The US Predicament Grows

It is time for the overseas lenders who continue to provide the financial heroin that keeps the United States addicted to ever-increasing foreign funds to pull the plug. Stop the flow of money into the US. It is time to pull the plug, or suffer the consequences. It doesn’t appear it is going to happen, unfortunately. Sunday, U.S. Secretary of State Hillary Rodham Clinton, during her visit to China, asked China to continue investing in the United States because the two countries' financial futures are closely tied together, and China has largely agreed to doing just that.

A look at what is going on in Congress will tell why. With millions of United States homeowners now struggling to repay money they clearly never should have borrowed, the country’s leaders have been righteously wagging fingers at predatory lenders who allegedly enticed innocent borrowers, and the country, into a financial snake pit. While the mortgage industry clearly deserves a good share of the blame, unindicted co-conspirators abound. The ringleaders are still at large and are, in fact, busy hatching a plan to dwarf the earlier mistakes. It is a plan that risks trouble not just for the United States but the world because it is crucial if the US economy, the world’s biggest, continues to flag, its ability to tow the rest of the world with it, will founder.

Contrary to the message bouncing off the marble walls of the US Capitol in Washington, DC, most borrowers in the inflating housing bubble clearly understood the terms of their loans. Most knew that they could not afford their mortgage payments once their teaser rates expired, but enthusiastically jumped into the debt pool anyway, believing that guaranteed real estate appreciation, or a quick and profitable sale, would keep them afloat.

Although both lenders and borrowers were acting in their own perceived self-interest, what can we say of our economic policymakers who are expected to protect the good of all? Their actions encouraged the whole sad circus. Were it not for the excessively low interest rates provided by the US Federal Reserve, the lax lending standards and moral hazards supplied by Congress courtesy of Freddie, Fannie, and the FHA and the many real estate subsidies built into the tax code, none of these predatory loans would have been possible.

Had lenders exercised better judgment and had borrowers avoided overly burdensome debt loads, both parties would clearly be in better financial positions today. Instead, as borrowers were demanding the credit to fuel their dreams of instant real estate riches, lenders were being ordered to accommodate them.

In past generations, homebuyers were required to save for down payments and postpone their purchases until they could actually afford conventional 30-year fixed mortgages. But in recent years, as home ownership became a matter of public policy, the government accused lenders of discrimination and urged lower standards and easier terms. With government guarantees in place, the mortgage industry was happy to both expand their revenues and promote a better society.


But by denying credit, even if it requires borrowers to forgo something they clearly want, lenders not only provide a valuable service to borrowers, but to society. Given the mess in which we now find ourselves due to the bad loans made during the real estate bubble, this lesson should have been well learned. Unfortunately it hasn't, as the same dynamic is now playing out on a much larger scale.

Faced with a prospect of downgrading its lifestyle, the US government is instead borrowing trillions of dollars to artificially inflate its deflating bubble economy. The money is being used to both expand the size of government and finance additional consumer spending. Given the increasingly frightening US financial position, this is the exact opposite of what it should be doing.

America’s global creditors are now making the same mistakes made by subprime mortgage lenders. They are loaning the country money that it will never be able to repay. In the process, they are enabling the largest expansion in the size of government since the New Deal and crippling an economy already suffering from excess consumption.

Although it may sound harsh, it would be far better for all involved if all of America’s foreign friends simply cut the country off. Since their loans are merely fueling the growth of the US government and artificially pumping up consumer spending, their savings will not only be lost but their sacrifice will severely exacerbate the US’s problems as well.

Just as homebuyers did earlier in this decade, the US government will borrow as much money as the world is foolish enough to lend, and it will use those funds to smother the life out of the economy. At this point the government is growing like a cancer, feeding mainly off the funds it borrows from abroad. In the process, it is placing a horrific debt burden on its people, committing them to either a lifetime of crippling interest payments or run-away inflation.

There is nothing inherently wrong with foreign lending. If funding were directed toward private business to enable capital investments, the loans would not only benefit lenders, but they would benefit our nation as well. The funds would fortify the country’s industrial base and provide the necessary foundation upon which to rebuild a viable economy.

If foreigners were to cut the US off, there would be some immediate pain, but tough love is exactly what the country needs right now. Forcing Americans to live within their means, particularly the US government, will be just as beneficial to the long-term health of the economy as similar restraint would have been had it been exercised by mortgage lenders. It's too bad so few of seem capable of making this connection, or learning anything from the mistakes of the past – even when the ink in the history books has barely dried.

Peter D. Schiff ( is president of Euro Pacific Capital, Inc of Darien, Connecticut, USA. He publishes the free, on-line investment newsletter