I’ve been trying to figure out what’s up with the economy these days. That ain’t easy, because you can’t look at America alone any more; you’ve got to look at the whole world. Fortunately, the good people at The Economist magazine in London enjoy looking at the whole world, and thus they publish some rather thoughtful articles about it. After reading some “big picture” articles over the last few days, I thought I’d offer my own thoughts about where America might be heading – i.e., are we going to be richer or poorer in the future? (And if richer, just how evenly is the wealth going to be spread?).

I’ve been alive for over 50 years now, and things were much simpler when I was young. Back then, America made most of what it used; grew most of what it ate or wore; and mined most of the minerals and oil and gas that it needed. And it did all of that right here on American soil. We didn’t think much about the “service economy” back then, but there still was one, e.g. lawyers, doctors, entertainers, retailers, bankers, educators, etc. But again, it was all-American.

Today, by contrast, we are much more integrated into the world economy. We depend on factories in Brazil and China and Germany to make most of what we use, and we import about half of the oil and gas that we need to keep us powered up. We still grow most of our own food and much of our own wood and clothing fibers (cotton, wool), although other countries can now do that cheaper (and are thus doing more of it for us as time goes by). A lot of minerals and metals like iron ore and copper now come mostly from other countries. Even some of our services are now coming from India or the Ukraine, via “outsourcing”. For an old timer like me, it’s kind of scary to be so dependent on other peoples and other lands for the basic things that we need in our everyday life, e.g. toothbrushes, shirts, telephones, autos, bedding, paper, tools, appliances, etc. If these other countries and peoples didn’t want to sell to us, we’d be sunk. So just what do we do to earn our keep these days? What do we have that they want out there in India and Japan and Oman?

America still provides the world economy with a whole lot of stuff. We still manufacture a lot of specialized products, e.g high-tech weapons and cutting-edge pharmaceuticals, which other nations aren’t set up for. And we still export some agricultural products and certain minerals (including coal). But most of what we provide to the world these days is “service oriented”. E.g., they know we are good at banking, financing, insurance, education (we still have the best universities, now filled ironically with foreign students), scientific research (still have the best laboratories), computer programs (e.g., Microsoft’s Windows operating suite and Office applications), entertainment (they still love our movies and pop music), management and engineering services, etc.

So we’ve now become dependent on the world at large, but so what? It all seems to be working. Despite an occasional loony dictator with an anti-American agenda (like Hugo Chavez in Venezuela who doesn’t want to sell us oil), most foreign leaders and business people know that if they don’t trade with us, they’ll go down too. People tend not to do stupid things when there’s money at stake.

The problem is, America seems to be buying more from the world then they buy from us. Our trade deficit seems to get worse and worse every year. According to the Economist, Americans spend over $700 billion more than they produce each year, the equivalent of 6% of our economy’s output. How do we do that? As with any family living beyond its means, we borrow. So far, the rest of the world seems perfectly willing to keep loaning us money, since our consumption habits help fuel their own economies. But you know this can’t go on forever.

Oh, another problem — most of what we sell the world these days requires brains. In a lot of ways that’s good; but we don’t seem to be putting enough effort into helping our youth to develop world-class minds. Other countries are doing much better in terms of getting their kids thru engineering schools and business degree programs. America still seems to be cranking out way too many lawyers and literature professors, while India and Ireland and China are nurturing scientists and engineers and entrepreneurs.

When I got out of high school, I went to engineering school for about $200 a semester, with maybe another $50 for books. In today’s money, that would be around $1,000 — even the cheapest state schools now charge much more than that. Back in the 60s and early 70s, the federal and state governments gave huge subsidies to the higher education system. They considered it to be an investment in the future. That investment paid off in the high-tech economic boom of the 1990s. But since the 1980s, government support for colleges has been cut way back, and tuitions have gone way up. Kids from poor and working class families in America can’t afford to get college degrees like they used to. American colleges stay in business by finding wealthy foreign students to take the place of the sons and daughters of the American working class. What is wrong with this picture?

