The Love-Hate Relationship between the U.S. Dollar and America’s Creditors

The Financial World According to Inya” Column by Inya Ivkovic, MA

For what it is worth, America’s creditors and debt-holders are anything but passive. They used to be a rather pliable bunch, but not anymore. In fact, some of the largest holders of assets denominated in U.S. dollars are fast-growing, emerging economies that are no longer insecure in the presence of the so-called developed economies. Quite the contrary, they are loud and clear in their criticism of U.S. foreign and trade policies, especially after the Great Recession has done a number on America’s international role, political influence and economic reputation.

China alone currently holds about $2.3 trillion in foreign exchange reserves. Approximately $800 billion consists of Treasuries issued by the U.S. government. At a press conference last year, China’s Premier Wen Jiabao had no problem publicly expressing concerns about the large amount and the security of capital lent to the U.S. Meaning, when a country’s main creditor is worried, the debtor should be, too.

The global economy and all parts of its sum are deeply intertwined; we are not alone spinning along with the planet. This implies that whatever goes on in our backyard will inevitably have consequences on international stages. It also means that our leverage is not what it once was. Our economy is weak, our debt monstrous and our deficit unsustainable, which is why we need to be attentive to thoughts and concerns of our creditors, particularly when they talk about the value of the U.S. currency, because our dependence on their help is great and not likely to be eliminated anytime soon, if ever.

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History teaches that a currency is unseated on the world stage first gradually, then suddenly. For example, although the U.S. economy unseated Britain’s economic dominance in the late 19th century, it took another six decades for the U.S. dollar to supplant the British pound, and it only did so after the latter had nearly gone bankrupt after WWII had ended.

Furthermore, although we are supposed to be in the first and gradual phase of the dollar’s decline, there are many currency market observers who are worried that time might not be on the greenback’s side this time around. For starters, emerging markets already constitute about 50% of the world’s GDP and their share keeps on increasing, and rapidly at that. In 2003, Goldman Sachs, for example, forecasted that China’s economy would surpass the U.S. by 2040. In 2008, the bank revised its forecast, cutting down the clock to 2027. Perhaps another revision will be made soon, considering that economists expect China to supersede Japan as the second largest economy in the world this year.

How could this be happening? Simply, developed economies are overextended and too dependable on foreign creditors. We sold our independence for “stuff,” and now there is hell to pay, starting with the rapid and far-reaching devaluation of the U.S. dollar.

Making things worse is the fact that the U.S. keeps living beyond its means, as if no lessons were learned from the financial and credit crisis. Recently, a spike in borrowing and spending has indicated that U.S. indebtedness is again in a strong upward momentum.

In the short term, the U.S. dollar is a sought-after commodity. Because of the dollar being in high demand, the costs of borrowing in the U.S. remain low. As long as this balance between the supply and demand is maintained, the U.S. government will be able to finance its domestic agendas, as well as its international military commitments.

Unfortunately, this also means that the U.S. borrows and pays its debts in foreign currencies, which explains why there is so little political and other will to resuscitate the dollar and develop effective protective policies.

Instead, easy money has created a Goliath of the deficit that, even if larger than life, David cannot defeat. The likelihood of this failure is precisely what worries foreign creditors and keeps them awake at night. Everyone’s kindness has its limits and our “kind foreigners” just might have reached the end of their rope.