Japan's shaky deficit solution

Japan's shaky deficit solution - Business Asia by Bloomberg - International Herald Tribune

WEDNESDAY, OCTOBER 26, 2005


The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real
GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

Greenspan's conundrum

Asia Times Online :: Asian news and current affairs

By Axel Merk

US Federal Reserve Bank Chairman Alan Greenspan is confused - why are long-term interest rates so low? Is what he calls "too low" a risk premium courtesy of his successful policies? Inflation runs at an 18-year high. Will gold climb further, and the dollar resume its decline?

Let us start with Greenspan's "conundrum". Many flat out say the market has it all wrong and will come to its senses, suggesting that long-term interest rates will rise dramatically. Maybe. Market prices reflect the average of all participants' expectations. If your opinion diverges from the average, then you may choose to invest accordingly in anticipation that the market will converge on your scenario. Of course, in the future, market prices will not reflect the facts then, but expectations at that point; be aware of the old saying that markets may stay irrational longer than you can stay solvent. While we often disagree with what the average is thinking, it is a good starting point in any analysis. If you know your



opponent's strategy, it is much easier to win than if you are convinced of yourself and blindly execute your own strategy without reference to your environment.

Similarly, if Greenspan tells us he doesn't understand the yield curve (the relationship between longer and shorter dated securities), we should be worried. He might just push the economy in the wrong direction if he doesn't know where it is heading.

Enough modesty - let us attempt to explain what so few have been able to. Some say low long-term rates suggest we have no inflationary pressures. Joe Battipaglia, an eternal bull who tells us to "look at the facts", dismisses arguments that inflation is in the pipeline and that the soaring price of gold is a reflection of jewelry demand picking up in Asia and China. With due respect to Battipaglia, this is nonsense. The gold price, in our view, clearly signals that we have inflationary pressures and a flight to hard money; the expected increase in jewelry demand cannot fully explain its rise.

But why are long-term interest rates so low then? Is it the foreign purchases of US debt? They are a factor in holding long rates down, but let us keep in mind that foreign governments tend to purchase mostly shorter-dated maturities. What about corporate America as a buyer of longer-dated debt securities? While the US consumer is heavily in debt, corporate America has amassed enormous amounts of cash after cleaning up its balance sheets - many US corporations are now adding to the demand rather than supply in the fixed-income markets as they manage their cash.

We believe there is another story behind the low rates of longer securities that is all too obvious: the US economy is slowing down. But there is a difference: after all, we had GDP growing at 3.3% in the 2nd quarter - not exactly a sign of a stalling economy. One can argue that GDP is overstated because of inflation, and that an economy that must offer "employee discounts" to sell cars is in trouble. We would like to take it a step further. We had one airline after another declare bankruptcy; now the world's largest automotive supplier, Delphi, has declared bankruptcy. General Motors and Ford are likely bankruptcy candidates. What is happening is that corporations cannot pass costs on to consumers. Greenspan has been arguing that prices have to rise at some point because of costs being passed on. Stagflation advocates have said that wage pressure will build. What is different from the 1970s is that we now have Asia at our doorstep flooding us with cheap goods. The analysis cannot stop there. We believe that companies that cannot adapt will simply disappear (or be kept alive with subsidies or protectionism). If you are a European exporter and cannot pass on your higher costs and lower margins due to a strong euro, you might just vanish.

The Greenspan conundrum, unplugged, means: Our low long-term interest rates suggest that we are going to lose entire industries in the looming economic downturn. Industries that cannot adapt quickly enough to our global economy will be wiped out; cutting expenses is important for them, but will not be enough, as no developed country can compete with the cost of labor in Asia. Instead these companies must focus on superior value. Some European firms have long embraced a luxury brand model; but that may not be enough if these firms do not control their distribution channels. As an example, Safeway dictates what the cost of a six-pack of beer is. If you can't meet that price, there will be others that will.

There are a number of reasons why it is so much more difficult to pass on higher costs these days. Much of it has to do with Asia over-producing goods as a result of their subsidized exchange rates. Asia believes that it must generate economic growth at all cost to provide jobs and political stability. The result is a surge in world commodity prices (we had high commodity prices before the hurricanes) and low consumer goods prices. In addition, take a US consumer that is heavily in debt, and you end up with very little pricing power. Corporate America is squeezed by both high raw material prices and a lack of pricing power, resulting in accelerated outsourcing. US policy makers have added to this vicious cycle with low taxes and low interest rates. What US policy has done is to accelerate a cycle to the point where the transition is too fast for old economy companies to keep up.

The US economy is a diversified economy with great success stories; one of the more recent ones is the rise of Google. Google is all that "old economy" is not: flexible and capable of thriving in this environment. Highly accommodating monetary and fiscal policies have helped pick up the slack of ailing industries. This is not the place to discuss whether an economy can survive long-term if it entirely dismantles its manufacturing base and exclusively focuses on services. What we do know, though, is that the accommodating policies have created inflationary pressures in just about all sectors of the economy where we cannot import goods from Asia. And while we are at it, we also created a phenomenal housing bubble that has allowed the US consumer to increase spending (by taking out home equity loans and refinancing) while real hourly wages have been on the decline.

