Monday, August 31, 2009

How is the US able to spend so much more than its Income?

Its quite amazing as to how the US has a savings rate of -7% (yes negative) and yet it holds the world in almost all matters.It is true that it is funded. How? Now thats the big question!I did quite a bit of research and here are the few reasons which I managed to find-->

1. USD as a Global Reserve Currency:

The US has a spectacular credit rating which has enabled the dollar to become the globel reserve currency, meaning that the probability of the US Govt defaulting on its loans is very low which in turn means US Dollar will be a very strong and stable currency. Every country has to hold reserves of some foreign currency/gold in order to save itself from potential political/financial crises. Hence most of rest of the world holds US dollars. Holding US dollar in terms of currency notes don’t give any returns, so they are used to buy US Treasury bonds. The bondholder has actually lent money to the US Govt.

2. Global Trade:

Most of the commodities (Oil, Gold, Silver etc.) are traded on USD globally. This means buyers and sellers of these commodities have to hold dollars. Hence there is a constant demand for dollars across the globe. Oil plays a very important role here since it is the backbone of every single economy in this world. Whichever currency in which Oil is traded, rules the world. There are theories which suggest that the reason behind Iraq attacks is that Saddam Hussein wanted to sell Oil in Euros which threatened the dollar dominance in the world. Same reason for potential attacks on Iran.

3. Artificially low interest rates:

Since the begining of the 21st century, the US has seen a period of artificially low interest rates. This was done initially to save the US Economy from the 2000-01 recession which was worsened by the 9/11 attacks. The economy made a smart bounceback because of the low interest rates. Consumption is inversely proportional to interest rates. When the interest rates are high, there is an incentive to save and when the interest rates are low, there is an incentive to borrow and spend. Hence the US consumers kept borrowing which was funded by the rest of the world.

4. Absence of an Institution called Family:

I have borrowed this point from M R Venkatesh, a noted economist from Swadeshi Jagran Manch. He says the prime difference between the saving nature among Indians and Americans is that the family culture in India is a huge deterrent to reckless spending. It is very common to see that Indians start accumulating wealth after marriage. This, he says is absent in America. The presence of Social Security and Healthcare benefits further redice incentive to save.

5. The strong consuming nature of the US:

The US is a very strong consumer in the international market. They import much more than they export, which is evident from their trade deficit year after year. The US pays dollars to exporters (Say China, Japan, Thailand, Korea, India etc.). These countries do not convert these dollars to their own currencies. Instead they are used to boost the forex reserves of the country. This in turn increases US debt.

6. Emergence of South Asia as a cheap manufacturing hub:

South asia’s emergence as a cheap manufacturing hub shifted US industries from manufacturing to services. This increased their imports massively as there was no incentive to produce the goods inland when they could be imported for a fraction of the cost. This is actually a result of the strong dollar and weak south asian currencies since weak currencies make exporting very easy.

All the points listed above are strongly inter-related and you could find a lot of cause-effect relationships. They could not have individually led to the present situation but collectively they have.

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