CEO Q Magazine Interview

(First Published Jan 31, 2007)

This IIM white paper provides the following: 1). A neutral assessment of the current U.S. economic and financial health, 2). An analysis of long-term consequences of current policy decisions 3). Emerging economic, social and geopolitical threats to U.S. financial prosperity 4). Risk mitigation strategies.

The policy paper addresses the key challenges facing the U.S. Government and attempts to answer the following critical questions:

1) U.S. Historical Perspective

No economy can sustain unlimited growth. The economy behaves in cycles; for every up cycle there is a down cycle, it is only a question of how long and how steep the curve is. The next decade is probably the most critical for U.S. socioeconomic prosperity. Let's start with a historical perspective:

For detailed historical perspective and economic date please visit US Economic Boom and Bust Cycles with Economic Indicators

• Over the long term, if government revenues are more than expenditures (surplus), then the economic health of the country is good, because the government can afford to invest in development projects such as research and development, education and infrastructure. With more income, the government can also afford to lower taxes, which increase corporate profits and attracts more foreign investors, resulting in more economic activities, creating more jobs and enlarging the consumer spending and government revenues overall despite income tax cuts. It is what I call a virtuous economic cycle.

• Over the long term, if government revenues continue to be less than the expenditures (deficit). This will result in accumulated debt. An increasing government debt will result in higher interest payments, and less money available for socioeconomic development. To pay for the debt, the government will have to raise taxes, which will reduce the competitive position of the country in the global economy and chase investors away resulting in less economic activities and more job losses. In order to avoid higher unemployment and social instability, the government have to raise more debt to fund spending and welfare support by raising the interest rate which will increase the cost of money, reduce corporate profits and slow economic investments, thus resulting in more job losses. It is what I call a vicious economic cycle.

But how good or how bad is the economy?

To properly assess the health of an economy, it is important to take note of the revenues, expenditures and debt numbers in relation to each other. Here is the big picture using bullet-point format:

• The size of the U.S. economy = $13 trillion. Commonly known as the Gross Domestic Product (GDP) - Mostly driven by inflated real estate and related asset pricing (housing and mortgage/financial bubble)

• U.S. National Debt is about $10.5 trillion (actual numbers are much higher, since U.S. government accounting rules do not meet private business accounting standards)

• Foreign debtors hold about 45% of the U.S. National Debt (Mainly China, EU, Japan and Oil producing countries)

Economic Crisis Indicators #1: Economic Growth Drivers

• The actual U.S. economic growth is much less than advertised. Since 2001, economic growth has been largely fueled by rapid increases in asset prices (housing bubble) and expanding consumer debt rather than spending on business investments and new income generation projects, this results in unsustainable and unhealthy growth.

• But how come the stock market is doing well? The short-term impact of the slowdown in real estate prices is to drive investors to move their money into the stock market for better returns. But as the dollar value drops and the interest rates increase, investors will move their money from stocks to bonds, gold or even to other international markets with competing currencies to avoid the depreciating dollar value. The investors are not aware of the highly inflated asset prices, especially the mortgage-backed securities promoted by Wall street as high-quality financial instruments, while in fact they are very high risk securities. Most investors base their investment on future expectations (speculation) rather than fundamental financial health.

• A careful analysis of the fundamentals of the U.S. economy shows declining manufacturing, production and business competitiveness compared to other nations in the global economy.

Economic Crisis Indicators #2: The Trend in US National Debt

• In 2000, the U.S. Government had a surplus (profit) of about $237 billion (the largest in U.S. history). In 2006, the budget deficit was about $390 billion (loss). For information on Whitehouse budget details please visit http://www.whitehouse.gov/omb/budget/fy2006/tables.html

• Although the 2006 budget deficit (loss) was only about 3% of GDP, the problem is the accumulation of losses over multiple years, hence the need for debt to finance the deficit. By the end of 2006 (over a period of 6 years), the accumulated national debt was about $8.3 trillion (the largest in U.S. history!). The U.S. Government has borrowed that money to pay for tax breaks, new Medicare drug benefits, the war in Iraq, foreign aid and other policies.

• A large national debt is bad. Why? The Government has to pay interest on the debt. As the debt and the interest payment grow, eventually all the Government can afford to do is pay the interest payments, with no money left over for other socioeconomic development investments or even critical expenditures. If uncontrolled, this could lead to states and national bankruptcy and major related socioeconomic crises.

• During the 2006 fiscal year, the U. S. Government spent $406 Billion of its budget on interest payments to the holders of the national debt. Compare that to Education at $61 Billion, and Department of Transportation at $56 Billion. When interest payments become larger than other critical socioeconomic budgets, this calls for major concern.