We do not see a conflict in low long-term rates and high gold prices - at least not for now (depending on Federal Reserve actions down the road, long-term rates can easily rise substantially). What about inflation and economic growth going forward? The Fed has been steadily raising rates. Bill Seidman, respected for his role in handling the Savings & Loan (S&L) crisis in the 1980s and now chief commentator on CNBC, says Federal Funds rates would need to move to 5.5% just to have a neutral impact on economic growth. We agree: even with the many small increases in rates, we still have an accommodating monetary policy, one that fosters growth and inflation. At the same time, the economy is clearly slowing down. Because consumer debt is at record levels and consumer spending comprises an ever larger share of the US economy, the economy is ever more sensitive to changes in interest rates. The federal government is also more interest-rate sensitive: not only has the absolute debt increased dramatically, but since the former treasury secretary, Robert E Rubin, abolished the 30-year bond, the duration of federal debt has significantly decreased. In plain English: the government has joined the large portion of irresponsible consumers by refinancing its debt with the equivalent of adjustable rate mortgages.

Corporate America has reasonable-looking balance sheets, but we cannot rely on them to bail this economy out. The reason Corporate America has not invested much of its cash is because it sees the shakiness of the American consumer and is reluctant to invest. Policies in the US and Asia have led to such a rapid acceleration in the pace of change that much of the developed world cannot keep up. We hear a lot about the US economy being less energy-dependent than in the 1970s. That's only partially true. We consume a lot more than we did in the 1970s. Nowadays, many of the goods are produced abroad, but it still takes energy to produce them. For now, foreign producers have absorbed the high energy cost through lower margins. We still need to transport these goods within the US, which is causing us plenty of pain with high energy prices. In Asia, companies also get squeezed more and more. While China is a cheap-labor country, it is not a low-cost country.

We believe Asia will continue its path as long as it can afford it. We also believe that we cannot assume Asian countries will react rationally when US consumption slows. It is unclear whether Asian countries will try to devalue their currencies even further in a desperate attempt to continue to sell to the United States, even at a loss. Governments in Asia may be more interested in political stability - presumably achieved through economic stability - rather than internal transformation. Some argue that Asia would be better off if the region deployed its massive labor force to focus on internal growth rather than feeding the US consumer. While that may be the case long-term, political leaders are afraid of the transition: if its largest customer, the US, were to diminish in importance, the void would pop some of the bubbles that years of over-expansion have caused within Asia.

What does this all mean for the dollar? We believe the dollar continues to be at serious risk as the balance of payments between the United States and the rest of the world is unsustainable and further escalating. Currently, foreigners have to purchase more than $2 billion worth of US denominated assets each day just to keep the dollar from falling. Until a year ago, many of these purchases were direct purchases of US government securities. Over the past year, a shift to direct investments has taken place; the highest profile move was China's failed attempt to purchase US oil firm Unocal. As China is rebuffed from securing its future resource needs in the US, it has moved to purchase resources in other regions in the world. Not only is China diversifying away from US dollar assets, more and more governments openly talk about moves to diversify their dollar holdings. As countries look for alternatives to the US dollar as a reserve currency, gold and the euro are gaining a higher profile. We also believe countries will intensify dealing in the local currencies of their trading partners. For example, as China wants to diversify its export market, it may acquire more euros to subsidize its sales to the region; conversely, as China is going to get ever-more resource hungry, it will engage in more trade with resource rich countries, notably Australia and Canada.

If US consumption drops, there might be a drop in the trade deficit. A lower trade deficit will require fewer purchases by foreigners of US dollars. However, a drop in the trade deficit may not be enough to support the dollar. The United States next year will pay more to foreigners in interest charges on its own debt than it receives in interest. With US debt growing rapidly, interest rates rising and much of US debt in short-term securities, this will have a negative impact on the balance of payments. Also, if - as we suspect - US consumption slows just as the housing market enters a more-serious decline, foreigners may be less willing to invest in US assets. We do not believe the fundamental pressure on the dollar will go away unless and until policies are put in place to foster savings and investment rather than consumption. In the short term, an already negative US savings rate may decline further as this winter's higher heating costs will surprise many. This will be offset in the medium term by an inability to extract further equity from refinancing; US credit card companies are also about to double the minimum payment required on outstanding balances, which may provide short-term relief to the reported savings rate. For now, consumers continue to believe that their real earnings will grow and have refused to cope with reality.

In the meantime, expect inflationary pressures to continue to build, just at a time when the US economy is slowing.

Axel Merk is Manager of the Merk Hard Currency Fund

US-China: Free market or statism

Rebelion. US-China: Free market or statism

US-China: Free market or statism

James Petras
Rebelión
The most striking aspect of the US (and European) trade conflict with China is Washington’s systematic rejection of the free market and its resort to heavy-handed dependence on state intervention. Equally astonishing, supposedly orthodox free market economists have joined the chorus of protectionist politicos (like Robert Zoellick, Deputy Secretary of State) in questioning China’s free trade policy and demanding that China abide by US directives instead of the free play of market forces (Financial Times Oct.7, 2005 p5). Worse still, some experts like Fred Bergsten, US director of the Institute for International Economics, are demanding more concessions from China under threat of a major economic confrontation. (Financial Times August 25, 2005, p 11).

Political Myths and Economic Realities
The US yearly trade deficit with China ($186 Billion USD by July 2005) is largely a result of US inefficiencies, not Chinese trade restraints. China has the lowest import barriers of any large developing country. In areas where the US has invested, innovated and is efficient, in agriculture, aeronautics and high tech, the US has a trade surplus. The US trade deficit is largely in the appliances, electronics, clothing, toys, textile and shoe industries where many US corporations have invested in Chinese subsidiaries to export back to the US. Over 50% of Chinese exports to the US are through US multinational corporations. The US trade deficit is in large part between the US state and its own MNC’s located in China.

