As Ben Bernanke took over the Federal Reserve chairmanship from Alan Greenspan, American newspapers speculated on whether he would continue the policies of his predecessor. Depending on who's talking, Greenspan's 18-year tenure was either brilliantly executed or exceptionally lucky.
He may have guided the US economy through a stock market crash in 1987, emerging market problems in the 1990s and then dot-com boom and bust, but looming behind it all is the Asian question. To what extent has Greenspan depended on the goodwill of Asian central bankers, not least China's, in indulgently buying hitherto-low-yielding dollar treasury bonds?
Putting it bluntly, the still-expanding economy and lowest unemployment rate for over four years that Greenspan leaves as his immediate legacy have come at a price: the US is collectively and individually steeped in unprecedented levels of debt. Indeed, the timing of Greenspan's departure may be fortuitous: Bernanke has taken over just as all the accumulating instabilities appear ready to reach a critical mass and take their toll on the American, and the global, economy.
Symbiosis in action
The US-China economic relationship – which ever more imbalanced trade flows have pushed into a key role in this precarious situation – is a symbiotic one. China's purchases of dollar assets have depended on the voracious demands of American consumers, which have in turn been fuelled by low interest rates made possible by those very purchases. Now, many American financiers and economists worry that those same Asian currency flows are playing havoc with the real estate market.
Debt is a powerful instrument – as Greenspan himself observed last June. "I think we've learned very early on in economic history that debt in modest quantities does enhance the rate of growth of an economy," he said. "It does create higher standards of living, but in excess, creates very serious problems."
By the end of that quarter, US households' debt hit a record US$11.4 trillion after shooting up at the fastest rate since 1985, while they spent a record 13.75% of their disposable income on debt service. Greenspan did no more about it than he did when he noted the "irrational exuberance" of the stock market in the run up to its collapse.
Last year, 69% of Americans owned their own homes, and thus had inflating home equity to add to the endless stream of credit offers arriving in their mailboxes daily. In fact, the Federal Reserve says that home equity withdrawal hit no less than 7% of GDP in 2005, with around half of that spent on vacations, cars and a wide variety of other consumer items.
At the World Economic Forum in Davos in January, hedge fund wizard George Soros warned that in 2007, when home prices stop appreciating, consumers are going to have to crank up their saving. He predicts that the consequent fall in consumption will cause a recession. "US consumption is such an important motor of the world economy that I don't quite see what can take its place," Soros said.
Almost as a sideshow to these eulogies on the US economy, Davos saw American treasury officials furiously trying to suppress delegates' fears about Asian governments redirecting their growing currency reserves away from dollar instruments. Having mortgaged the rug on which it stands, the last thing the US needs is for China and Japan's central bankers to drag said rug from beneath its feet by abandoning the treasury bond market.