Very few have predicted the kind of funk that the U.S. economy would slip into 18 months ago. Even the Oracle of Omaha, Warren Buffett, missed the warning signs of the panic and chaos that ensued when financial derivatives unraveled onto credit and financial systems. However, what Buffett did predict was the downward pressure on the U.S. dollar. He knew that importing, more than exporting, would eventually force the dollar to weaken. Two winters ago, he said, “Force-feeding a couple of billion a day to the rest of the world is inconsistent with a stable dollar.”
Many Americans think a weak dollar is good for a number of reasons. Particularly vocal are the exporters, who get to sell more stuff that is now cheaper on international markets, potentially resulting in a lower U.S. trade deficit. Of course, to make it really work, it would have to be selling less of Wal-Mart and more of Boeing. Better yet, even China has hinted that it might play into this “strategy,” if it could be called such, by allowing the yuan to increase against the greenback.
Undoubtedly, a higher yuan is bound to please the hard-hit manufacturing sector that has had a beef with China and its policy of controlling the yuan at great cost to workers in developed countries for quite some time. However, there are two sides to every calculation and those cheering the dollar’s fall are forgetting the flip side of its relationship with the trade deficit.
It is a simple, yet scary equation. The more Americans trading their wealth for goods and services manufactured and offered outside the country’s borders, the greater the risks of putting the country on the chopping block. During the first three quarters of 2009, the U.S. spent approximately $275 billion more on imports than it received in income from exports. Keeping such an imbalance between imports and exports year after year, decade after decade, cannot help but result with a huge pile of claims and IOUs against the U.S., the majority of which are held by China. According to some estimates, China is holding a Mount Everest of dollar bills and other foreign currencies, likely totaling a whopping $2.0 trillion.
Over the years, China has presented itself as the “kind foreigner,” lending quite a few of that $2.0 trillion back to the U.S., just so that the latter could keep its lights on when things got really dark during the Great Recession. However, even China is bound to tire of getting the low-yielding T-Bills in return for its kindness from a country suffering under high deficits and donning a weak currency. That is not a description of a good investment, even if its guarantor is a country such as the United States. Sooner or later — more likely sooner — China and other kind foreigners are very likely to start asking for something more in the way of returns.
These higher returns may come in the form of higher interest rates, which also mean decreasing economic growth rates. Alternatively, foreign lenders may seek to trade some of their U.S. dollar holdings for ownership in prime U.S. companies. This is not something we should put by China, because it has tried it before. For example, in 2005, one of China’s state-controlled oil companies has tried to take over Union Oil Company of California (a.k.a. Unocal), but had to give it up after being met with a towering wall of political outrage.
In 2009, however, the U.S. has much less moral and political credit to block such takeovers from happening, especially if China appears to be playing along by increasing the yuan and keeping certain Congressmen from manufacturing states happy. Besides, there are plenty of battered investors out there, too, who would want nothing better than to collect the takeover premiums, tender their shares and never think about them again. There is a long list of U.S. large-caps that have given virtually nothing to their investors over the past decade, so selling them off to the Chinese would mean to many nothing more than good riddance.
Eighteen months ago, Warren Buffett said that, “The truth is we’re selling America to the rest of the world. It’s just a question of in what form we sell it to them.” Everything else being equal, it seems to me that selloff is likely to come in the form of foreign acquisition and, considering how fast the dollar is sinking, the time for foreign ownership might come sooner, rather than later.