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A Temporary Band-Aid, Not a Fix

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On August 31, 2007 the United States crossed a historic fiscal milestone, or millstone, as the national debt topped $9 trillion, according to the Bureau of the Public Debt, prompting Congress to again raise the federal debt ceiling. The interest alone paid in 2006 on this prodigious sum, which has ballooned nearly 60% since 2000, was more than $400 billion.

There are several factors driving up the national debt, but the main culprit appears to be a compulsive borrow-and-spend mentality that has turned the world’s wealthiest nation into the world’s biggest debtor. To pay for this imbalance with its trading partners, the U.S. absorbs close to three-quarters of the net savings generated by the world’s exporting countries. In total, foreigners hold about 25% of the U.S. debt.

American assets have become attractively affordable to foreigners flush with cash, and lately there are indications that the huge dollar holdings held by China, Japan, and major oil producers are translating into notable acquisitions in many areas of the U.S. economy.

Increasingly, the vehicle for this investing is the sovereign wealth fund (SWF). Set up by foreign governments to more productively invest their surplus capital, these prodigious investment pools now encompass an estimated $2.5 trillion. In this latest wave of foreign investment, Asian and Middle Eastern governments are taking significant stakes in financial institutions–a cornerstone of the U.S. economy.

In the wake of the subprime mortgage debacle, big American financial institutions have come under increasing pressure to shore up their deteriorating balance sheets and the SWFs have been only too willing to lend a helping hand, though their significant positions in Blackstone Group, Citigroup, and Merrill Lynch have also had the effect of diluting the stakes of existing shareholders.

This has raised some economic and political concerns, in part because the strategies, governance, and portfolios of the funds are largely opaque and because, as state-controlled entities, their decisions may potentially be driven by non-economic factors.

For now the SWFs are providing a welcome, and needed, dose of liquidity at a time when the U.S. economy is undergoing a period of slowing growth and financial markets are experiencing distress. A recent study by the International Monetary Fund concluded that SWFs could enhance market liquidity and the efficient allocation of financial resources, serving to dampen asset price volatility and lowering liquidity risk.

While SWFs are providing some relief today, that money does not represent a structural solution for the problems created by America’s gargantuan appetite for debt. One of those problems is the enfeebled dollar, which is stoking inflation by, among other things, making the cost of energy a much more critical factor in family budgets. A weak dollar makes it easier for foreigners to buy American assets. Then there is the fast-approaching retirement of the baby boomers and escalating healthcare costs.

Fixing, or even alleviating, this situation will require consensus, discipline, and sacrifice, elements that have hitherto eluded the country’s political leadership. The U.S. economy remains a marvel of resilience and productivity, but the burgeoning obligations of the nation’s unprecedented debt load threaten to undermine the very foundation of that economy. At this point, only two things are certain. We are living in very interesting times and there isn’t a moment to lose.

Steven Rog?(C), CMFC

Portfolio Manager

R.W. Rog?(C) & Company

Bohemia, New York


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