Government policies and actions often have inadvertent side effects and these are made even more worse in an interconnected world where actions taken in Beijing can have an immediate effect on Americans at home. The USA has enjoyed a place second to none since WWII and the advantages this brings to Americans are universally taken for granted. One prime example, is the dollar's place as the world's reserve currency. This makes dollars attractive to foreigners especially for a country that continually must borrow from foreigners to pay for government deficits and the US foreign trade deficit. However, the dollar itself has no intrinsic value other than the strength of the country it represents and its status as the world's reserve currency is a result of its relative stability.
Changes in tax policy towards interest and dividend distributions and capital gains forced changes in the way Americans thought of investments in general, investments that were needed to be properly placed to put the United States on a path of sustainable growth and not boom and bust cycles.
It is often lamented in the media that Americans save almost nothing and merely spend, spend , it is not often pointed out that it is difficult to achieve REAL savings in bank deposits, money market accounts and especially any taxable investment. Real in this case means after tax and after inflation are taken into account in the current tax environment. In the late 90s and the 00s the Federal reserve forced interest rates very low, in some cases negative in real inflation adjusted terms. The government turned a blind eye to the fact that much of these "returns" were illusory and taxed them again. First inflation, the governments stealth tax would get savers and then the IRS. It's a wonder that anyone would save in a mere savings account. Even with high rate of return in a money market of say 5% would be whacked at the marginal tax rate of say 30% and then rendered less than the rate of inflation. So the real effect is a negative rate of return on many of these "investments". Much as people do in a hyperinflation condition, sometimes its best to spend the money before it can be shrunk or taken by the IRS.
Dividends are also singled out in the tax code for double taxation as businesses which really are owned by the shareholders are taxed with business taxes and then the owners of the business are taxed again when they receive their dividends. As a result many companies ceased to offer significant dividends and focused instead on growth; companies including Microsoft and many other TECH companies followed these practices. Dividends were in fact looked upon with disparagement.
US government policies would in fact discourage savings and investment, yet people found ways to better their conditions with any tool at their disposal. Some would call this greed, but deferring immediate spending by saving for the future should be looked as a virtue instead of the vice that the tax code treats it. Instead the advantages of the home mortgage deduction caused many people to look at their homes as investment vehicles and not as a mere place of residence. After the real estate slow down in the late 80s during the 90s they started to steadily improve. More and more money started to flow to up scaling and building homes. Favorable tax treatment made this look better and better as it became the conventional wisdom that "home prices always go up". Meanwhile, companies pursued a growth mantra where actual profits did not matter as everything would be achieved by growth. Capital gains were taxed at the point of sale and hence the jack boot of government could not suppress growth of assets until the profits were actually received. To further these capital gains taxes were lowered to speed this development along.
During the Clinton years this growth oriented stock market resulted in another boom time as technology and outcome stocks took off. Large sums of money poured into the stock market by people seeking real return on investment. Internet ventures selling pet food, Crispy Cream Donuts, Telecom Stocks all had a tremendous run ups resulting in huge taxable gains for the federal government. Most of these companies had little real revenue but showed much anticipated growth and growth versus solid business fundamentals as was formerly exhibited by good earnings and dividends. As employees pocketed big bonuses and stockholders cashed out the government found a windfall fall into their hands, a revenue completely unexpected by the revenue authorities at CBO and Treasury. While Clinton was hamstrung from funding new programs by the Republicans, the money was flowing in from the stock market. The federal budget actually came into a balance. This balance was itself less than it appeared as this balance took into account Social Security inflows which were already pledged to retirees. Instead this money was spent.
What matters most to a country is its relative economic prosperity. It is this relative prosperity that determines its share of the world output of and from there its military and industrial potential are achieved. The rest of the world was not sitting idle while the United States squandered its advantages.
Economically the United States faced new challenges as Asian countries started to make striking advances. First Japan in the 1980s went on to take over much of the electronics industry and semiconductor fabrication in particular. The Chinese and Indians were also rising up from Communism and socialism and each had particular advantages. The Indians had many people that could speak fluent English, quickly call center jobs moved to India, followed by programming jobs and higher and higher technical services. Legal research, readings of X-rays and MRIs by skilled radiologists in the US could also be done conveniently using the Internet. Anything that could be done remotely with someone with good English skills could be done in India.
China a country with a workforce larger than the US, Europe and Japan put together was determined to regain its rightful place in the world, and especially to become the dominant power in Asia. They also rightfully wanted to provide a better life for their people many of who were in a state of poverty far below the normal experience of a western country. Starting slowly and moving steadily up the value chain they succeeded in putting large number of rural peasants into manufacturing jobs. Many Chinese would attend US universities, work in the USA and later return to China as conditions improved.
The Chinese presented the west with a large untapped, virgin marketplace. However, in order to gain access to this market foreign companies were made to jump many hoops, including creating research centers and building manufacturing plants in China. Western countries made large transfers of intellectual capital to China in the hope of sharing this bounty. The Chinese want to learn the technology, build products for themselves and not merely buy foreign goods. As noted by Pliny the Younger in ancient Rome, the Chinese do not want any of our products, they take only our gold and are only willing to buy some stained glass! Not much has changed over the centuries.
While the US would be dogmatic in pursing its free trade agenda, China would pursue an old mercantilist one at our expense, protecting even insignificant segments of their workforce from competition (like Chinese cartoonists!). The government has put in place mechanisms to limit foreign penetration and impede Chinese from purchasing foreign products. To achieve this they have created elaborate mechanisms to maintain the growth of their economy and to prevent it from overheating despite the dollar inflow.
