American Consumers are Losing their Crown

With the US Dollar Index breaking decisively below its long-term support level, the sun is finally setting on the golden age of American consumption, just as it begins to rise on Asia. As America’s economic dominance fades, so too will the faith in the central thesis that has explained its apparent success and has shaped the majority of recent economic theory.

At issue is the belief that a nation can grow and prosper by borrowing from abroad in order to consume imported goods. To consume at the pace that it has, America exchanges income-producing assets such as companies or property, or interest bearing IOUs such as Treasury notes or mortgage-backed bonds, for foreign-made clothes, toys and electronics. Economists call these transactions “growth”. But rather than discovering a new path to prosperity, America has simply stumbled on a shortcut to financial ruin, and in doing so appears likely to pass the leadership of the global economy to Asia, and particularly China.

For years America has convinced the emerging market countries that their prosperity is a function of our consumption, which has led, for instance, to a first-half 2007 trade deficit with China of $176.6 billion in imports against only $35.3 billion in exports, much of which is for processing by US-linked companies and re-export. It is argued that export-oriented economies would falter if not for the insatiable American willingness to consume (a “virtue” that is assumed to be uniquely American). As the dollar falls into the abyss, this myth will be shattered.

My forecast is that over the next two to three years the US dollar index will fall to 40; half of its current value. As this happens, much of America’s economic power will be transferred abroad. The chart below approximates current per capita US dollar GDP for 30 nations, including the United States, listed in descending order.

Luxembourg

91,926.63

Norway

76,447.78

Ireland

57,163.07

Switzerland

54,466.77

Iceland

53,532.47

United States

46,085.15

Sweden

44,454.36

Netherlands

42,762.96

United Kingdom

41,959.85

Canada

41,347.87

Australia

37,981.52

France

37,416.55

Germany

36,779.14

United Arab Emirates

36,180.87

Japan

36,021.22

Singapore

32,082.02

Spain

31,726.55

New Zealand

24,511.95

Greece

24,030.41

Israel

20,510.55

Portugal

19,287.51

Saudi Arabia

16,612.16

Poland

9,214.27

Chile

8,335.70

Russia

8,183.02

Mexico

7,755.69

Argentina

6,548.80

Venezuela

6,393.99

Brazil

5,518.21

Peru

3,328.55

A 50 percent decline in the value of the dollar will simultaneously increase interest rates, consumer prices and unemployment in the United States, while causing stock and real estate prices to fall. Consumption, which accounts for better than 70 percent of US GDP, should collapse as a result, producing a significant recession. My forecast is that US GDP will contract by at least 20 percent. (The Fed may seek to mitigate the nominal decline with expansive monetary policy, but such moves will only result in an even greater contraction in real GDP.)

Assuming a 50 percent decline in the value of the dollar and a 20 percent fall in US GDP, the chart would now look something like this:

Luxembourg

183,853.25

Norway

152,895.56

Ireland

114,326.14

Switzerland

108,933.54

Iceland

107,064.94

Sweden

88,908.73

Netherlands

85,525.93

United Kingdom

83,919.70

Canada

82,695.74

Australia

75,963.04

France

74,833.10

Germany

73,558.27

United Arab Emirates

72,361.73

Japan

72,042.44

Singapore

64,164.05

Spain

63,453.11

New Zealand

49,023.91

Greece

48,060.83

Israel

41,021.10

Portugal

38,575.02

United States

36,868.12

Saudi Arabia

33,224.32

Chile

16,671.40

Russia

16,366.03

Mexico

15,511.38

Argentina

13,097.61

Venezuela

12,787.97

Brazil

11,036.41

Peru

6,657.09

Obviously, these projections are very rough. Not all foreign currencies will rise in step and not all foreign GDPs will remain constant at today’s levels in local currencies. However it is the concept that is important. Notice how America falls from 6th place to 21st. America’s per capita GDP falls from 58 percent of Luxemburg’s, the top nation on the list, to a mere 20 percent. America’s per capita GDP falls from 14 times that of Peru, the lowest nation on the list, to only 5.6 times.