And a further problem — the brainy economy is making things worse for the poor. Kids growing up in Appalachia and the inner city ghettos and Midwestern rust-belt towns are pretty much shut out from the high tech world. The worsening distribution of income here in the USA (rich clearly getting richer, poor clearly getting poorer, middle class clearly shrinking) is definitely tied to this. If the trend continues, with maybe 1/3 of America living well in the international economy and the other 2/3 stuck with stagnation at best and despair at worst, you wonder if social unrest will eventually rear its ugly head.

At present, interest rates in the USA are low because foreigners don’t seem to invest on their home turf. There are plenty of good things to invest in out in the developing world, but America has a much more stable legal and financial system. Plenty of good investment projects in South America and East Asia (e.g. factories, mines, shipping ports, roadways) went bust over the past 20 or 30 years, not because they weren’t working out economically, but because of politics. Here in the USA, the politics are also dirty, but there are more protections against greedy leaders getting their hands on economic wealth (Russia being an extreme counterexample).

As a result of interest rates being low (and having been low for almost two decades now), housing values are very high in the US. The lower the mortgage rate, the more house you can theoretically buy. However, you can’t really buy more, as prices go up. So if you’re a young couple looking for your first home, things are worse than ever. However, if you already own a house, you believe that things are swell. So swell that you stop saving and spend all of your paycheck. American businesses likewise aren’t investing as much as they used to, and thus more money is available to takeover other companies, or to pay higher dividends. This helps to support stock prices, which in turn promotes consumer spending.

For now, this crazy mechanism all seems to work. But in the long run, America is going to have to pay off its borrowings with interest. Had it used the borrowed money to invest in better physical infrastructure and better education for its youth and more efficient industrial facilities, it would experience enough GNP growth to comfortably meet these debts and still improve income levels. However, it hasn’t done that; it seems to be letting its capital, both tangible (e.g., production machinery, computers, Interstate highways, research laboratories) and intangible (accumulated knowledge held by scientists, engineers, management
experts, patents, etc.) run down, just so that it can keep spending today. In other words, it is spending its past wealth to live well, while forgoing the investments needed to live even better (or just as well) tomorrow. At the same time, China and India are investing in education and in facilities very heavily.

At present, the American economy is still very robust. Even $65 a barrel oil and $3 a gallon gasoline and some disastrous hurricanes don’t seem to be slowing it down very much. But everything has its limit. During the 1990s, a whole lot of wealth accumulated in America, as computers and technology finally kicked in to improve business efficiency while creating all sorts of new opportunities. Much of that wealth is still with us. Unfortunately, most of it did not go into cheaper education or improved roads and subways or new scientific discoveries or more efficient factories and warehouses; instead it went into inflated stock prices, bigger automobiles, and bigger houses. Now we’re seeing what a bad idea that was as stock prices stagnate and fuel prices skyrocket. There is a savior technology coming over the horizon: hybrid autos, which get fantastic miles-per-gallon. However, that technology did not come from Detroit; it was engineered for consumer use in Japan by Toyota and Honda. Obviously, the Detroit automakers were too busy building huge SUVs in the 1990s and weren’t interested in investing in R&D; for hybrids.

Various economists are warning of a huge interest rate jump that will be triggered when foreign governments stop buying US securities, followed by a rapid deflation of the housing “bubble”, triggering a severe recession and an escalating unemployment rate. I don’t think that scenario necessarily has to happen (although the danger is certainly present). But if the current trends and policies (or lack thereof) continue over the next decade, I do see America falling behind in terms of wealth and strength throughout the 21st Century. Or even worse, 2/3 of America will be locked into long-term decline, while 1/3 will continue to get richer. At some point, the unlucky two-thirds might start resenting the talented third.

The couple living next door to me has three kids; one who is 5, one is 3, and one is 2 (a cute little girl). Unless some kind of unexpected techno-economic miracle comes along that lifts all boats (e.g., if cold fusion can actually can be made to work), or a new wave of leadership emerges which encourages sacrifice today to finance investment in tomorrow, I don’t want to imagine the America that these kids will face in their adult years. As with Rome in the 6th Century or Constantinople in the 15th Century, it may not be a very exciting — or safe — place to be.