When an American company purchases Chinese products the dollars that are received by a Chinese company they must by law be given to the Bank of China and exchanged for Renminbi the Chinese currency at an offically set exchange rate. The Chinese government takes these dollars and invests them through a single government agency frequently in US Treasury securities and other foreign investments. These Renminbi injected into the Chinese economy would tend to increase the money supply and lead to inflation, raising prices and making Chinese goods less attractive. Instead the Chinese government sops up this money by selling sterilization bonds much of this money so as to keep Chinese price levels low. (Note the same term "sterilization" which was pursued by the US Federal Reserve in the 1920s). Furthermore they maintain a strict exchange ratio with the dollar so that this unstable situation can continue. Chinese are not tempted to buy US products with their dollars as they are immediately sequestered.
The result of this merry go round is the Chinese import dollars, and sell products to us, they then take these dollars and inject them back into the US to finance both its federal budget deficit and the current account deficit. Goods flow pretty much one way, we only export dollars. Relatively poor Chinese are in effect forced to pay for Americans living beyond their means. They at least hope these foreign "investments" will pay off and at least not decline in value. Recent events have shown this to be a rather dubious position.
China's sudden arrival on the economic map of the world has caused a great deal of turmoil. It is as if a country that never existed before just popped into existence. Such cases are rare in the world for example Germany after its unification under Bismark. In this case the relatively poor Chinese pricing structure made their labor so much less expensive that those in the developed world and without environmental laws or the need to provide their workers benefits such as health care they had an even greater advantage. As a result in this new "flat world" the manufacturing jobs moved to China. The Chinese people learned from their western teachers and were not content to merely be the workers at foreign owned firms. New companies such as Huawei,Lenovo pointed the direction - direct competition on America's home turf. Western countries labor force was priced out of the market and with time these levels would have to adjust. As jobs hemorrhage in the US and flow to China wages in China will go up while American wages stagnate or in real terms decline until balance is achieved. This phenomenon is not a new one as its been observed even the ancient world. Skilled artisans in ancient Greece could no more compete with the slave labor of Ptolemaic Egypt any more than we can against labor rates in China that seem almost as cheap. Unfortunately, Migrating to the Danube basin is a less an option for us.
The US military has had fits as its suppliers move all their production offshore, as fewer and fewer people take up engineering in the US while the Chinese seem intend on producing millions of them. In the 80s and 90s the Department of Defense approached this problem by requiring domestic content of much of what they ordered. Integrated circuits, flat panel displays were required to come from a US supplier or a supplier that could contract with a foreign one to build the product in the United States. This lead to all sorts of problems as the very high manufacturing volume is what in fact drove productivity and quality up while driving costs down. The relatively low volume military purchases were barely enough to prime a production line. Whereas in earlier years the electronics industry was heavily influenced greatly by the buying requirement of DoD it was not firmly attached to commercial developments, and these were not in the USA but in Asia.
Intellectual capital was also flowing overseas as even many defense contractors moved programming jobs to India. Claiming the design conception and specification would remain in the USA and only the "mere" coding steps would be outsource much of this work went to India. American know how was being replaced by American know nothingness. Americans flowed into other fields as engineering and programming became a ticket to the next reduction in force. Instead they pursued other fields such as finance became an even bigger part of the US economy. When technology workers were needed is was both cheaper and in some cases easier to import them from overseas, especially from India on an H1B visa. Americans lower education standards made US graduates look less appealing. Even our most elite students from Stanford or MTI are regularly waxed in foreign technology competition.
From the perspective of a military strategist these are frightening developments. While most high technology manufacturing is now done in Asia and the US is dependant on foreign supplies of energy the US is very unprepared if something should happen to disrupt the world order. Most of the motherboard and many semiconductor plant are located coincidentally in Taiwan, the supposedly renegade provence of China which Chinese leaders want very much to bring to heel. The hallmark of the American military has been based on good engineering, technical advantage and raw power. These are clearly slipping away.
Now as economic conditions improve in China they are finally free to pursue their Fourth Modernization, that of their military. With a large Diaspora of US educated students returning to enjoy the Chinese resurgence, access to western technology and skilled work force the Chinese are ramping up a new navy not just outfitted to defense but to project power in their immediate neighborhood. Another potential flash point exist with the Japanese for access to disputed territory with oil and natural gas resources. A stronger Chinese navy gives politicians in Tokyo and navy men in Annapolis nightmares.
The US aircraft carrier battle groups are the main means of projecting US power around the world. The Chinese are working on submarine technology to neutralize them and to throw us back across the Pacific if the need arose. They now routinely shadow these battle groups and gain more familiarity with them, much as the Russians have done over the years. The US is also heavily reliant on satellites for communication and to guide munitions to target. The Chinese demonstrated quite ably their technical prowess in shooting down these satellites.
If any great power conflict came into being, the US would more closely resemble Great Britain facing the Nazi submarine wolf packs. Britain almost starved. Dependent for everything but food, this would not resemble our WWII experience. The Chinese also hold a set of cards more significant that any in the Furher's hand - a huge amount of US assets that can be dumped in the market in a "nuclear option". The Chinese have already threatened to use the nuclear option if they are not happy with US policies. Nor are they happy with the poor state of their investments which they entrusted to us and we have blown. With the US is dependent for operating cash from the Chinese over a billion dollars a day, we must gradually take Chinese concerns into consideration in whatever we do. Our freedom of action is limited by our reliance as a nation on the Chinese dole. The day is coming when permission from China may be required before embarking on any new programs, must like it did in the days of the Sun Emperor.
While many American politicians talk with boldness and a can do attitude, repeating platitudes about the our greatness and how we won the Second World War this country is in a different position now than in 1941. We are no longer either self sufficient, we are no longer technically superior and we are in a weak financial condition in hock to potential adversaries and facing exploding costs from government programs that are on a course to explode. And, the current crop of candidates are all offering us more goodies!
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