China’s exports are largely based on imports of parts from overseas, which are assembled and then sold abroad. According to the Financial Times, “…China is merely the last stop for a lot of the goods Asia exports to the US, importing…components from elsewhere in the region – including Japan. The local value added in its exports is as low as 15% (FT Oct 11, 2005 p5).” In other words China is a huge importer from other countries with which it has a trade deficit, largely with Asian manufacturers, oil exporting countries and Third World exporters of raw materials. China’s overall trade surplus is largely based on its commerce with the US. US tariff and quotas against Chinese goods will prejudice world trade.

Contrary to US political and academic ideologues, China is one of the most liberal economies in Asia. By 2003 the ratio of China’s stock of inward investment (inflows of foreign investment) to GDP was 35% - against 8% in South Korea, 5% in India and just 2% in Japan (Financial Times Sept. 15, 2005 p 11). Moreover, China is the world’s third largest trading nation. In 2004, China’s ratio of trade to GDP reached 70%, far greater than the US and Japan which have ratios to trade to GDP below 25%.

Orthodox economists and US Congressional members argue that China’s currency (renmimbi) is undervalued and that a larger revaluation would reduce the US trade deficit. Over the past several years the US dollar has been devalued in relation to several currencies – including the Euro, the pound and the Swiss franc – and yet the US trade deficit has increased. The focus on Chinese currency reform is totally beside the point. The key problem is that US capitalists are not investing in domestic productive sectors, they are not upgrading their productive sites, nor are they introducing technological innovations to lower costs. Instead they are investing overseas, in non-productive sectors at home, speculating in real estate, today (and IT, yesterday), increasing profits via cuts in labor costs – hardly a sound method to compete with low-cost labor producers.

The failure of the US MNCs to support a universal national health plan and their reliance on private medicine increases the cost of production by 10% contributing to the loss of competitiveness of US enterprises and an increase in the trade deficit.

Chinese economic policy with regard to foreign investment is far more liberal than US policy. In 2004, foreign invested enterprises in China accounted for 57% of China’s exports. In contrast in the US, the Committee on Foreign Investments in the United States (CFIUS), constantly resorts to “flexible” definitions of “public interest”, “national” or “strategic” interests to prevent foreign investors from investing and acquiring US firms. The highly publicized and successful US political intervention against the Chinese petroleum company, CNOC’s, attempted acquisition of UNOCAL is the most recent example.

Moreover the efforts of New York Senator Schumer and his congressional allies to slap a 27.5% tariff on imports from China would not reduce the US trade deficit as US importers would turn to other efficient Asian producers and Chinese manufacturers could relocate in adjacent countries. The result would be increased consumer costs, adversely affecting US domestic commerce without creating new jobs for US workers.

The “protected industries” in the US include some of the worst garment sweatshops paying below the minimum wage, some of which can be found in close proximity to Senator Schumer’s offices in New York City. The problem is not foreign competition – that should be a given in a free market economy – but becoming efficient, which means investing in high tech and automated production, training, paying highly skilled workers, engineers and designers and providing stable employment so that workers can accumulate the experience and know-how which contributes to greater productivity.

The 1995 Uruguay Round Agreement on Textiles and Clothing (which the US signed) purported to eliminate quotas by January 1, 2005. US textile manufacturers had ten years to upgrade, modernize, and restructure prior to the advent of free trade. Instead they chose to rely on lowering labor cost, subcontracting to sweatshop labor contractors and political payoffs to lobbyists, politicians and labor bosses to impose new restraints on Chinese exports. The US reneged on its agreement to end quotas, pressuring China to limit Chinese exports to the US throughout 2005 and beyond (Financial Times Sept. 1, 2005 p1).

Current US “quotas” on Chinese exports already affecting textiles, clothing, color televisions, semiconductors, wood furniture, shrimp and steel have only increased the cost to US consumers and domestic sellers and increased profits for US monopoly producers in these same sectors, making them even less competitive. US producers paying monopoly’ prices to protected domestic manufacturers are hardly likely to be in a position to export and improve the US balance of payments.

The argument of “unfair competition” based on cheap labor is not convincing. The cost of labor is not the decisive factor affecting market competition or trade balances. Many low wage labor countries are not competitive. Many high-wage and high benefit Scandinavian and Low Countries compete successfully in the market relying on quality and specialized products, having abandoned production of labor-intensive consumer items. The resort to moralizing about trade terms especially by anti-union employers who avoid pension and health payments and provide the least time off for vacation and maternity in the Western world is pure cant. The fact is that substantial sectors of the US economy are not competitive given the product lines in which they are engaged, the inferior quality of their goods, the lack of long-term, large-scale investments in upgrading technology and productive organization and the siphoning off of profits to speculative sectors or to offshore subsidiaries.

Hiding between tariff walls, quotas and demagogic “China bashing” is simply an excuse to avoid the harsh discipline of the free market. Facing up to the free market would force the US business and political elite to own up to the fact that we have, in many sectors, a second-rate capitalism directed by a third-rate state.

The Myth of the “China Threat”
Instead of accepting the economic challenge from China and recognizing the need for re-thinking the misallocations of resources and the over-reliance on the paper economy, retrograde business elites and overpaid trade union bosses have joined forces with neo-conservative ideologues in promoting the idea of China as a national security threat which needs to be confronted militarily. The fusion of militarism abroad and protectionism at home has gained many adherents in Congress and in the executive branch – setting the stage for a self-fulfilling prophecy. Faced with increasingly bellicose rhetoric from Washington, China looks eastward toward strengthening its military and economic ties with Russia and Central Asia while diversifying its trade with Asia, Latin America, the Middle East and Africa.