Economic Crisis Indicators #3 : Consumer Debt

• Consumers are the main engine of any economy, the less money the consumer has to spend or invest, the less is the economic growth. By the end of 2006, the U.S. consumer debt was about $11 trillion.

• According to the Commerce Department, the personal savings rate for 2006 was a negative 1 percent; the worst in 73 years!. This is the lowest level since the Great Depression, which could be a problem for the millions of retiring baby boomers and for the job market.

• U.S. home mortgages debt = $8.2 trillion. Due to the housing bubble in recent years, U.S. homebuyers took on more debt to buy overpriced homes, thus reducing share of disposable income. Many Americans refinanced their homes during the real-estate boom to pay for living expenses. With the expected housing bubble bust, Americans could lose a significant part of their wealth and savings.

• The slowing economy will lead many small businesses and consumers to go bankrupt. Foreseeing this, U.S. lenders have lobbied the Government to make changes to the bankruptcy laws, to make it more difficult to get rid of debt.

• The banks will suffer from huge losses and will have liquidity and credit problems resulting in additional limitations on economic activities.

Economic Crisis Indicators #4: Interest Rates

• To stop the free-fall of the housing and financial sectors the Federal Reserve will reduce the interest rates close to zero, but the continuing decline of the U.S. dollar value will force the U.S. to raise interest rates to prevent a currency crash (major devaluation in US dollar).

• The higher the debt and the interest rate, the more costly the financing will be and the less money is available for investing in economic development and business growth.

• In 2006, the average return on equity investment (stocks) was 8% while the bonds interest rate was 5%. With major financial market losses, investors will flee to more secure investments. Higher interest rates result in lower investment activities, because investors will buy gold and more secure bonds than risky stocks, thus hurting the stock market and impeding economic recovery.

Economic Crisis Indicators #5: Foreign Debt & Investment

• In early 2006, overseas investors held $13.6 trillion in U.S. stocks, bonds, real estate, businesses and other assets.

• About 40% of the U.S. public debt is owed to foreign holdings. China, Japan, the EU, Saudi Arabia and Oil Exporters are the largest creditors. They financed the U.S. economy expenditures by buying U.S. Government and corporate bonds and mortgage-backed securities. They are the United States' biggest bankers, any of which could cause the United States serious financial problems, if they so desired.

• According to the Commerce Department, the United States paid more to its foreign creditors than it took in from its overseas investments. The gap was about $2.5 billion for the last quarter - the first time that has happened in more than 90 years! (Are you noticing the negative trends in numbers?)

• For fiscal year 2006, investment flows turned negative by $7.3 billion from a surplus of $11.3 billion in 2005. It was the first time investment income has been negative on records going back to 1929. That means foreigners earned more on their US holdings than Americans earned on their overseas investments.
   

Economic Crisis Indicators #6: Balance of Trade & Global Competitiveness

• The U.S. 2005 balance of trade deficit was $723 billion. The number for 2006 is expected to be higher. In other words, foreign companies are better at competing than domestic U.S. companies. With the improvement of IT & Telecom technologies, offshoring will increase and knowledge networks will expand. In other words, the U.S. businesses will decline in international competitiveness. The United States is not the only economic superpower any more. In a global economy, the name of the game is global competition: Boeing vs. Airbus, Intel vs. AMD, GM vs. Toyota, and so on. The U.S. cannot compete with China’s low-cost manufacturing or India’s low-cost services. Several of U.S.’s largest companies such as Intel, Boeing, GM and Ford are closing local factories and laying off workers due to slowing demands and increased global competition. In 2005, the U.S. lost more than 500,000 jobs. Similar numbers are expected for 2006, higher numbers for 2007 and 2008.

• According to Commerce Department (March 15, 2007) the imbalance in the current account jumped 8.2 percent to $856.7 billion, representing a record 6.5 percent of the total economy. It marked the fifth straight year the current account deficit set a record.

Economic Crisis Indicators #7: Oil Prices

• The rapid growth of China, India and other developing countries will create major demands for oil, thus depleting the energy supply. This will result in an inevitable increase in oil prices, thus negatively impacting transportation and energy costs, raising the cost of local products and services and reducing company profits and household disposable income. Soaring energy costs, combined with negative personal savings rates create strong negative forces that impede U.S. economic growth.

• With the shortage in world supply of oil, some analysts claim that this is the main driver behind the U.S. policy towards Iraq, Sudan and Iran - that is to control as many oil supply sources as possible and pre-empt EU, China and India.

