An Analogy

Back in January of 2005 the following was posted to a message board on the Motley Fool:

Why is it, exactly, that a trade deficit is bad? What is it, exactly, that is bad about China, Japan, the pope, the Duke of Edinborough, or the man on the moon buying US assets, or government debt?

I responded with an analogy:

"You used to own your home, free and clear, and even had some investment income (net foreign investment surplus). You had a decent income (GDP) and were living the good life.

Then you began living beyond your means, buying high priced toys that you couldn't really afford (trade gap) and taking expensive vacations (government deficit spending on military misadventures). You started drawing down your retirement savings (raiding the SS trust fund). You took out a mortgage on your house (foreign investment in US assets).

Pretty soon, your disposable income was starting to feel the pinch because instead of investment income coming in, you had interest payments going out. Nevertheless, you didn't want to decrease your standard of living, so you increased your rate of borrowing. You refinanced the mortgage with an ARM (selling shorter term treasuries at suppressed rates) to pay for a vacation in the middle east, and took out a home equity loan and spent it on more toys (selling mortgage backed securities to foreigners). Then you started maxing out your credit cards (selling high-yield corporate bonds to foreigners).

(This is where we stand right now. Continue the analogy forward, to see what happens next.)

As your total debt grew, your disposable income shrank. It became much harder to find people willing to loan you money (dollar crashes, trade gap shrinks). Your standard of living dropped like a rock. No more toys, no more vacations, and all your income went to paying for essentials and interest payments. Then rates went up on your ARM (nobody buying treasuries), and you started missing payments on the home equity loans (Fannie Mae collapses). You declared bankruptcy to erase the credit card debt (corporate bankruptcies) finally you reached the point where nobody was willing to lend you more cash (deflationary spiral).

You lost your car and house (foreign ownership of everything worth owning), and the stress broke up your marriage (civil unrest). You lost your job (depression), and are left living under a bridge and waiting in soup lines for your daily meal."