The Hollow Economy

The US Federal Reserve is expected to raise interest rates in the United States again today. One might look and say that's a good thing. It means that the economy has recovered nicely and they are now taking steps to level things off, right?

Not necessarily. The US economy is in a very fragile place right now. With the foreign trade deficits increasing rather alarmingly, foreign debt holdings against the US are also alarmingly large - some some two trillion dollars, and increasing on a nearly daily basis.

With the US dollar slipping in value recently against the C$, and more importantly when compared to currencies like the Euro, the US is in a nasty little place. The trade deficit is the what is keeping the US economy moving at all. (Noticed the $30 DVD players in the stores lately, not to mention the nearly cancerous expansion of Wal-Mart stores?) The US economy is currently being driven not by its manufacturing base, not by its high-tech, but by consumer spending - much fuelled by consumer debt.

The last time the US was in a place like this was the 1970s. At the time, they could increase interest rates fairly easily, thus making the dollar an attractive investment by way of government bond issues. Today, they have a much bigger problem because people have been leveraging the equity in their homes to finance all sorts of purchases - cars, home theater systems, computers and the like. Increase interest rates too much, and people won't be able to afford the mortgages on their homes. (The popping sound you hear is the housing bubble letting go)

Worse, sooner or later, the government is going to have to go to the world to finance its military spending for its lovely little wars in the Middle East. Although they could simply print more money, they can't do that for any length of time without seriously devaluing the dollar (and triggering an inflation cycle not unlike what happened in Germany around WWII - where a wheelbarrow full of Marks was required to purchase a loaf of bread). Similarly, the cost of borrowing on the world stage will be increasing quite dramatically over the coming months and years as the total amount of US foreign obligations increases.

In either case, the US is walking an increasingly delicate financial tightrope. With BushCo staging up a third war in the Middle East, the probability of a disastrous economic crunch happening on the streets in the US grows. Apply the wrong kind of pressure somewhere, and the whole house of cards will collapse.