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.)
The risks are clear: We are a nation very dependent on future borrowing to support our current standard of living. We are also a nation dependent on sources of financing that are increasingly nervous with our future borrowing requirements. We therefore are a nation that could very easily loose access to the foreign-sourced financing we have become dependent on. In short, we are now a nation vulnerable to being forced to raise taxes dramatically or turn to the Federal Reserve to monetize our future funding needs.
As Treasury borrowing dramatically ramps up in the out years immediately ahead, the call for a new global financial regime will also ramp up. If that regime is implemented it will not be a U.S. dollar-based reserve-currency arrangement. The result will be a significant and permanent reduction in the standard of living of all American citizens almost overnight as the reserve currency role of the U.S. dollar is devalued.
Individuals can and often do go bankrupt. Sovereign nations can also go bankrupt. The bankruptcy of a nation just looks different. The beginning of the event is usually marked by a collapse of the nation's currency. What unfolds next for a country like the United States will probably be highlighted by the number 20, as in 20 percent inflation, 20 percent unemployment, and 20 percent interest rates.
The origin of this financial train wreck has more to do with politics than economics. We are a nation hooked on borrowing simply to support government-sponsored consumption. We are a nation that demonstrates every day a clear lack of political will to cure our debt addiction.
Consider: If you were a career Washington politician, which would you view as the least painful: a decision that could result in personal political suicide or a decision to procrastinate on a decision that could avoid a national economic suicide that you might be able to blame on someone else?
I think we all know the answer to the question. Consequently, there will probably be a "Thelma and Louise" moment for the U.S. dollar in the not-too-distant future.
Fred A. Kingery is a self-employed, private-equity investor in domestic and international financial markets from New Wilmington, Pa.