US militant “protectionist militarism” with its confrontational approach to China threatens to block the free market of knowledge and technology. China’s dynamic growth is not primarily based on “cheap labor” – it relies on the production of millions of highly trained scientific and professional workers each year. Each year tens of thousands of Chinese students, professors and scientists train abroad – many in the US. Very few US students pursue advanced degrees in science and engineering, with the result that foreign students – including Chinese – are increasingly critical to the US science workforce. In this free flow of ideas and scientists, both China and the US theoretically benefit – from a “free market” perspective. But as we have argued the US is opposed to the free market – especially in the free flow of scientific ‘know-how’.

The US is doing everything possible to restrict the exchange of scientists, technology and knowledge – by a wide-ranging definition of “national security”. Given their military definition of the China challenge, Washington argues that Chinese students and scholars should be restricted in what they study, what they learn as well as their access to technology. Universities, under Pentagon and Department of Commerce ruling, would have to secure special licenses and mark restricted areas within laboratories to prevent foreign students from using supercomputers, semiconductors, lasers and sensors in their research. The Department of Commerce plans to tighten controls in the export of commercial technologies (Financial Times Sept. 1, 2005 p 11). From a free market perspective US export controls to China are self-defeating, lessening exports thus increasing the trade deficit, and have little impact on China’s access to technology via Japan, Korea and Europe. In contrast, in July 2005 the European Union signed contracts with China to develop commercial usages of the Galileo satellite navigation system.

From a militarist-protectionist perspective the restrictions on ideas and the free circulation of scientists and students can be seen as part of a campaign of political and perhaps military confrontation and encirclement.

‘China bashing’ is merely a response to the loss of competitiveness. Nationalist demagogy in a declining global power is a compensatory mechanism for the failure of US capitalism to keep up with the competition – at least from its locus in the US economy.

China’s Competitive Advantages
China not only out-competes sectors of advanced capitalist countries but it competes successfully with low wage nations through the constant application of innovative techniques of production. Moreover China is increasingly competitive at middle and high-end goods that go beyond consumer durables, garments and electronics. The competitive advantages are derived from the priorities designated by the state and the use of financial mechanisms and incentives. The claim that China “artificially” keeps its currency low thus gaining a competitive advantage is only voiced by the US and some European states. No one in Asia, Latin America, Africa or Oceania is complaining. With many regions of the world, China has a negative balance of payments, so that its overall surplus is much smaller than the China bashers who focus only on US-China bilateral relations would lead us to believe. Japan’s global current account surplus is larger than China’s by $153 billion to $116 billion USD (FT Oct. 11, 2005). There are no complaints from Japan, South Korea, India, Brazil, Argentina, Russia or Iran about an undervalued currency. In global terms, Japan and Germany account for 30% of the global current account surplus (228 billion Euros) and China only 8% ($70 billion USD).

The US trade and budget deficit is exclusively a problem of internal failures: low or negative savings, high speculation, no up grading of backward or uncompetitive sectors, artificial propping up of uncompetitive state subsidized sectors and large-scale, long-term US investment in productive facilities in China. Out of ignorance or cowardice, US Congressional leaders like Senator Charles Schumer refuse to confront the fact that the US trade deficit is in large part a product of the imbalance between exports by US MNCs located in China selling to the US market over exports from US based manufacturers. For US politicians, it is easier to get re-elected by taking cheap shots at an emerging economic power than to confront China-based US MNCs which finance electoral campaigns.

The US Imperial Threat to China
Throughout history, established global states, which are indebted and dependent on rising new powers, generate politicians who react with irrational resentment and belligerence. The gross failure of the Federal Reserve to contain the irrational exuberance in the paper and speculative economy over the past two decades, its complicity in the growth of unsustainable trade deficits, its outrageous support for tax cuts divorced from any link to the export economy marks the Bank and its Chairman as among the principle culprits in the decay of the US competitive position in the world market.

The danger is that as the US competitive position declines, a coalition of backward industrialists and civilian-militarists will try to compensate by provoking political confrontations and even inventing military threats to justify a military build-up. The politics of confrontation however will cause greater harm to the US MNCs than to China. After all it is the US which has imposed political barriers to the entry of Chinese investors in the US, while China has welcomed over 100 billion dollars from the leading US MNCs into the Chinese market. It is China which is financing the US trade deficit by purchasing US T-notes of declining worth, sustaining US over-consumption and under-investment.

In contrast to Washington’s restrictive policies on Chinese investments in US energy companies, China welcomed large-scale investments by Peabody Energy (the world’s largest coal company by sales) in joint venture mines (Financial Times Sept. 21, 2005 p19).

China is increasingly diversifying its trade and sources of energy. Its trade in Asia surpasses that of the US. China has increased its security links with Russia as a counterweight to the bellicose posturing of the US neo-conservative militarists and liberal Democratic “humanitarian” imperialists.

Washington’s increasing reliance on rearguard statism, whether in imposing tariffs, quotas, political restrictions on takeover bids, or blocking private investments is doomed to failure. Ultimately the US competitive or non-competitive position in the world market will determine who will be the next economic superpower. The only way for US capitalism to answer the China challenge is to save, invest, innovate, produce and compete in a free market – free of atavistic statism and militarism.

Washington continued effort to weaken China’s export capacity to lower its trade deficit has taken the form of an open-ended crusade. In July 2005, China announced a 2% revaluation of the renminbi and shifted from a peg against the dollar to a link to a basket of currencies. China promised even greater flexibility over time, to allow its exporters to adjust to the more competitive conditions. The US economy, with all its inefficiencies, could not take advantage of this opportunity and demanded more concessions, a bigger re-valuation and less exports, hoping that state intervention would weaken China’s export industries. The escalation of Washington’s demands on China is ‘open-ended’ – one concession granted ‘confirms’ neo-conservatives in the Bush Administration that they can secure others, setting the stage eventually for a ‘recovery’ of US export competitiveness. Even the US Federal Reserve Chairman recognizes that a stronger Chinese currency (or other Asian currencies) will make little difference to the US trade deficit (FT Oct. 11, 2005 p5). As all G20 countries meeting in Beijing pointed out the problem is the structural weaknesses in the US.

