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Our Currency, Your Problem
By Niall Ferguson
The New York Times Magazine
The New York Times
Sunday, March 13, 2005
http://www.nytimes.com/2005/03/13/magazine/13WWLN.html?
Every congressman knows that the United States currently runs
large "twin deficits" on its budget and current accounts.
Deficit 1, as we well know, is just the difference between federal
tax revenues and expenditures.
Deficit 2 is generally less well understood: it's the difference
between all that Americans earn from foreigners (mainly from
exports, services, and investments abroad) and all that they pay out
to foreigners (for imports, services, and loans). When a government
runs a deficit, it can tap public savings by selling bonds. But when
the economy as a whole is running a deficit -- when American
households are saving next to nothing of their disposable income --
there is no option but to borrow abroad.
There was a time when foreign investors were ready and willing to
finance the U.S. current account deficit by buying large pieces of
corporate America. But that's not the case today. Perhaps the most
amazing economic fact of our time is that between 70 and 80 percent
of the American economy's vast and continuing borrowing requirement
is being met by foreign (mainly Asian) central banks.
Let's translate that into political terms. In effect, the Bush
administration's combination of tax cuts for the Republican "base"
and a Global War on Terror is being financed with a multibillion
dollar overdraft facility at the People's Bank of China. Without
East Asia, your mortgage might well be costing you more. The toys
you buy for your kids certainly would.
Why are the Chinese monetary authorities so willing to underwrite
American profligacy? Not out of altruism. The principal reason is
that if they don't keep on buying dollars and dollar-based
securities as fast as the Federal Reserve and the U.S. Treasury can
print them, the dollar could slide substantially against the Chinese
renminbi, much as it has declined against the euro over the past
three years.
Knowing the importance of the U.S. market to their export
industries, the Chinese authorities dread such a dollar slide. The
effect would be to raise the price, and hence reduce the appeal, of
Chinese goods to American consumers -- and that includes everything
from my snowproof hiking boots to the modem on my desk. A fall in
exports would almost certainly translate into job losses in China at
a time when millions of migrants from the countryside are pouring
into the country's manufacturing sector.
So when Treasury Secretary John Snow insists that the United States
has a "strong dollar" policy, what he really means is that the
People's Republic of China has a "weak renminbi" policy. Sure, this
is bad news if you happen to be an American toy manufacturer. But
there are three good reasons that the administration is tacitly
delighted by the Asian central banks' support. Not only is it
keeping the lid on the price of American imports from Asia (a
potential source of inflationary pressure). It is also propping up
the price of U.S. Treasury bonds; this in turns depresses the yield
on those bonds, allowing the federal government to borrow at
historically very low rates of interest. Reason No. 3 is that low
long-term interest rates keep the Bush recovery jogging along.
Sadly, according to a growing number of eminent economists, this
arrangement simply cannot last. The dollar pessimists argue that the
Asian central banks are already dangerously overexposed both to the
dollar and the U.S. bond market. Sooner or later they have to get
out -- at which point the dollar could plunge relative to Asian
currencies by as much as a third or two-fifths, and U.S. interest
rates could leap upward. (When the South Korean central bank
recently appeared to indicate that it was shifting out of dollars,
there was indeed a brief run on the U.S. currency -- until the
Koreans hastily issued a denial.)
Are the pessimists right?
The U.S. current account deficit is now within sight of 6 percent of
GDP and net external debt stands at around 30 percent. The
precipitous economic history of Latin America shows that an external-
debt burden in excess of 20 percent of GDP is dangerous.
Yet there is one key difference between the United States and the
countries south of the Rio Grande. Latin American economies have
trouble with their foreign debts because those debts are denominated
in foreign currency. By contrast, the United States' external
liabilities are almost entirely denominated in its own currency.
It therefore makes more sense to compare the United States with
other members of that exclusive club of countries that have
produced -- and hence been able to borrow -- in international
currencies. The most obvious analogy that springs to mind is the
United Kingdom 60 years ago.
During the Second World War, Britain financed its wartime deficits
partly by borrowing substantial amounts of sterling from the
colonies and dominions within her empire. And yet by the mid-1950s
these very substantial debts had largely disappeared. Unfortunately,
this was partly because the value of sterling itself fell
significantly. Moreover, sterling's decline and fall did not reduce
the U.K.'s chronic trade deficit, least of all with respect to
manufacturing. On the contrary, British industry declined in tandem
with the pound's status as a global currency. And, needless to say,
the decline of sterling coincided with Britain's decline as an
empire.
From an American perspective, all this might seem to suggest
worrying parallels. Could our own obligations to foreigners presage
not just devaluation but also industrial and imperial decline?
Possibly. Yet there are some pretty important differences between
2005 and 1945. The United States is not in nearly as bad an economic
mess as postwar Britain, which also owed large sums in dollars to
the United States. The American empire is also in much better shape
than the British empire was back in 1945.
Even the gloomiest pessimists accept that a steep dollar
depreciation would inflict more suffering on China and other Asian
economies than on the United States. John Snow's counterpart in the
Nixon administration once told his European counterparts that "the
dollar is our currency but your problem." Snow could say the same to
Asians today. If the dollar fell by a third against the renminbi,
according to Nouriel Roubini, an economist at New York University,
the People's Bank of China could suffer a capital loss equivalent to
10 percent of China's gross domestic product. For that reason alone,
the PBOC has every reason to carry on printing renminbi in order to
buy dollars.
Though neither side wants to admit it, today's Sino-American
economic relationship has an imperial character. Empires, remember,
traditionally collect "tributes" from subject peoples. That is how
their costs -- in terms of blood and treasure -- can best be
justified to the populace back in the imperial capital.
Today's "tribute" is effectively paid to the American empire by
China and other East Asian economies in the form of underpriced
exports and low-interest, high-risk loans.
How long can the Chinese go on financing America's twin deficits?
The answer may be a lot longer than the dollar pessimists expect.
After all, this form of tribute is much less humiliating than those
exacted by the last Anglophone empire, which occupied China's best
ports and took over the country's customs system (partly in order to
flood the country with Indian opium). There was no obvious upside to
that arrangement for the Chinese; the growth rate of per capita GDP
was probably negative in that era, compared with 8 or 9 percent a
year since 1990.
Meanwhile, the United States may be discovering what the British
found in their imperial heyday. If you are a truly powerful empire,
you can borrow a lot of money at surprisingly reasonable rates.
Today's deficits are in fact dwarfed in relative terms by the
amounts the British borrowed to finance their Global War on (French)
Terror between 1793 and 1815. Yet British long-term rates in that
era averaged just 4.77 percent, and the pound's exchange rate was
restored to its prewar level within a few years of peace.
It is only when your power wanes -- as the British learned after
1945 -- that owing a fortune in your own currency becomes a real
problem. As opposed, that is, to someone else's problem.
--------------
Niall Ferguson is professor of history at Harvard and author
of "Colossus: The Price of America's Empire."
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