CHAPTER 2: Sunset in the West

The End of the U.S. Economic Supremacy

"What is of the greatest importance in war is extraordinary speed:
One cannot afford to neglect opportunity." - Sun Tzu

My dad was an infantry soldier during World War II. If you saw the movie Saving Private Ryan, you would have a good idea of what landing in Normandy was like for my dad and his comrades on the early morning of D-Day. Of the 550 men in Dad’s engineering battalion, only 50 were still alive after the first hour of combat. This certainly became a defining moment in the life of my dad.

Likewise for the millions of U.S. soldiers who spent World War II fighting in the Pacific, the war years were a defining experience not only in their personal lives, but for their entire generation. When Dad and his fellow soldiers came home from the war, they returned to a United States that was much stronger and more prosperous than the one they had left.

At war’s end, the United States was the world’s only remaining and functional industrial power. Europe was, for the most part, a bombed-out shell, with Germany, France, and the Soviet Union all in shambles economically. Japan, likewise, was made to pay a devastating price for initiating what the Chinese still refer to as the "War of Japanese Aggression."

Unlike Europe and Japan, however, the United States was full of shining new factories that could produce abundant quantities of industrial and consumer products with great speed and efficiency. Hence, the world’s industrial center of gravity had shifted to the United States US from Europe for the first time in history. The United States became the world’s leading economy and its primary manufacturing center. We continued to hold the position as the world’s largest economy throughout the remainder of the twentieth century and into the twenty-first.

A Tough Pill to Swallow

This will be a tough pill for many of us to swallow, but the fall of U.S. economic and military supremacy is inevitable, and will be here much sooner than most of us realize.

It has happened to every empire throughout history. In ancient times, the Persians and the Medes ruled the world. Later, the Greeks and Romans took center stage. The British Empire in the nineteenth century was the economic and military superpower that governed much of the planet. It appears, unfortunately, we are next on this list of Great Power nations to go into eclipse.

The question for investors is brutally simple:

Will we go down with the ship? Or will we seize upon new opportunities and prosper?

The simple fact is that the United States is exporting its money and its manufacturing muscle to China at a rate that is both alarming and unprecedented in this nation’s history. During 2006, the United States rang up a stunning $232.5 billion trade deficit with China. In fact, the United States is running a multibillion-dollar trade deficit with every one of its top 10 trading partners.

While the United States continues its headlong plunge into deepening trade deficits, China has been accelerating in exactly the opposite direction, ringing up unprecedented surpluses. During the first half of 2007, China's trade surplus zoomed to a record-breaking $112.5 billion. That was the first time the nation’s surplus broke through the 100-billion dollar barrier over any six-month period. While the United States' deficits grew deeper, the Chinese trade surplus had skyrocketed by 85 percent over the previous year for the month of June 2007.2 Sadly, it seems the United States is driving in reverse.

It may seem like a distant memory, but the United States was the world’s banker less than 20 years ago. It is now the world’s largest debtor nation that the world has ever seen. The U.S. debt-to-GDP ratio is a mind-boggling 400 percent.3 While Chinese wage earners save more than 30 percent of their income, the United States has descended into a negative personal savings rate. Despite their empty bank accounts, U.S. consumers continue to flock to malls and big box stores, buying cheap imports, financed by credit cards and by loans made against the evaporating equity they hold in their homes. The cyclone of volatility that rattled the world’s equity and credit markets following the United States' notorious subprime loan debacle revealed all too sharply the wobbly underpinnings of the U.S. economy.

China now holds the power. What’s more, the bulk of China’s financial power is poised directly over the United States’ economy. As I mentioned in the first chapter, China cashed in most of its foreign currency surplus by purchasing U.S. Treasury bonds until recently. In other words, China routinely accepted U.S. IOUs in return for its huge reserves of foreign exchange.

The tide began to turn when the Chinese central bank announced it would diversify its holdings into higher-yielding assets, having realized that Treasuries just didn’t pay enough interest compared to other investments. Because U.S. Treasuries are denominated in a sinking currency, the U.S. dollar, China’s returns have been depressed even further.

But China’s decision to diversify a portion of its investments is just a hint of the economic threat the United States faces. The Chinese government has the option of simply turning off the flow of credit to the United States entirely by declining to buy any more U.S. Treasuries. The result would be a sudden rise in U.S. interest rates, which would trigger a steep plunge in the value of the dollar and a bloodbath on U.S. stock markets. The net effect would be a deep recession in the United States, so deep that it might well rival the Great Depression of the twentieth century.

Would China ever pull the plug on the U.S. economy?

...would you like to read more