Ruminations, July 18, 2010

Is the U.S.too big to fail?

During the first few months of the economicdownturn, federal tax dollars were shipped off to private financialinstitutions in order to keep them solvent. The rationale for doing so was thatthe institutions were so big that a failure on their part would bring downmost, if not all, of the American economy. These companies were adjudged toobig for us to allow them to fail.

Is the UnitedStates too big to be allowed to fail? Considersome of the consequences if the UnitedStates fails economically:

1. Total public debt of the United States is over $13 trillion. Failure means that all those who have invested in the United States — countries, organizations and individuals — will lose their investments.
2. The U.S. imports $2.5 trillion worth of goods annually. Failure in the U.S. would eliminate the market for these goods and drive down the other economies in the world.
3. China alone owns over $1.6 trillion in U.S. securities. Failure would cause the value of those securities to drop precipitously.
4. The U.S. dollar is the reserve currency of the world. As such, foreign countries hold U.S. dollars to facilitate their foreign trade and as a buffer against financial crises.
5. The International Monetary Fund (IMF) facilitates development and loans primarily to poorer countries. The U.S. contributed $108 billion to the IMF this year. Failure of the United States would have severe ramifications to the development of poorer nations.
6. Immigrants, legal and illegal, send approximately $48 billion to their countries of origin each year. Failure means that that source of revenue would be non-existent.
7. The United States employs approximately 11 million immigrants. Failure would mean that these jobs would cease to exist and the countries of origin would see the immigrants return and join the ranks of the unemployed.

So, it looks like the UnitedStates is too bigto fail – the rest of the world cannot afford to let the UnitedStates fail. But, just as we would ratherrestructure the financial system makeup so that no institution is too big tofail, so does the international community want to restructure so that it is notso dependent on the UnitedStates.

For example, China,which is substantially dependent on the UnitedStates remaining economically strong, has begun to cuttheir purchases of dollars and U.S.securities. They have purchased some gold and, last week, Premier Wen Jiabaoassured German Chancellor Angela Merkle that Chinawould support the 11-year-old euro. Indeed, just 10 years ago, the dollar madeup 70 percent of the world’s currency reserves and today it hovers just over 60percent. There have also been calls for a substitute reserve currency calledSpecial Drawing Rights (a collection of currencies with the advantage that thefailure of any one nation, even a very big one, would have a reduced effect onthe global economy).

So, we are too big to fail but that doesn’tmean we can’t. And the rest of the world is beginning to hedge their bets.

Trade

The consensus among liberal and conservativeeconomic historians is that one of the factors that extended the GreatDepression was the Smoot-Hawley Tariff of 1930. The tariff resulted inretaliatory tariffs by trading partners and cut U.S.exports and imports in half.

For the past 65 years or so, the prevailingapproach to tariffs has been to keep them low or nonexistent so as to increasetrade and let exporters and importers take advantage of the comparativeadvantage of nations. When tariffs are imposed, they are often imposed inretaliation for other actions taken by an offending nation.

Germanyright now fears that the U.S.will increase tariffs on European cars sold in the U.S.in retaliation for Germany’srefusal to provide subsidies to General Motors’ European subsidiary Opel.

That’s really not a bad idea. Consider that the UnitedStates had a trade deficit of more than $30billion with the European Union. Furthermore, the tariff on American carsexported to Europe is 10 percent of the vehicle’s value and the tariff onEuropean cars imported to the UnitedStates is 2.5 percent of the vehicle’s value.

Seems like it’s time to end the Marshall Planand treat Europe like an equal. Whether it’s2.5 percent tariff or 10 percent tariff, it should apply both ways.

Quotewithout comment

American humorist Sam Levinson (1811-1980):“It’s so simple to be wise. Just think of something stupid to say and thendon’t say it.”