The printing machine

Has Yale historian Paul Kennedy been watching I.O.U.S.A? For someone who chronicles The Rise and Fall of the Great Powers for a living, he doesn’t often dwell on such comparatively mundane matters as the federal deficit — unless, perhaps, it hinges on America’s future as a Great Power.

That’s what he does in a forecast for 2009 in The Wall Street Journal.

As Ivy League celebrity historians of empire go, the sober Kennedy is a lot more my speed than the Kiplingesque Niall Ferguson, imploring America to take up the White Man’s Burden. And whereas Ferguson has painted a scenario for 2009 that might be described as the mother of all soft landings, Kennedy has a rather more sober, or sobering, outlook.

Presumably Kennedy penned his piece before the news on Tuesday that the federal deficit for the first three months of fiscal 2009 exceeds all of 2008’s. But he saw the writing on the wall: “I have never, in 40 years of reading into the economics of the Great Powers, seen the figures moved so often, and in such vast proportions. Clearly, some people do believe that Washington is simply a printing machine.” Worse, he worries Team Obama will shovel the money out the door willy-nilly; in other words, not only will nonexistent money be spent, it will be spent foolishly. And even worse still…

The third thing I’m really scared about is that we’ll likely have very little money ourselves to pay for the Treasury bonds that are going to be issued, in tens of billions each month, in the years ahead. Sure, some investment firms, bruised by their irrational exuberance for equities and commodities, will take up a certain amount of Treasury issues even at a ridiculously low (or no) rate of return. But that will not cover an estimated budget deficit of $1.2 trillion in 2009.

And in response to the argument (advanced by Ferguson, among others) that foreigners will snap up that paper in a heartbeat, Kennedy sees this state of dependence on foreign investors looking more and more like the “state of international indebtedness we historians associate with the reigns of Philip II of Spain and Louis XIV of France — attractive propositions at first, then steadily losing glamour.”

Do people really think that China can buy and buy when its investments here have already been hurt, and its government can see the enormous need to invest in its own economy? If a miracle happened, and China bought most of the $1.2 trillion from us, what would our state of dependency be then? We could be looking at as large a shift in the world’s financial balances as that which occurred between the British Empire and the United States between 1941 and 1945. Is everybody happy at that? Yet if foreigners show little appetite for U.S. bonds, we will soon have to push interest rates up.

And while rising powers like China and India are still growing (if slowing), they’re not stuck with the burden of, in Kennedy’s delicious phrase of 20 years ago, “imperial overstretch.”

As I suggested at that time, a strong person, balanced and muscular, can carry an impressively heavy backpack uphill for a long while. But if that person is losing strength (economic problems), and the weight of the burden remains heavy or even increases (the Bush doctrine), and the terrain becomes more difficult (rise of new Great Powers, international terrorism, failed states), then the once-strong hiker begins to slow and stumble. That is precisely when nimbler, less heavily burdened walkers get closer, draw abreast, and perhaps move ahead.

If the politicians won’t exercise fiscal restraint, it’s essential to implement an investment strategy that will profit from the actions they take. Here’s one possibility to consider before Inauguration Day next Tuesday.