If we blow away the statist froth, propounded by our free-market economists, we would recognize that what China is demanding is that the US really live up to its free market ideology.

US Treasury Secretary John Snow, driven by the protectionist pressures from a Congress responding to backward sectors of the US economy and civilian militarists in the Executive, endlessly seeks to impose diplomatically what the US economically cannot achieve via the market – a reduction in the US trade deficit. Behind the veneer of diplomacy, Washington threatens a “trade war” via exorbitant tariffs of 27.5% and a hostile propaganda campaign labeling China a “currency manipulator”. A “trade war and demonization” strategy will most likely strengthen the civilian militarists and their campaign of military encirclement and nuclear brinksmanship in the Taiwan Straits. The confrontational strategy will provoke a Chinese defensive response which will lead to major US economic crises – as China unloads its US Treasury Bonds and reallocates its trade surpluses from the US to internal, Asian and European options. Washington will also see a loss of Chinese markets, investment opportunities leading to an attack on the profit margins of major US MNCs in China as Beijing increases its economic exchanges with Asia, Russia and the rest of the world.

If the civilian militarists’ war with Iraq heightened the economic deficits and weakened the US competitive position, a neo-conservative confrontation with China will likely precipitate a deep structural crisis and probable collapse of the US economy, as we know it.

Conclusion
US colonial wars, the re-concentration of income in the upper 1% via tax cuts, the relocation of US MNC subsidiaries as overseas exporters to the US rather than exporters from the US, the dominance of the speculative economy (IT, real estate) and the ascendance of import intensive commercial capital over productive capital are the main reasons for the unsustainable $700 billion dollar current account deficit and the $500 billion dollar budget deficit. The speculator-militarist empire builders seek to divert attention from their failed policies by engaging in blatant deception and falsely blaming the ‘devious and threatening’ Asians, especially the Chinese. A report published in September 2005 by two leading European think tanks totally demolishes this ideological smokescreen. They point out that the US current account deficit grew by $529 billion between 1997 and 2004 but China accounted for only 7% of this rise, compared to 30% for Russia and the Middle East (Financial Times Sept. 16, 2005 p2). US “blame the Asians” demagogic calls for Asian currency re-valuation would lead to deflation and economic stagnation without solving the US trade deficit. The key to lowering the trade deficit is for the US to engage in structural adjustments. These include re-introducing taxes on the very rich and developing an industrial and monetary policy that promotes local production for export and penalizes speculative investment and overseas relocation. This would increase local saving and investments, lower imports and stimulate exports.

Given the political ascendancy and economic centrality of multinational capital, the major investment banks and financial houses and the extensive web of real estate-construction and mortgage banks along with militarist neo-conservative control of the White House, there is virtually no possibility that US capitalism can rectify, correct or reform its strategic direction.

In the face of the embedded power bloc, which protects non-competitive producers and promotes US re-location of production abroad, the only logical outcome is the militarist-protectionist amalgam which defines US policy today. The backward sectors of US capital, together with the neo-conservative militarists, and the reactionary trade union bureaucracy promote “protectionist nationalism” at home and imperialist wars abroad. The competitive free-market multinational corporations promote overseas market openings but rely on a state, which depends politically on the extensive non-competitive manufacturing and subsidized agricultural sectors and the civilian militarists.

The calls by US economists for China to reform its currency, to accept US quotas on its exports, to retain a highly inferior military defense system while facing US power in the Far East is an attempt to forge a hodgepodge “consensus” between free market manufacturing MNCs and militarist-protectionists. Harmonizing interests between a rising industrial capitalist power like China and a militarist-speculative-commercial power like the US is a difficult chore in the short run and an impossible task in the medium term. China’s booming demand for commodities has helped many Third World countries, while US agricultural subsidies and trade constraints have hurt these countries. US military belligerency in the Middle East has alienated the majority of the Arab and Muslim world, and divided Europe and its own population. Germany and Japan have accumulated massive trade surpluses at the expense of US-based exporters. The US ruling elite’s resort to militarism in all of its brutal, colonial and invasive forms in Iraq and Afghanistan has exacerbated both the external and internal deficits, while demonstrating the strategic military weakness of an empire predominantly dependent on local satraps and military sepoys to sustain it. The US empire emptied of its domestic manufacturing export sector and relying on speculators and commercial importers (compradors) projects a militarist ideology to shore up the empire. These very forces have substantially weakened the competitive position of the US in relation to China’s rising free market technological-industrial power.

The Chinese leaders cannot capitulate to US demands without destabilizing their own rule and the economic model they preside over. Strong capital inflows in 2005 from US, European and Asian speculators are betting on a re-valuation of the renminbi (China’s currency), creating conditions for a financial crisis if the Chinese regime recklessly moves toward an unregulated monetary policy. Secondly the ruling class free-marketeers in command of Chinese policy have gutted the public welfare system in favor of privatization, forcing Chinese workers, employees and shop owners to save to pay for education, housing, health care and retirement and thus have less income for domestic consumption. Chinese savings to pay for basic services limits domestic consumption and forces the Chinese regime to realize profits via exports. Accepting US dictates on reducing exports will destabilize the entire free market model. The elite basis of Chinese rule, in which 5% of the population controls over 50% of all private assets, faces escalating opposition from unemployed workers, exploited peasants and displaced urban and rural dwellers. Between 2001 and 2004 mass protests grew from 4,000 to over 70,000. China needs to create 15 million jobs a year, which requires the GDP to grow at least 8%. The Chinese ruling class believes economic growth will stabilize their rule. Since the growing social inequalities are embedded in the concentration of political-economic power at the top, they can only be changed by socialist movements from below. The rulers’ program is to “increase the pie” hoping the trickle down effect will increase consumption and stabilize their rule and privileges. US pressure on China’s rulers to increase domestic consumption and decrease exports threaten to undermine domestic class relations and undermine the growth and profit rates. The free-market, export-oriented Chinese ruling class, like its US imperial counterpart, is hardly volunteering to sacrifice its class power and privileges to accommodate its economic competitors.