China is conspicuously absent from the list. Its current per capita GDP is only about $2,200. However, were China to allow its currency to float freely, my belief is that the yuan would rise far more significantly than other currencies. I have no idea how much more significantly that rise will be, but let us assume that its rise against the dollar would be double the rate of the typical currency in the Dollar Index. That would result in China’s per capita GDP rising to $8,800, just above Peru’s but still below Brazil’s.

Factoring in China’s enormous population means that such a significant rise in its per capita GDP would have a profound impact on global consumption. Consider the following table, in billions of US dollars, of the GDPs of the G-7 nations plus China:

United States

13,928.462

Japan

4,599.358

Germany

3,036.853

China

2,871.019

United Kingdom

2,552.655

France

2,370.843

Italy

1,949.878

Canada

1,357.073

Now consider the table with my assumptions regarding exchange rates and a 20 percent decline in US GDP.

China

11,484.08

United States

11,142.77

Japan

9,198.72

Germany

6,073.71

United Kingdom

5,105.31

France

4,741.69

Italy

3,899.76

Canada

2,714.15

Under this scenario, China supplants the United States as the world’s largest economy, not in 30 or 40 years as is commonly believed, but perhaps as soon as before the end of this decade. The US retains its lead over Japan for second place, yet the margin declines from over 300 percent to just 10 percent. (My prediction is that the yen will rise more significantly than most other currencies meaning that Japan’s GDP will likely surpass US GDP as well.) Further, the GDP of the 13 nations sharing the euro is currently about US$12.8 trillion. After the dollar’s decline it will rise to a staggering US$25.6 trillion, more than twice that of the US. As a result, considering the EU as a single nation, the US economy would then rank fourth among the world’s largest, with its GDP declining from 43 percent of world GDP to only 21 percent.

Current ideology holds that a recession in the United States as severe as the one I am forecasting would be catastrophic for the global economy. But this short-sighted view overlooks the effects of such tremendous dollar gains in the GDPs of the rest of the world. Wouldn’t the increased consumption of everyone else offset the effects of the decreased consumption of Americans? It is not as if factories around the world would shut down if Americans stopped spending. All that would change would be the nationality of the buyers.

As American consumer spending declines, foreign spending will rise to take its place. With an explosion in foreign purchasing power, consumers around the world will see the dollar values of their incomes and savings soar. Globally, goods will fall in price and consumers around the world will snap up the bargains. Goods that were formerly out of reach for many foreign consumers will now be affordable. The reverse will occur in America. As production is diverted away from poorer Americans to more affluent foreigners, consumer prices in America will rise sharply. Goods that Americans used to easily “afford” will now be out of reach.

As gold surpasses $700 per ounce, oil tops $80 per barrel, and wheat prices exceed $9 per bushel, Americans are already getting a taste of things to come. Prices for these and other commodities are rising as a direct result of the weakness in the dollar. As this weakness intensifies in the months ahead, commodity price increases will accelerate. However, as their own currencies rise, many foreign buyers will actually experience price decreases. The result will be even greater demand for commodities from abroad just as domestic demand subsides.

Further, as the world stops exporting so much of its savings to America, there will be far more capital available to foreign entrepreneurs to invest productively. Think of the crowding out effect of so much of the world’s savings being lent to American consumers. Now imagine the foreign investment boom that would follow as foreigners reclaim access to their own savings.

The American propensity to consume is not a unique talent. Any nation can emulate it so long as it finds willing lenders and suppliers. Production on the other hand is an entirely different matter. It requires free markets, limited government, the rule of law, savings, capital and hard work. The world economy will not be brought to its knees simply because Americans stop consuming. Rather it is America’s service sector economy that will collapse once the rest of the world stops propping it up.

Peter Schiff is President of Euro Pacific Capital, Inc. in Darien, Connecticut.