RUNAWAY SPENDING/DEFICIT MAY SPELL DOOM
RUNAWAY SPENDING/DEFICIT MAY SPELL DOOM
2005-09-06 at 11:39:00 am #12741
Runaway spending, trade deficit may spell doom
Analysts say the U.S. economy could go into a tailspin if interest rates ratchet up and foreigners stop investing heavily.
New York – Buy now, pay later: It’s been the mantra of American consumers for decades.
The results are obvious in the ballooning balances on credit cards and
mortgage loans, and in the mushrooming U.S. trade deficit, which
reflects the nation’s nearly insatiable appetite for cheap, imported
Low interest rates, especially since the end of the 2001 recession,
have fed the debt beast at home, allowing U.S. consumers to accumulate
nearly $11 trillion in debt as they buy more homes, more cars, more
clothes, more dinners out.
At the same time, foreign investment in the U.S. is helping to keep the
dollar strong, which holds down prices on those imports Americans covet.
But what would happen if interest rates suddenly weren’t so benign or
if foreign governments, corporations and individuals stopped investing
so heavily in America?
Some analysts fear such actions could trigger doomsday scenarios in
which the bills come due and Americans can’t pay. The consequences for
the U.S. economy could be heavy.
The Associated Press asked several experts to discuss these potential
disasters and spoke to others who believe that while the country may be
in debt, it’s not in danger.
The credit-card crunch
The tool that has made it ever so easy for Americans to buy – and buy – is the credit card. And buy they have.
Outstanding balances on credit cards have risen to more than $800
billion, or about $7,200 per U.S. household. It’s more than double the
indebtedness of a decade ago – and it doesn’t include an additional
$1.3 trillion in debt for cars, appliances and personal loans.
What if interest rates suddenly shot up, say 3 or 4 percentage points,
requiring burdened borrowers to greatly increase the amounts they have
to pay each month on their debt?
“It would undermine the housing market and could quickly result in
credit problems that would affect the entire (U.S.) financial system,”
says Mark Zandi, chief economist at Economy.com.
Such an event isn’t beyond the realm of possibility if global
investors, for instance, shift their money out of the U.S. or if a
terror attack riles financial markets.
Some American borrowers already are in trouble, and more are likely to
stumble as interest rates rise and the new bankruptcy law makes it
harder for consumers to be relieved of their debt, said Howard Dvorkin,
head of Consolidated Credit Counseling Services Inc. in Fort
“You’ll see creditors get more aggressive at collecting debt, the
reason being that they can,” Dvorkin says. That will turn many
borrowers into “the walking wounded,” struggling to keep up with card
payments and limited in what they can buy – a massive drag on the
But skeptics don’t see a big economic shock in the offing.
Zandi says interest rates are most likely to go up at a measured pace,
giving most consumers time to adjust to higher payments. Some may see
their credit limits cut.
Still, much of the recent debt has been taken on by lower-income and
lower-middle-income families, who borrowed aggressively to maintain
their standard of living as wages stagnated.
“Going forward, it will be harder for them to maintain their spending and their living standards,” Zandi says.
Americans have taken on more than $8.8 trillion in mortgages to buy
homes, up an astounding 42 percent since the 2001 recession. And
rapidly rising prices in recent years have made many home owners feel
wealthy, so they’ve ramped up day-to-day spending.
But that run-up in prices – what Federal Reserve Chairman Alan
Greenspan has described as “froth” – increasingly looks like a bubble.
“The bigger bubble is actually in the financing of homes,” says economist Ed Yardeni of Oak Associates in Akron, Ohio.
Millions are buying homes with no down payments. Or they have
adjustable-rate mortgages or interest-only mortgages or
What brings such a great party to an end?
“Interest rates going up just 2 percent would do it,” says Peter
Morici, a business professor at the University of Maryland in College
Park. That, he says, would suppress prices, lower sales and put a
squeeze on those who were marginally qualified to buy because their
payments would suddenly go up.
“Some people will lose their homes,” Morici says. “Many people will just be hurting.”
A recent survey by mortgage insurer The PMI Group of Walnut Creek,
Calif., has found that the risk of home-price declines has increased in
36 of the nation’s 50 largest markets.
But Doug Duncan, chief economist for the Mortgage Bankers Association
trade group in Washington, acknowledges that there may be “tiny
bubbles,” particularly in areas such as Las Vegas and along both
coasts, where speculators are rushing in to buy property and flip it
quickly for a profit.
But most buyers, he says, see their homes as a place to live or to retire, with appreciation as “the frosting on the cake.”
Duncan also believes the Federal Reserve Bank is sensitive to the
potential impact that higher rates could have on the housing market -
and, consequently, will move cautiously.
The Asian money market
Why is everyone so worried about China?
China’s growing exports to the U.S. are a major factor in the explosion
of the nation’s trade deficit, which could exceed $700 billion this
year. At the same time, China is one of the largest foreign investors
in U.S. Treasury securities, with holdings of $244 billion, second only
to Japan. The Chinese buy U.S. bonds and make other investments here
because they need to recycle the dollars they earn from exports.
What such investment in the United States by foreign powers means,
however, is that “U.S. financial vulnerability continues to grow,”
Lehman Brothers said in a research report. Its concern is that U.S.
efforts to slow Chinese imports, perhaps by imposing quotas, could
trigger retaliation from China.
If China stopped buying U.S. securities, or even started dumping them,
it would send the dollar into a tailspin. That would not only make
imports more expensive but could push interest rates up, end the
housing boom and maybe tip the U.S. economy into recession.
But C. Fred Bergsten, a former U.S. Treasury official who heads the
Institute for International Economics in Washington, says it “would be
crazy” for China to alienate the U.S. The reason: China needs America
as a major export market to fuel its own economic growth and to create