Oil costs, Chinese imports widen gap in U.S. trade

The Globe and Mail: Oil costs, Chinese imports widen gap in U.S. trade

By DOUG PALMER

Friday, October 14, 2005 Page B8

Reuters News Agency

WASHINGTON -- The U.S. government says its trade deficit rose in August to the third-highest level on record as imported oil costs and imports of Chinese textiles and other goods soared.

Surging energy prices stoked the biggest monthly rise in import prices in nearly 15 years, a separate report indicated.

The U.S. Commerce Department said the August trade gap grew 1.8 per cent month over month to $59-billion (U.S.), just below economists' forecasts of $59.5-billion. Record imports of $167.2-billion beat record exports of $108.2-billion.

Much of the climb in the trade gap was the result of oil price gains, partly offset by a surge in civilian aircraft exports.

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The trade report indicated crude oil import prices reached a record $52.65 a barrel, lifting the total paid for crude imports to a record $17.2-billion in August.

A separate U.S. Labour Department report indicated surging oil and natural gas prices pushed import prices up 2.3 per cent month over month in September, the largest jump in nearly 15 years, and more than twice expectations. Petroleum import prices climbed 7.3 per cent while non-petroleum import costs rose by a record 1.2 per cent, the U.S. Labour Department reported. Stripping out petroleum and natural gas, import prices rose a much smaller 0.4 per cent.

Kurt Karl, head of economic research and consulting at Swiss Reinsurance Co. in New York, said the high oil prices mask an improvement in the underlying trade gap. Imports from China hit a record $22.4-billion, boosted by a 3.1-per-cent jump in clothing and textile shipments. Imports of those products in the first eight months of this year climbed more than 53 per cent from the year-earlier period, reflecting the end of global textile quotas on Jan. 1.

A fourth round of talks aimed at stemming the flow of Chinese textiles into the United States collapsed yesterday. U.S. Treasury Secretary John Snow is in China to meet with finance chiefs from the Group of 20 industrialized economies. Mr. Snow, who is also expected to meet Chinese President Hu Jintao, has been vocal about the need for a looser Chinese currency.

Why the US Trade Deficit is so large and why it matters - - Dr. Peter Morici

Why the US Trade Deficit is so large and why it matters - - Dr. Peter Morici

By Professor Peter Morici, Robert H. Smith School of Business, University of Maryland
Oct 12, 2005, 13:59

Professor Peter Morici is a recognized expert on international economic policy, the World Trade Organization, and international commercial agreements. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission.
Thursday, the U.S. Commerce Department will report the August deficit for trade in goods and services. The July deficit was $57.9 billion, and the August number may be a bit larger or smaller. Either way, it will be too large, and we need to ask why it persists.

Since January 2002, the deficit on trade in goods and services has risen from $29.9 billion to $57.9 billion, and is now about 5.5 percent of GDP. Only $12.3 billion of that jump may be attributed to petroleum imports. The balance of the increase was a deteriorating position on nonpetroleum goods and services.

Budget Deficit Sophistry

In the discussions about the trade deficit, a great deal has been made of the U.S. federal budget deficit; however, during the second quarter the current account deficit, which includes goods, services, investment income and transfer payments, was $196 billion but the federal deficit was only $70 billion.* The budget deficit, and the foreign borrowing to finance it, is less than half the problem.

In 1991, the federal budget deficit was huge and the current account was in surplus. When Bill Clinton left office in 2001, the budget was in surplus and current account deficit was in deficit. That is the absolute opposite of what those who blame the trade deficit on the budget deficit would have us expect.

Of course the budget deficit matters but so do a lot of other factors. That said, it is hard to find good reasons for the rest of the problem in the competitive fitness of U.S. business.

Each year the World Economic Forum computes a growth potential index for 117 economies. It examines factors like public finances (e.g., budget deficits, efficacy of the tax system), the environment for the cultivation and commercialization of technology, and quality of civil institutions (e.g., the prevalence of corruption, evenhandedness of the judiciary and respect for law), and openness to international competition. In this assessment of national competitive potential, the United States ranks second after Finland—China and India rank 49th and 50th. Also, the WEC ranks the fitness of businesses, and on that score the United States ranks first—India ranks 31st and China 57th.**

Our labor force is much stronger than education entrepreneurs in search of higher taxes would have us believe. Virtually our entire native born population finishes high school, two thirds receive some post secondary training, and our universities are among the nation’s most prolific export industries. The most important determinant of quality in the classroom is the student population, and if our universities are populated by dullards, why do so many foreign students want to pay our pricey tuition?

U.S. productivity is advancing briskly. Since 1999, private business productivity has increased 3.2 percent a year; in durable goods manufacturing, where technology matters as much as anywhere, productivity has been advancing at a 5.4 percent pace. We have to go back to electrification, the railroad and the opening of the West to find epic events that so transformed our economy and the global economy as contemporary American innovations in new materials, electronics and logistics.

