October 9, 2009
If you've seen the movie "Thelma and Louise," you'll never forget the ending: In the last scene, the two main characters head down a dirt road in their top-down convertible. The road dead-ends at a very high cliff. The last picture of the movie shows the car in a dramatic free-fall off the cliff.
That ending is a perfect metaphor for the fate of the United States dollar. Our currency is headed for a free-fall off a cliff in the international foreign-exchange markets. Why is this almost a certainty? Consider the following:
At no other time in our nation's history has the federal government ever attempted to embark on a borrowing binge like the one about to unfold; not during the Revolutionary War, the Civil War, or even World War II.
During World War II, marketable federal-debt levels reached a record 120 percent of GDP. Almost 100 percent of the financing for borrowing came from the savings of American citizens. When the war ended, the borrowing stopped. Our country emerged from the conflict with 100 percent of our industrial-economic might intact. We were a net-creditor nation to the rest of the world, we exported more than we imported, and we enjoyed this very strong economic position with no real competition for over 25 years. Most importantly, the U.S. dollar became recognized as the one and only global reserve currency. As the U.S. economy grew, the war debt was reduced to a comfortable 35 percent of GDP.
Today, our nation faces the opposite. We are now a net-debtor nation, we run large trade deficits, we have minimal private savings, we face significant economic competition from all corners of the globe, and, most ominously, over half of our marketable federal debt is owned by foreign countries that are not particularly friendly to our nation. Thus, the global-reserve currency status of the U.S. dollar is being seriously challenged. And yet, we continue to set records with unending federal borrowing.
How did this serious challenge to the reserve-currency status of the dollar happen?
About 10 years ago, an unprecedented economic imbalance developed in the world's global trading pattern. China became the world manufacturer of first resort and the United States became the world consumer of last resort.
China, with its low-cost labor pool, became a magnet for global manufacturing. The result, after almost a decade, is that China has become a leading exporter of low-cost, quality-manufactured goods. The accumulated trade surpluses over the years have generated a cash surplus position for China of over 2000 billion U.S. dollars. Not surprisingly, the communist nation has become the single largest holder of U.S. Treasury debt outside the United States. About 800 billion of the 2000 billion cash surplus that China holds has been invested in U.S. Treasuries. The Treasury debt held by China now represents 23 percent of the 3428 billion of Treasury debt held by all non-U.S. citizens. Additionally, the 3428 billion of Treasury debt held by non-U.S. citizens now constitutes over 50 percent of all privately held marketable debt issued by the U.S. government. The 23 percent position held by China in particular, and the over 50 percent position held by non-U.S. citizens in general, represents a financial Achilles heel for the entire U.S. financial system and the reserve-currency status of the dollar.
Economic warfare against the United States is now a very real possibility. Should China and a like-minded group of other non-citizen holders of U.S. debt wish to diversify away from an excessive exposure to the U.S dollar, then our government's ability to secure financing could become seriously questioned. In addition, our ability to conduct foreign policy and military operations anywhere in the world would also have to factor in the calculus of future financing. (There is plenty of precedent for this economic warfare; the 1956 Suez Crisis is one example.)
