America's Financial Chickens Coming Home to Roost

There are moments in bubbles that afterwards everyone wonders why they weren't challenged at the time. From the Tulip Craze to 1929 to the dot.com bubble (remember Pets.Com?), there are strange happenings that seems crazy in retrospect. At this time, the bubble may turn out to be America's economic pre-eminence in the world, and we may wonder in ten years why we thought it wouldn't turn out badly.

For years, we have been shifting our manufacturing overseas, while continuing to import huge quantities of petroleum. The trade deficit should be enough to scare anyone, but the savants of Wall Street assure us that it's just an innocent sidelight to globalization, which clearly benefits the U.S. along with everyone else.

So while China and India build factories, we build bigger and bigger houses. And when they become so large and expensive that we cannot logically afford them, we get creative about mortgages. The only way that anyone could believe that this would work in the long term is by subscribing to the greater fool theory that there will always be someone ready to buy the house for enough money to justify the financing. Mathematically, it couldn't happen forever.

So rather predictably, the subprime (euphemism for junk) mortgage market has gone south and the banks need fresh capital to cover their enormous losses. Bringing us back to the first point. The sovereign funds, for which you should substitute "foreign governments," are coming to the rescue, having enormous reserves of U.S. dollars due to the trade deficit. These are the IOU's with which we've been maintaining our collective lifestyle and they are coming due. When China wanted to buy an American oil company, we were able to balk. We didn't need them. Now, we need foreign capital to keep our big financial institutions healthy and they are never going to be as American again.

It's not going to stop. The trade deficit rose again in November. Not a single presidential candidate of either party will tell the American people that they need an extra dollar or two of taxes on the price of gasoline to save the country (and perhaps Social Security) from ruin. In ten years, we'll wonder why.