So where is the problem? I suggest we look in three places.

Broken Industrial Policies

Despite the generally good U.S. policy environment, certain industry policies place undue burdens on the growth of export and import-competing sectors and push capital and labor into other industries. Most important among these are policies that weigh heavily on manufacturing, and in particular durable goods manufacturing where so much competitive potential seems unfulfilled.

Americans pay about 50 percent higher prices for health care than do competitors, for example, in Germany and France. Whether these prices are paid through premiums to private providers or taxes for government delivery systems, these higher costs heavily burden employers with union contracts requiring rich benefit requirements, or where benefit expectations are established by competing unionized employers.


Environmental policies raise costs in U.S. energy-intensive industries above those in Western Europe and elsewhere. For example through Republican and Democratic administrations, U.S. policy has encouraged the use of natural gas in electrical generation while limiting natural gas development. Regulation and litigation make it very difficult to build large LNG terminals to import gas anyplace but in the Gulf region, and have made it impossible to build a new petroleum refinery in more than 25 years. Sadly, higher natural gas prices are driving petrochemical manufacturers to Europe to find cheaper feedstock. Other industries adversely affected by dysfunctional energy policies include plastics, metals and industries fabricating those materials.

Our legal system relies more heavily on case law and torts to protect private interests but it can be abused. Too frequent and expensive lawsuits visit particularly on durable goods manufacturing where liability extends as long as the product is in use, even if ownership of the company has changed several times or the assets have been reorganized by bankruptcy.

Overall, the National Association of Manufacturers has estimated higher benefits costs, regulatory compliance costs and lawsuits add nearly 13 percent to U.S costs that foreign competitors do not bear. These bias growth toward non-goods producing activities, and we import more and export less in the bargain.


Poorly Written and Enforced Trade Agreements

U.S. trade deficits have been driven up by the ineffective negotiation and implementation of trade agreements. These have permitted, for example, China to subsidize manufacturing with zero interest loans and pirate intellectual property, EU governments to underwrite Airbus with risk-free capital from government treasuries, and most industrialized countries to rebate value added taxes on their exports to the United States. Many governments require U.S. investors to give away technology, source components locally that might be more cost-effectively made here, or hit export goals.

The United States is much more dependent on personal and corporate income taxes to finance government than the EU and other countries that levy substantial value added taxes. U.S. trading partners may rebate their value added taxes on exports and impose these levies on imports. An arbitrary interpretation of WTO rules prohibits the United States from making similar border tax adjustment on its exports and imports.

The standard value added tax in the EU is averages about 19 percent, and when rebated on exports and applied to imports—these adjustments provide a 19 percent subsidy on EU products sold in U.S. markets and a 19 percent tax on U.S. products sold in the EU market.

The United States has acceded to special and differential treatment in the WTO that permits developing countries to maintain much higher tariffs on manufactured products, and affords them weaker enforcement on a whole range of issues from subsidies to intellectual property to conditions imposed on U.S. investors. As a consequence, U.S. firms move production to developing countries to scale tariff barriers—consider Brazilian and Chinese auto tariffs—and then they encounter all kinds of pressure to transfer technology and move the suppliers of critical components production into these markets. And, the steel, plastics and microprocessors are then not made here!

The Bush Administration seems bent on repeating the mistakes of the past. It is not making parity in tariffs a bottom line requirement for Doha negotiations, foreign government latitudes to lay on subsidies will likely emerge substantially in tact, rules for foreign investment and exchange rate manipulation are not on the table, and U.S. dumping and subsidy/countervailing duty laws, which provide the only real defense against these subventions and abuses of free and open trade, are under assault with only tepid defense from U.S. negotiators.

Currency Manipulation

Perhaps the largest single problem is the almost complete absence of meaningful disciplines for exchange rates, which the Bush Administration has chosen not to effectively address. Since January 2002, the dollar is down an average of 14 percent against all currencies. The dollar has fallen an average of 24 percent against the euro and other industrialized country currencies, but it is up an average of about 1 percent against the Chinese yuan and other developing country currencies.

The Chinese 2.1 percent revaluation announced July 21 was too small to significantly affect the value of the dollar or have a measurable effect on trade. The Chinese yuan remains fixed at about 8.1 per dollar thanks to substantial Chinese government purchases of dollars; other Asian central banks continue similar currency policies lest they lose export markets in the United States and elsewhere to China.

Chinese government purchases of dollars and other securities easily exceed $200 billion per year and 12 percent of China's GDP. Chinese government purchases of dollars and other securities create a 33 percent subsidy on China's exports.

Overall China and other foreign governments are purchasing more than $82 billion in the second quarter of 2004, creating a 17 percent subsidy on the sale of foreign goods and services to Americans.

What Are the Consequences?

Apologists for the trade deficit argue that it indicates the strength of the U.S. economy, because it is financed by productive investments in U.S. industry. That is less than half true. Most of the capital we import to finance our nearly $800 billion dollar current account deficit goes into foreign holdings of U.S. securities—U.S. government bonds, bank deposits, corporate bonds, and the like. These now total about $5 trillion dollars and are growing at a pace of about $500 billion a year—that’s more than half the trade deficit. And not all of these are private investors seeking haven from the uncertainties of foreign capital markets—remember about $395 billion of those $500 billion in paper assets purchased in 2004 went in the coffers of foreign central banks.

At five percent a year, the debt service comes to $250 billion and that debt services increases at about $25 billion a year. Do you think our kids should be saddled with that? If so, feel comfortable in the knowledge that borrowing for a wild spending spree on imports today to saddle your kids with debt is building a sound America for tomorrow.

