At last count, the United States owes the rest of the world over two trillion dollars. That’s two thousand billion dollars, a lot of money even for the late Senator Everett Dirksen. As recently as the 1970’s, America was the major creditor nation, lending money overseas and investing its dollars abroad. We were exporting food, airplanes, technology and even consumer goods. In those days, the total of all imports to and exports from the US to the rest of the world amounted to slightly less than 12% of its GDP. And almost half of that was trade between the US and Canada and Mexico.
But no more. Over the past 3 decades, the US has bought far more goods than it has sold. And those goods now are sold to America from factories in China, the far east and South America, as well as massive amounts of oil from Venezuela and the other OPEC countries. The current monthly balance of trade deficit is running at about $58 billion. China alone reports to have over $1 trillion in US money in its coffers. And our total foreign trade has risen to above a quarter of our adjusted GDP.
So, this is really bad for the US, right? Not necessarily. At least not in the short-term and perhaps not even in the long term. Here’s the reasoning.
China, and the other exporters to the US, have been willing to play the role of a modern Mercantilist — as if the defunct Mercantile system of the 17th century was somehow still alive. (see Wikipedia for a good definition of Mercantilism and why it failed.) But mercantilism was based on seizing a positive balance-of-trade (one exports more than one imports), tariff protectionism, and the accumulation of foreign lucre in the form of real money, i.e. gold bullion. In these post-Bretton Woods (floating currencies), post-1971 (Nixon cancels dollar convertibility; no more gold standard) and post WTO-treaty (no tariff or price-fixing) days, none of this applies.
So, China and Saudi Arabia continue to ship real wealth into the United States in the form of plasma TV’s, baby toys, seafood and energy, and in return accept pieces of paper called dollars. More usually, of course, they take electronic computer notations entered onto the electronic books of central banks. The result is that the rest of the world has been massively subsidizing the standard of living of American citizens so that they could keep their own factories and plants working — and citizens from overthrowing their often despotic regimes.
Now the problem becomes, what do these foreign countries do with this mountain of US dollar-dominated electronic IOU’s?
Ultimately, popular wisdom says they have to return them back to the United States — where they can spend them on buying goods and services here.
Well, they’ve already done that.
But the US dollar accounts for 67% of the world’s reserve currency, and the US economy, with 5% of the world’s population, represents over 1/3rd of the world’s GDP. Suddenly bringing back all of those dollars to the US would be a tough go here. Inflation would soar and import prices would go through the roof as these extra dollars flooded the domestic market. The dollar, of course, would immediately fall, making our exports far cheaper to buy abroad — if there were any buyers left.
But it would be a disaster overseas. Country after country would collapse into depression as hundreds of millions of workers would suddenly find their factories no longer able to export profitably to US consumers.
So let’s pretend you are the central banker in charge of China today. What can you do with your trillion dollars right now? First, you can buy lots of US T-bills from the American treasury. Fortunately, now that the US Government needs to fund its half-trillion dollar deficit created by fighting the Iraq war, you can once again buy 30-year treasury notes. But their yield is terrible: under 5% right now, and perhaps headed lower.
Being a prudent banker (lest you be shot) you only buy several hundred billion dollars worth of T-bills. Of course, you keep several hundred billion dollars in your electronic vault to use as “reserves” to back the several hundred billion Renminbi (the “people’s currency”) you’ve printed to pay for all those new domestic factories and high-rise Shanghai condos the developers are building.
Next, you start buying commodities on the world’s markets. Fortunately, all the commodities you want happen to be denominated in dollars on the world’s commodity exchanges. Great! So you buy concrete, steel, aluminum, oil, gold and silver. The prices shoot up but you’ve been able to get rid of another several hundred billion dollars. Then you start buying American companies like seaports (Long Beach), computer manufacturers (IBM PC Division) and oil companies (Conoco) — whoops — that last one is deemed “strategic” by the US government and they won’t let you do it.
Then you slowly allow your currency to move upwards viz-a-viz the US dollar — it’s undervalued at least 58% per the Economist’s Big Mac standard so as not to scare the US markets.
Next, you convert your dollar hoard into Yen, Euros, Pounds and Swiss Francs. Again very slowly so as to let the air out of the US dollar very gradually. The UK £ breaks $2 to 1 and the € jumps to almost $1.40 but the world goes on.
Finally, you start investing in the US and global stock markets. Through your subsidiary pension funds (which are much less transparent than your central bank holdings) and the world’s private hedge funds (such as Blackstone) you start buying public equities and corporate debt. The stock markets explode in growth as a result.
Problem. What do you do with the next trillion dollars you make over the next 10 years?
Suggestion: buy sub-par US mortgage debt. There will be a lot on the table for sale. And since ultimately you really can’t spend all those dollars outside of the US forever, eventually you’ll have to buy “Made-in-the-USA” goods and services. At least that’s how the theory goes.
Either that or face the consequences: the world needs the US a lot more than the US appears to need the world. If it has to, the US treasury could limit the overseas dollar repatriation at any time. Even France made the Franc unconvertible in the early 1980’s. After all, only 22% of total US GDP is foreign trade, and a third of that is with Canada and Mexico — and they’re safely inside the NAFTA free-trade zone. Rest assured that this “nuclear option” contingency has been well simulated at the Treasury.
The best solution? Keep all of those dollars safely tucked at home, and use them as reserves to print more Yuan/Renminbi. That way we all inflate world-wide at the same Fed-controlled rate, just like our banks do here inside the US. Giving up your central bank sovereignty to the US Federal Reserve Bank is better than losing your head! All the world’s currencies have become fiat currencies anyway, backed only by the “full faith and credit” of their respective governments. Of course I could be wrong.