from Follow the Money

Selling off little pieces of yourself

June 29, 2005

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If the US wanted to fund its current account deficit by selling equity, it would need to sell off the equivalent of 40 Unocal’s a year -- whether Chinese state firms, European firms, Japanese insurers or Saudi princes. That is a lot. But a $800 billion current account deficit is -- as I consistently try to note -- really, really enormous (among other things, the 2005 US current account deficit will be about the size of 2005 US goods exports).

Peter Schiff does the math in a slightly different way. To raise $800 billion, the US would not need to sell off the Dow’s crown jewels. ExxonMobil and GE are safe. But the US would need to sell off a solid chunk of industrial America, and a few big global brands too.

... These three deals, totaling $21.55 billion, are just drops in an enormous bucket. This year alone America’s current account deficit is likely to be $800 billion. To put this number in its proper perspective, $800 billion is equal to the combined market capitalization of the following fifteen Dow Jones companies: Alcoa, American Express, Boeing, Caterpillar, Coca-Cola, DuPont, General Motors, Hewlett-Packard, Home Depot, Honeywell, 3M, McDonalds, Merck, SBC Communications, and Walt Disney.

In other words, to finance just one year’s purchases of consumer electronics, granite counter-tops, vacations, automobiles, furniture, appliances, clothing, toys, and net interest and dividend payments, Americans will basically give away the equivalent of half of the companies that comprise the Dow Jones Industrial Average.

Warren Buffet agrees

Having China bid for U.S. companies such as Unocal ``is an inevitable consequence of what we are doing in trade,’’ billionaire investor Warren Buffett said in an interview on CNBC. American purchases of Chinese shoes, furniture and textiles, give the Chinese dollars that they can spend, he said.

``Sometimes, they buy our government bonds, as their central bank has done, but other times they are going to buy our assets. If we are going to consume more than we produce, we have to expect to give away a little bit of the country,’’ Buffett said.

That’s right, but with one qualification. Since so many of Unocal’s assets are abroad, we in the US are not so much selling off bits of ourselves as selling off our existing overseas assets -- specifically, ownership of gas fields and pipelines in Thailand and Indonesia, along with some Unocal assets in central Asia.

(Thanks to Calculated Risk, MC3 and others who participated in the comments section of previous posts for the links)

The also US sells a bit of itself when its sells debt to finance our current consumption, not just when it sells equity. Debt, of course, does not carry with it any explicit "control" -- and, as connoisseurs of the sovereign debt literature know, debt does not become equity when a sovereign defaults. The Bank of Japan or the People’s Bank of China will never formally take over the management of the US economy. That is not the way the world works: Argentina made its own monetary policy choices while it was in default. More important, there is no realistic risk the US will default, if for no other reason than it can erode the real value of long-term Treasuries and Agencies held overseas too easily in other ways.

But that does not mean that rising US external debt does not carry with it some risks -- including the risk that future US economic policy would have to be directed less at internal balance and more at pleasing US external creditors (See DeLong). Think what would happen if the United States’ foreign bankers started to demand much higher interest rates to rollover their existing claims absent a change in US fiscal policy, for example. That is not direct control, but there was a reason why James Carville thought the bond market was so powerful early in the Clinton Administration.

By taking out so much debt now, debt that will have to be rolled over for a very long time -- the US is betting that the tides won’t turn. If the money now rolling in (the global savings glut) ever threatened to roll out, or just not roll in at the current pace, selling so much debt every year might seem a bit less innocuous than it does now.

One of the side effects of the attempted purchase of Unocal by CNOOC -- a bid that may offer too small a margin over Chevron’s bid to be worth the hassle -- is renewed attention to the fact that, be it by selling debt or equity, the US has to give up its existing assets or pledge to transfer its future income abroad to finance its current consumption. Future tax revenues (treasury bonds), future mortgage interest payments (mortgage backed securities/ Agencies) and future corporate profits are all being sold off to finance the United States current consumption binge.

The scale of the debt the US is now taking on -- or the scale of assets that the US would have to sell to avoid taking on debt -- strikes at least me as a real national security issue, even if you agree with Sebastian Mallaby, and think that the sale of Unocal’s Asian assets is not.

The importance of the Chinese government in American financial markets is not news to Agency and mortgage backed security traders. But CNOOC’s bid for Unocal certainly makes the Chinese government’s growing presence in US financial markets more visible. That is bound to make many people -- not just Paul Krugman -- a bit uneasy.

On the other hand, China’s presence in US markets is the almost inevitably consequence of a "stable disequilbrium" that is based on the purchase of $250 billion plus of external assets -- be they Treasuries or oil companies -- by the government of China and various Chinese firms, whether state-run or not.

More on CNOOC in my next post.

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