Further, persistent U.S. trade deficits undermine U.S. growth. These shift employment away from export and import-competing industries, which enjoy higher productivity and pay higher wages. Trade deficits are a key reason why the wages of most workers with only a high school education or a few years of college have barely kept up or lost ground against inflation during the recent economic recovery.

U.S. manufacturers are particularly hard hit. Cutting the trade deficit in half would create nearly 2 million more manufacturing jobs. An effective policy to end currency manipulation and cut the trade deficit would particularly benefit highly competitive U.S. durable goods manufacturers, such as producers of machine tools, industrial and construction machinery, auto parts, and electronic equipment.
U.S. import-competing and export industries spend at least 50 percent more on R&D and encourage more investments in skills and education than other sectors of the economy. By shifting employment away from these trade-competing industries, the trade deficit is reducing U.S. investments in knowledge-based industries and skills and handicapping U.S. growth.

Slashing the trade deficit in half would add more than one percentage point to U.S. productivity growth and potential GDP growth each year.

*Net federal government savings.

**It is important to remember that China and India still have highly regulated economies and are troubled by corruption, and the legacy of Communism leaves China with fairly undeveloped infrastructure to support world class businesses. That is one reason both countries rely, for example, so much on conduits like Wal-Mart and Li & Fung to reach western markets.

U.S. breaks with tradition in putting its subsidies into play - Business - International Herald Tribune

News Analysis: U.S. breaks with tradition in putting its subsidies into play - Business - International Herald Tribune

WASHINGTON It was described as a listening tour to figure out how to write the 2007 farm bill. But when the U.S. agriculture secretary, Mike Johanns, visited 17 farm states this summer, he was preparing the ground for the significant U.S. trade compromise announced Monday.

By going to America's farmers and ranchers, whether they tended small fruit orchards or huge rice plantations, Johanns was breaking with tradition. He put on public record voices that are rarely heard from: the majority of American farmers who are failing under the U.S. subsidy system - not just the heads of trade associations and agribusinesses that benefit mightily from the $19 billion annual program.

Late last week he announced the results of his talkfest: Existing U.S. farm subsidies are seen as unfair by many American farmers and need to be changed. It was a conclusion that has been the gist of public debate in recent years - 10 percent of American farmers receive more than half of the subsidies - but rarely among American politicians worried about the farm vote.

Having done his duty, Johanns passed the baton to the U.S. trade representative, Rob Portman, who was able to make the offer in Geneva, knowing that the ground had been plowed and Congress was on notice that farm subsidies were in play.

The U.S. proposal, which would cut contentious tariffs by 55 percent to 90 percent over five years and reduce some kinds of farm subsidy programs by 60 percent, shows that the administration is serious about this trade round: Bush is spending some of his dwindling political capital to attack the holy grail of farm subsidies.

But the political tradeoff could be big: Wall Street and many other American businesses have increased their lobbying power in Washington. They are desperate to get these talks to work so that new markets will be opened to U.S. business and trade. If the administration can crush farm subsidies, it will also reduce America's gaping budget deficit.

To be sure, that means answering farm state politicians in Congress who see Europe - not the United States - as the guilty party in the global farm debate. But to the outside world, the subsidies have become a rallying cry to eliminate poverty - and farm subsidies are considered one of the worst evils.

The so-called Doha round of trade talks is meant to help developing nations by improving the access for their goods to wealthy markets, and agriculture is the crucial issue for those whose farmers are being crushed by inexpensive food exported by farmers from rich nations who receive heftier subsidies. But that argument does not move many in Congress or the administration who are desperate to reduce U.S. farm subsidies to help whittle the deficit.

Indeed, it is this talk of fairness within the American farm community - and not bleeding hearts for impoverished African farmers - that could become the rationale for reducing farm subsidies.

The European Union gives its farmers huge subsidies, imposes higher tariffs and - worst of all in the view of the administration - closes its market to some of the United States' biggest farm exports. The ban on American beef from cows raised on growth hormones is just one that stirs strong feelings.

According to Bob Goodlatte, the Virginia Republican who is chairman of the Agriculture Committee of the U.S. House of Representatives, the only way to break the logjam is for the United States to negotiate greater market access for its products, not only in Europe but the big developing countries like Brazil and China.

"Our trading partners need to understand that we will do everything possible to ensure the competitive position of American farmers and ranchers," he warned recently. "However, we cannot unilaterally disarm and scrap our farm support programs without other countries doing the same thing at the same time."

To pull off this political hat trick, Portman will have to rely heavily on his personal popularity in Washington and his genial profile abroad.

Unlike his predecessor, Robert Zoellick, who was accused of arrogance by members of Congress and clashed openly with Peter Mandelson, the European trade commissioner, Portman has the confidence of members of both U.S. political parties for his rare sense of bi-partisan compromise: he puts even sharp-witted figures like Mandelson at ease.

And his teamwork with Johanns shows more than a small resemblance the duo of Franz Fischler, the former European agriculture commissioner, and Pascal Lamy, Europe's former trade commissioner, both of whom worked together to persuade the EU to offer to eliminate all of its contentious agricultural export subsidies at trade talks in Geneva last years.

This summer, as he was preparing to take over as the new director general of the World Trade Organization, Lamy was closely watching Johanns' forays into the American heartland.

While Johanns' conversations with U.S. farmers may not be as glamorous as the summer rock concerts that helped break the logjam on relieving the debt of impoverished nations in July, they could prove as least as effective for helping those same countries in the trade round in Hong Kong this December.

Iran official says US incapable of going to war - Forbes.com

Iran official says US incapable of going to war - Forbes.com