised to find that what we want might not be just Ferraris and houses at Malibu Beach. It might be better schools for our kids, better housing with attention to energy efficiency and savings, insurance and retirement considerations, safer neighborhoods, more effective transportation.

Posted by GordonFBJ | Report as abusive