Heavy foreign investment signals a vote of confidence, not a loss of autonomy, as the U.S. celebrates the 4th of July
America celebrates its Declaration of Independence from Britain on July 4th. These sentences from the document forged in Philadelphia in 1776 still rank among the most stirring words ever written in a political text: "We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty, and the pursuit of Happiness. That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed." Of course, the nation has often fallen far short of the social and political revolution announced by the founding fathers. It took a brutal civil war to end slavery and federal troops to topple Jim Crow. The battles between farmers and the moneyed interests, capital and labor, were long and often violent. Nevertheless, after 56 democratically held Presidential elections, it's fair to say that America's political revolution has been remarkably durable and successful. Question is, is America losing its economic independence 234 years later? And if so, does declining economic independence threaten the nation's hard-fought political gains? "How Empires Decline"
The reasons for worry are apparent and abundant. The most prominent revolve around the federal government's $13 trillion in debt. Foreigners now hold more than half of the Treasury bond market and almost a fifth of the corporate debt market, according to Paul Warnock, professor at the Darden Business School at the University of Virginia. China alone is an investor in some $900 billion in Treasuries. There are widespread fears that China now possesses an economic stranglehold over the U.S. American companies have hollowed out their country's manufacturing base, shifting much of their assembly lines into cheaper regions of the globe, especially China. The necktie class is losing jobs to outsourced service-sector employment, most notably to India. Taken altogether, a growing number of commentators foresee an empire in decline, brought down by too much debt, too much consumption, and too little production. "This is how empires decline," writes Harvard University historian Niall Ferguson, perhaps the most erudite of the declinists. "It begins with a debt explosion. It ends with an inexorable reduction in the resources available for the Army, Navy, and Air Force." There's no gainsaying that the risk is there. The long-term budget deficit and debt projections are on an unsustainable path. In that sense, the alarms are a healthy response. But the operative word is "long-term," and they have less relevance when the unemployment rate is at 9.5 percent and only 590,000 private-sector jobs have been created over the past six months. What's more, there's a mountain of difference between dependence on another nation that comes from weakness—a colony, say, that makes a living selling natural resources—and that which comes from strength, where the ties reflect gains from commerce. At the moment the global capital markets are comfortable making a big bet that America isn't losing economic independence or political resilience—or becoming a colony of China. For instance, as investors flee the debt of such countries as Greece and Spain, which they fear won't be able to meet their obligations, they're flocking to U.S. Treasury notes. That has driven the yield on 10-year Treasuries to a mere 2.9 percent. The rate has come down from the 4 percent level reached in April. China's Leverage
For another, the dollar is reasserting its value as the global economy's main currency. It's the euro that's crumbling instead. As for the Chinese government, it may have some theoretical ability to blackmail the U.S. government, but in reality its room for maneuver is extremely limited. Playing the Treasury card would lead to an enormous loss in wealth and trade. If China dumped its Treasuries in a pique, it would drive down the value of its remaining Treasury holdings, sink the dollar's value, and mostly likely put the U.S. into a recession—hardly a good way to sell Chinese products in America. "I am less concerned that any one particular country holds a disproportionate amount of our debt," says V.V. Chari, economist at the University of Minnesota and the Federal Reserve Bank of Minneapolis. "It's not clear that they really have bargaining power." It's even more important to realize that debates over economic independence are far from new. We've been here many times before. The most recent telling example is the fear over the rise of Japan in the 1980s. Its export-oriented companies shattered many of their U.S. competitors. Eventually Japan Inc. seemed to dominate everything from steel to computer-memory chips. Japanese titans of industry and finance shook American confidence by snapping up U.S. golf courses and trophy office buildings. The U.S. budget deficit was enormous, too. When author James Fallows shared a beer in a Japanese bar with an English friend in 1986, his friend said, "Why don't you just face the fact that you're second-raters, like us?" The pressure to embrace an America First policy was enormous. Yet with the benefit of hindsight it's apparent that behind the trauma American companies learned from the competition. They restructured their operations and embraced technological innovations. And on the policy side, the advocates of opening up even more to trade and welcoming immigrants triumphed. It's no coincidence that the economy enjoyed a powerful growth spurt in the 1990s and the federal budget was in surplus by 1998. Low Tariffs, or High?
It's a story that echoes throughout our history, including a famous fight among the founding fathers that is worth remembering on the Fourth of July weekend. "We were politically independent," says Douglas Irwin, professor at Dartmouth College. "But how economically self-sufficient should we be is a debate that has divided us since the first Washington Administration." A fierce battle was fought between Treasury Secretary Alexander Hamilton and Secretary of State Thomas Jefferson and his Congressional ally James Madison during the Washington Administration. It was an arcane dispute over tariffs. Import tariffs were critical to funding government expenditures and public debt, and Hamilton wanted to keep tariffs modest and nondiscriminatory. Jefferson and Madison were eager to hike tariffs to get rid of the public debt and to commercially discriminate against Britain. They strongly believed that the U.S. had achieved its political independence but that it was too reliant on Britain for capital and trade. Free trade may be the right philosophical stance, but they believed mercantilism was the practical choice in the real world, says Irwin. They wanted greater economic independence, not more interdependence. (You can read about this fascinating chapter in U.S. history in Professor Irwin's section of the book, Founding Choices: American Economic Policy in the 1790s. Hamilton won. And although the nominal amount of public debt didn't decline, it did come down from some 30 percent of gross domestic product in the early 1790s to a bit more than 10 percent by 1815. Since the Washington Administration, fights over economic independence have revolved around trade (buy from foreigners or make it ourselves?), finance (rely on foreign borrowing or domestic capital?), and immigration (let people in or keep them out?). But the fact is that America operates in a global economy, and its economic abundance is tied to other nations. "So independence really means healthy, robust, resilient interdependence," says Professor Ronald Jepperson, professor of political science at the University of Tulsa. Adds V.V. Chari, economist at the University of Minnesota: "At the end of the day most people think about it as the same as self-reliance for a household." In practice, this means it's politically imperative to put the public debt and national deficit on a downward trajectory once the economic downturn is well past and job growth is again robust. These actions will give us greater self-sufficiency and freedom of movement. It will also encourage investors to snap up Treasury notes, making it easier to bring our fiscal house in order. Yet let's also remember the wisdom of Hamilton and embrace open borders and foreign capital and entrepreneurial immigrants. Hamilton wrote in a 1791 letter to his rival Thomas Jefferson: "My commercial system turns very much on giving free course to Trade and cultivating good humour with all the world." The words aren't as eloquent as Jefferson's opening statements in the Declaration of Independence. But it's a perspective that experience shows has been essential to the struggle of living up to the glorious ambitions of that document.