Economic Crisis Indicators #8: Dollar Exchange Rate

• In the past few years, the U.S. dollar has slipped about 40% against the Euro and other major currencies. In other words, U.S. citizen's buying power is reduced significantly. The weaker dollar causes the price of imports to rise (Wal-Mart buys about $20 billion in goods from China alone). The low-income sector has not felt the price increase because of the intervention of the Chinese Central Bank to prevent the floating of its Yuan currency. If China allows the Yuan to float freely, then the prices can increase 50% or more. Not only would the price of imports increase, but local goods will increase as well, due to the following; (1) the increased cost of imported raw material and components (2) the increased price of foreign products, will provide coverage for local producers to increase their prices, in order to make more profit.

Economic Crisis Indicators #9: Economic Confidence

• What is the U.S. economic outlook? If you compare the global economy to the stock market and the U.S. economy to a company listed on that market, then the real question is: Would you invest in a company that is losing money and increasing its debt for several years in a row? Or would you invest in one of its competitors which shows increasing market share and profit (surplus)? Granted that "USA Inc." is the largest company in the global market, but the global investors put more weight on profitable growth and performance trends than the size.

• The worst thing that could happen to an economy is the loss of confidence. If the U.S. Government does not commit to reducing federal budget deficits, control financial markets greed, and investors speculations, at some point in time foreign banks and investors could panic and rush to dump their dollars to be the first out of a sinking currency, thus making the economic crisis far worse and recovery more difficult. China has already signaled its intention to decouple the currencies, which could lead to the loss of trillions of dollars in U.S. treasury value. In order to minimize that loss, the Chinese will have to sell off some of their U.S. holdings. The real danger is how much and how fast China will do so. If they decide to do it quickly, they will prompt huge panic by other lending countries. Investors will have to copy China’s moves, resulting in a disaster to the dollar value, interest rate, stock market, homeowners and the U.S. economy as a whole.

3) The Impact of The Economic Crisis : U.S. Social Risks

• Social Security payments go in the Social Security Trust Fund. The purpose of any surplus payments to Social Security is to pay future benefits. But the U.S. Government has spent all of the money in the Social Security Fund. That's part of the national debt.

• By 2025, nearly a quarter of Americans will be over 60, a shift with huge implications for the U.S. social services budget and economy. Those baby boomers will be a major voting force and will influence Government decisions to raise taxes to support Social Security and Medicare, which will reduce individual salaries, companies' profits, investments and domestic competitiveness.

• With lower Social Security payout and higher healthcare and living costs, many seniors will have to go back to employment to support themselves, thus competing with the younger generation for the already declining number of jobs. The higher labor supply and lower demand for employees will create intense competition and increase work stress on the individual and the society. Think of the younger generations resenting the baby boomers, blaming them for a falling standard of living.

• I would not be surprised if many senior and richer U.S. citizens start emigrating to other more affordable countries, taking their savings and wealth with them so they can live there for the rest of their lives, or simply to invest in stronger economies with stronger currencies. Because of the extremely high US healthcare costs, some Americans are already traveling overseas to get treated and buying their prescriptions bills from foreign pharmacies via the internet.

• Lower federal and state budgets will result in higher cost of education, this will lead to less access to equal opportunities and will increase the socioeconomic gap.

• Think of the impact of a thinning middle-class layer and the increase in an economic distribution gap. That can result in a major social and political crises, further complicating recovery.

• The deteriorating economic conditions can stress the social fabric of the nation. Extreme socioeconomic situations are more likely to produce racial, religious and political extremism. Blaming other groups is a classic response to the times of hardship, especially when others practice a different religion or belong to another race or economic class.

4) U.S. Geopolitical Risks and The Economic Crisis

• No one disputes the right of the United States to defend itself against terrorism, however, the way it is conducting the war on terrorism is a highly controversial issue inside and outside the country. Regardless of one's positive or negative opinion of the current U.S. foreign policy, the launch of the U.S. war on Iraq with "a fabricated WMD threat report" or "bad-intelligence”, without the support of the international community, the 600 thousand Iraqi civilian casualties, the extensive infrastructure destruction in Iraq, the Abu Ghuraib torture scandal, the Haditha's civilian massacre scandal, the Iraqi sectarian war, the Guantanamo prison camp, the disregard of the Geneva Convention's agreement on torture and the treatment of prisoners of war and the ignoring of the Middle East peace process have all hurt the U.S. fight against terrorism and destroyed the American international goodwill and trust.

