At the moment the United States of America is the disproportionate beneficiary of Globalism's disruptive effects on the distribution of economic and political power. The cyclical nature of history suggests that a day will come when the US loses these advantages. The timing will not likely be simultaneous, but they will be linked. Financial markets are trying to figure this out, and we see the global financial market's net conclusions expressed in currency valuations and interest rates.
I am not an economist but experienced in the business of suffering from past ups and downs of our domestic economy. My experience ranges from that of a small business owner to employee. My academic training in business came after most of my experience in it, so the expression of my thoughts here are intentionally simple and incomplete in order to delivers a few obvious insights that may contribute to a better understanding of what is going on in the world.
Long Interest Term Rates
There is no such thing as long-term interest rates any more. There are only short, shorter and a bit longer due to the fluid structure of modern financial markets that modifies the functional meaning of "long-term" by facilitating the option of day trading in long term debt instruments. Long-term rates are kept low by a factor that accounts for this fact.
This modern fact of life has come about because of the rapid advances in the worlds of domestic and international finance since America's Savings and Loan crisis in the late 70s and early 80s. Once 30-year mortgages became bundled as pooled investments sold in the open market as investment units traded daily, investors no longer made a long-term commitment when they bought long-term loans. The terms given a debt instrument had more to do with the borrower's requirements for planning payments and the standardization of loan attributes to make different loans similar enough to bundle. Granted, the demands of marketing to investors' portfolio planning strategies and benefits also drive investment terms of maturity, interest rates and payment structure.
Thus, the Savings & Loan crisis opened the doors to democratizing the exclusive world of finance for both borrowers and investors increasing the fluidity and scope of public investment in real estate, business and government debt. Any one of these investments may be bought and sold again within seconds or minutes and not years or decades. Hence, there is no such thing as long term investor commitment to publicly traded long term bonds or other financial instruments as long as the issue is of sufficient size and perceived quality to facilitate the ease and profitable execution of transaction. The only brakes on this rapid flow of capital might be substantial regulatory penalties for early withdrawal or for rapid resale imposed upon the investor by the issuing institution or governmental agency. Marketplace competition currently works against both institutions and governments seeking to structure or impose such penalties.
From the borrower's side the issue of term commitment is more fractured. Due to the abundance of cash floating around (in western economies especially), it has been relatively easy for borrowers to manipulate and switch borrowing vehicles. Few consumer borrowers actually hold their loans to a 15-year or 30-year term. As interest rates or loan packages fluctuate in their terms and conditions to attract borrowers, consumers shift their strategies. As long as they can make payments, then the lenders are more than happy to roll loans over modifying terms and rates.
This is why economists and investment gurus focus so much on the health of the American consumer, who is more or less over extended according to the interpretive perspective of the evaluator. If the aggregate consumer truly begins to have trouble making payments, then sand will be dumped in the gears of liquidity and ease of switching from one lending option to another. Anything that affects the consumer's ability to make monthly payments or to structure consumer and real estate debt so that they can make monthly payments, threatens the entire US economy and, through Globalism, significantly affects (not threatens) the entire world economy. Some of those factors are the cost of energy, taxes, short-term interest rates, employment and pay rates.
The fact that US consumers experience a negative rate of savings is evidence that wages have not kept pace with expenses. Aggregately, the gap between consumer income and outgo has been mostly filled by refinancing their homes, which has generated huge demand for long-term mortgage loans and/or new innovatively short-term loans with initially lower, but more quickly viable interest rates.
Perceived Value of the US Dollar
I read that identified US Government obligations now total over $50 TRILLION! This is up from $20 trillion in the year 2000. At $50 trillion government obligations total 4X the US Gross Domestic Product (GDP). In 2000 the $20 trillion figure was about 2X US GDP. These debt figures do not include US consumer debt, which is huge by itself. No consensus exists as to how manageable either of these massive aggregates of debt may be, but a fairly broad consensus exists that they will combine to pressure the value of the US dollar downward. While the dollar is worth substantially less that it was in 2000, the questions remain: when, how quickly and how far has it yet to fall? Or will it?
The US dollar is only worth its perceived value. Two dimensions of dollar value exist: its worth as a measure of the US economy and its functional role in facilitating world trade and investment (reserve currency). The US dollar benefits immeasurably from its denominating role in international trade. The historical stability of the US government, economy and, most importantly, its financial markets has made the abundantly supplied dollar the preferred medium of denominating trade and financial exchange.
Partly this is due to the historical dominance of US industry. For example, historical US leadership in the development and sale of petroleum resources has led to the price of crude oil being denominated and traded worldwide in dollars. The fact that the US public has been the biggest purchasing entity of consumer goods means that many dollars are needed to finance and facilitate these transactions. Companies in other countries that want to sell to the American consumer must use US dollars at some point. They earn profits in US currency that must be invested. It is easy to invest US dollars in US government bonds, which have an excellent reputation for dependable security backed by a wealthy citizenry that can be taxed to pay the government's bills.
As related above, American financial innovation has created many opportunities of huge dimension to attract investment. Financial returns have been good over the long-term, and the country has been a safe place to invest for over 100 years, so anyone making a little extra has sent their money to American financial markets regardless of citizenship or even politics in most cases. However this will eventually change when potential returns of US investments do not justify the risks of lost dollar value due to structural economic and financial imbalances. The question is when and by how much?
I believe that the primary unknown lies in the realm of the US dollar's functional capacity as the facilitator of world trade. There seem to be substantial obstacles to its easy substitution as the world's primary trade currency. Once the cost-risk equation of dollar instability exceeds its functional value as the agency of trade and investment, then it will drop more closely to its economically determined value. Other unknown factors tied into this complex equation are US military power and diplomatic effectiveness as well as the perceived future direction of the US economy vis-à-vis the other nations of the world. Currently, America is still the biggest kid on the global block, but most of the rest of the world wishes it were not so. Some, like China and India, are in the position to eventually do something about that. Europe has tried to do so repeatedly, but so far has been too divided in its approaches to US policy to take America's place as the leader of free world market capitalism.
The Euro creeps towards parity of global usefulness as a currency due to the European Community's now larger consumer market and stable finances. If the Asian Giants of China and Japan ever make substantive progress towards the goal of a common currency inclusive of the Asian Tigers of Korea, Singapore, Taiwan, Thailand, etc., huge downward pressures will come to bear on the US dollar. But coordination of Asian governmental and financial policies is many more times easier desired than done. So gold and other commodities become the value storehouses of current favor.
The outcome of the dollar's future has as much to do with the world markets' perceptions of US political-military strength, financial stability and economic vitality as it does with the reality of those factors. Huge wild cards are in the deck of the future from US entanglement in Iraq (with Iran and the Arab world vitally interested in the outcome) to how the American consumer can stay working and earning enough to stay on top and perhaps even reduce his huge, creatively financed debts spent on a lifestyle detached from the responsible fiscal reality of relative financial freedom of want and oppressive obligations to creditors.
In this short article it is impossible to cover all aspects of the issues briefly touched upon here. I have sought to elucidate some critical connections with simplified observations of the socioeconomic forces at work in the world today. The various components contributing to the perceived value of the US dollar and the viability of the US economy are like the proverbial cards assembled into a house. Unfortunately, the US resident is living in this house of cards. We will all experience the consequences of its eventual collapse in one way or another.
The questions still remain, "When? Where? How?" My answer is anytime. It is not rational to hunker in a bunker, but one should be plan some contingencies. Keep abreast of how markets value the dollar and be mindful of the ability of the consumer to pay his bills. Lastly, loss of military and political prestige and effective leadership will be disastrous both financially and economically to the US.