[A-List] Who are these foreigners?

Henry C.K. Liu hliu at mindspring.com
Tue Feb 14 09:30:31 MST 2006

The White House's Economic Report of The President, prepared by the 
Council of Economic Advisors, was released yesterday. Among other 
things, it asserts that the low US savings rate and the record trade 
deficit may not be "cause for alarm".  Echoing Bernanke's theme of 
global savings glut, the report said foreign countries were saving too 
much rather than the US saving too little.  In term of numbers, it 
predicts growth at 3.4% for 2006, unemployment at 5%, with 2 million new 
jobs created in 2005 and inflation at 2.4%. It is a picture of wine and 
roses. Household spending in 2005 exceeded after tax income, yielding a 
negative household saving rate compared to the average rate of 10% for 
the 1980s. The report argues that the negative saving rate is more than 
offset by asset appreciation in homes and equity, the so-called wealth 
effect.  While household net worth in 1998 dollars for 25-34-year olds 
declined in 1998 to $15,500 from the 1983 high of $19,504, it was still 
higher than the $6,072 registered in 1962.  While asset appreciation 
helped households with older heads who already own a home, it is hard 
for those entering the home market for the first time.  Home ownership 
appears to be a new form of stealth social security transfer, with the 
young paying for the tax-free capital gain of the retired elderly, and 
home affordability has fallen to a 34-year average.  This is no comfort 
since, thiry-years ago included the 1978 crash after which fours years 
of low homes prices distorted the affordability index by home prices 
falling by almost two thirds from their pre-crash peaks. Greenspan has 
warned that capital gain does not finance new investments because they 
exist only on paper.  This is not entirely true, as high asset value can 
generate more debt without altering the debt/equity ratio.  The problem 
is not that capital gain is only a paper gain, but that the gain now 
goes to finance debt-driven spending, rather than debt-driven 
investment.  Thus the investment needs is met by foreign capital, so 
that while the assets remain on US soil, the income generated by these 
foreign owned assets goes to foreigners.  While asset price is risen, 
cash flow form such assets has not increase at the same rate.  This was 
made tolerable by low interest rates so that after tax return on capital 
remain attractive, boosted by expected continuing asset appreciation.  
Thus if wither interest rate should rise, or asset value should fall or 
merely stop rising, the cash flow from investment would face problems.

Still, who are these foreigners?  Legally, a foreigner is anyone who is 
not a US citizen. Financially, anyone regardless of citizenship, who 
hold dollars is not a foreigner to the dollar economy. Financially 
"foreigners" cannot by definition invest in the dollar economy, only 
dollar holders can.  With the dollar money supply expanding continuously 
to provide monetary elasticity to an expanding dollar economy, what we 
have is a recycling of dollars within the closed circuit of the dollar 


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