• The common international perception is that the Iraq war is driven primarily by the U.S. interest to control Iraqi oil resources and that the current U.S. Government foreign policy is driven by an ideology of domination and exploitation rather than peace and collaboration (regardless if it it is true or not, perception is reality). Both trust and goodwill are critical elements of productive diplomatic and business relationships. Without those elements, it is much more difficult to promote the U.S. global socioeconomic agenda and this will seriously hinder the collaboration  with foreign central banks and investors for the needed economic recovery.

• In addition to the Iraq war, the U.S. financial, political and weapon support of Israeli war on the Palestinian territories and Lebanon in 2006 have increased anti-American sentiments and fueled terrorist recruitments, thus providing more future risk to the U.S. stability and economy and increasing expenditures on security and defense. War policies take away from Government's time, effort and budget and are almost always at the expenses of socioeconomic development initiatives such as education and infrastructure development.

• The U.S. media and foreign policies are erecting major psychological and political barriers to socioeconomic exchange between the U.S. and about 1.5 billion Muslims in more than 30 countries, further fueling extremists' agenda for driving the situation into the clash of civilization, another future World War or "Armageddon" which is driven by, and hoped for, by extremist religious groups on both sides of the conflict.

• The onslaught of post 9/11 negative media toward Arab and Islamic countries is having a major impact on U.S. foreign policies and economic relations. An example is the rejection of Dubai's winning bid to manage the U.S. ports. It is worth noting that Dubai (UAE) is a moderate Arab country and a U.S. ally. As a normal psychological reaction to those policies, many of the rich Arab and oil investors are considering investing elsewhere (rather than traditional U.S. markets). Arab countries are awarding lucrative national development projects to competing European and Chinese companies. For example, the development of Sudan's oil industry is now dominated by the Chinese oil companies instead of the traditional American companies. Many of the elite and rich Arab families, tourists and businesses are going to competing European schools and economies to spend their money and build stronger investment and business partnerships.

• While the U.S. politics, army and media were busy with the Middle East hostilities, China, Russia and the EU were busy building stronger socioeconomic relations with Middle Eastern countries through joint economic development initiatives and open cultural dialogues. It is a known fact, "people do business with people they like". Why else do you think Dubai lost the U.S. port deal after they won it? Why else do you think Sudan choose China instead of the U.S. as its primary oil investor and partner? Who do you think has a better global competing strategy; the U.S. or the EU, Japan & China?

• The Palestinian-Israeli conflict and the U.S. animosity with Iran has led the Iranian Government to plan Euro-Perto Bourse in an effort to weaken U.S. dollar domination on oil trade. The new Bourse will compete with New York's Mercantile Exchange (NYMEX) and London’s International Petroleum Exchange (IPE) for international oil trades. It should be noted that both the IPE and NYMEX are owned by U.S. corporations. The IPE was bought in 2001 by a consortium that includes BP, Goldman Sachs and Morgan Stanley. In fact if there was peace in the Middle East, the Iranian nuclear energy project would actually help the U.S. economy, because it allows Iran to export more oil, thus reducing the price of oil.

• In 2005, U.S. dependency (in dollar amounts) on imported oil was half of imported manufactured goods. If the U.S. launches another war or an attack on Iran, that would most definitely lead to a sharp increase in oil prices and further risk for the U.S. economic recovery. Not to mention the ability of Iran to finance and support attacks on the U.S. anywhere in the world.

• Tensions with Russia, Iran, North Korea, Syria, Venezuela and other Latin American countries can lead to an escalation that may unify these countries to build a major force against the U.S. causing further damages.

• Except in a few isolated cases, history shows that the fight against terrorism cannot be won by military force alone. Only political solutions can result in a lasting peace. By watching how people and organizations adapt to conflicts and improve their fighting weapons and tactics, one can see that it is only a matter of time before the opponents of the United States will acquire or develop much more dangerous terrorizing weapons, such as dirty bombs (biological, chemical or nuclear). Another 9/11- scale attack or several other smaller attacks could result in major havoc on the U.S. economy and cause investors to flee to more stable business environments.

• The continuation in the current foreign policy direction may risk some creditors getting back at the United States through economic measures. That could cause major economic damage.

About the Author:
Med Jones is the President of International Institute of Management (IIM) - A U.S. based strategy think tank. Jones is recognized as one of the few economic gurus who predicted the current U.S. economic crisis. He challenged the U.S. President, Federal Reserve Chairman and the popular opinions of the world economists in January of 2007. Jones is quoted in worldwide media on the topic. He is also known as the Economic Oracle for the accuracy of his predictions. For more information about the author, please visit Med Jones Profile

CEO Q Magazine Interview