Passing The Devalued Buck

As 2008 gets underway, the United States' dependence on foreign-supplied capital is becoming ever more apparent. The question for the New Year: how long can the taps remain open? With few big American investors able or willing to open their wallets, Morgan Stanley and Citigroup recently sold large chunks of their businesses to sovereign-wealth funds in Asia and the Middle East. The buyers were enticed with very favorable terms in the form of preferred shares with high dividend streams, plus seniority over existing shareholders, which offers greater claims on assets and profits in the event of disaster. The courting will continue; Merrill Lynch recently announced that it is still looking abroad for capital despite a recent $5 billion sale of stock to the government of Singapore.

While these deals are necessary, they are nothing to celebrate. After all, Americans are simply selling off assets to satisfy our debts and to fuel consumption. This is known as selling the cow to buy milk.

Meanwhile, foreigners investing and selling into the U.S. markets over the past year have themselves pulled a short straw. The U.S. stock market lagged behind foreign markets in 2007, as it has for much of the decade. Debt investors suffered from the implosion of securitized U.S. home mortgages, and exporters to the U.S. saw their profit margins erode with the falling dollar. Even conservative holders of U.S. cash or government bonds took it on the chin as the dollar plummeted.

Despite this financial train wreck, 2007 was another record year for Wall Street bonuses. Although the large investment banks lost tens of billions of dollars, and sold the world on bogus financial structures that now threaten disaster, the executives at the top U.S. firms are once again being showered with embarrassing riches. In this "heads we win, tails you lose" aspect of American finance, these firms have made it clear that their executives will not be forced to share in the misery of their shareholders.

Of course, none of this has stopped the foreign run on U.S. companies. The recent infusions have totaled a staggering $27 billion, and could go much higher. No doubt many see the falling dollar as an opportunity to snap up seemingly sound U.S. assets at bargain-basement prices. However, as the weakness of the American economy and the global costs of our mismanagement are becoming increasingly harder to ignore, it can only be a matter of time before the buyers become more wary.

In recent months, financial institutions around the world have ceased lending to one another. The freeze results from a global financial minefield seeded with exploding U.S. subprime debt. There is no certainty about who holds such debt, how much it may actually be worth and whether those holding it may be on the brink of insolvency. In an environment where invisible risk is everywhere, banks logically stop lending. The European Central Bank has responded by pumping in €350 billion ($500 billion) in short-term loans in hopes of cajoling European banks to loosen up. Although the policy seems to have generated some short-term success, this type of cavalier monetary policy does not come without inflationary consequences that will be borne by eurozone consumers.

Meanwhile, U.S. policymakers are mollycoddling American consumers. Of particular concern is the Bush administration's mortgage-freeze plan. By unilaterally shifting the financial pain to lenders, many of whom live overseas and don't vote in U.S. elections, politicians are making it clear that American consumers will not be allowed to suffer the ill effects of excessive indebtedness.

Damaging as the plan may be, it is nothing compared with what some presidential candidates and members of Congress are cooking up. As the housing crisis gets political, we can expect ideas such as a perpetual freeze on foreclosures, automatic loan reductions and enormous tax breaks financed by increased deficit spending. Delinquencies on auto loans are reaching record highs. What's next, a moratorium on car payments? In an election year, anything is possible.

With the U.S. economy finally stalling under its gargantuan debt burden, the rallying cries for Fed rate cuts have been deafening. Although "Helicopter" Ben Bernanke has done his part by cutting rates 100 basis points and devising new ways to shower the country in cash, his efforts have not been enough for ravenous bankers and politicians. Their zeal to keep the housing bubble from deflating, and the economy from tipping into recession, should make it clear to foreign investors that the United States will continue to rely on dollar depreciation as a blunt instrument to fight all its economic battles. As a result, America will remain a financial black hole in the coming year.

These are real risks that will not go unnoticed by a world already saturated with depreciating U.S.-dollar-denominated debt. Given that access to foreign savings is vital to America's economic survival, we should think twice before biting the hands that feed us.

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