In high school, I wrote a paper on the controversy over the Second Bank of the United States, c. 1830. I was recently reminded of it listening to Ed Schultz, a leftish talk radio host. He was going on about the horrors of U.S. external debt. After listing how many billions were held by various countries, he suggested that if a few of those countries decided they didn't like our policies on global warming or foreign affairs, we would be in deep trouble. They could call in their loans, U.S. interest rates would shoot up, and the average American homeowner would suddenly find he was paying much more for his mortgage or car loan than he expected (summary by memory, details probably wrong, basic argument I believe accurate).
There are two things wrong with this argument. The first is that the U.S. government borrows on a world capital market, and capital is fungible. If South Korea gets mad at us and South Koreans insist on cashing in U.S. treasury securities as they come due, refusing to buy any more, and investing in Japan instead, that frees up capital that would otherwise have been invested by someone else in Japan—which can then be used to buy the next issue of T-Bills. If the South Koreans decide, for some odd reason, not to invest anywhere at all, that decreases the world supply of capital by a tiny fraction of the total and pushes up world interest rates, not several fold as Mr Schultz seems to imagine, but by a minuscule amount.
Much the same mistake is made by those who explain the Iraq War as an attempt by the U.S. to make sure it can get enough oil. Oil, too, is a fungible commodity with a world market. Middle Eastern countries that depend on oil revenue are unlikely to stop pumping and selling it, whoever runs them. If Iraq decides to sell to France instead of to the U.S., that frees up whatever oil France would otherwise have bought for our use.
The second mistake was pointed out, as best I recall from my high school researches, by Daniel Webster c. 1832. Then as now, there were vocal worries about foreigners owning too much of America. Webster pointed out that foreign investment meant, not that they had our stuff, but that we had their money. If push came to shove, if foreign governments tried to pressure the U.S. by threatening to withdraw their citizens' investments, we could keep it—refuse to pay back the debt. Their capital, after all, in the form of canals and the first railroads, was immovably located under our jurisidiction.
7 comments:
It's true that the world market is for fungible capital, but that doesn't mean that damage can't be done to us. In particular, the US government is borrowing money by selling bonds -- those bonds are worth something exactly to the extent that the US has a good international credit rating.
If Japan (who owns 30% of our debt) or China (currently investing the most) decides to divest, it's not just that the current money supply will fluctuate, but rather that US t-bills will be seen as a riskier proposition. It's as if our credit rating was lowered, which means that we would have to offer more favorable terms (i.e. higher interest rates), which leads to all those negative outcomes.
Many modern markets are heavily affected by the biggest investor, the "market maker". If the market maker decides that the investment needs to take a dive, they can pretty easily make it happen at least for a little while. This rarely happens because it's not the in the market maker's best interest, generally -- they're a big investor! But we're now in the position of having China and Japan be the market makers for US t-bills, which is worrisome to the extent that they may choose to do something to the market based on externalities, like some internal national goal.
I think people are right to be a bit worried that China could decide to screw us financially. The good thing is that it hurts them as well. The more intertwined our economies get, the larger the disincentive they will have. So we're moving in the right direction, at least.
Insofar as people usually conflate public debt and the trade deficit, I am always amused at the idea that we are sending rectangular, green pieces of paper to them, they are sending cars to us, and somebody is finding something to complain about this arrangement from our perspective. You seem to have proposed that foreign investment here is a similar puzzle: they are sending rectangular, multicolored pieces of paper to us, letting us keep the buildings, and someone is finding something wrong with this from our perspective.
"If Japan (who owns 30% of our debt) or China (currently investing the most) decides to divest, it's not just that the current money supply will fluctuate, but rather that US t-bills will be seen as a riskier proposition."
To begin with, Japan and China aren't people and can't "decide to divest." It isn't the Japanese government that owns that fraction of our debt, it's individual Japanese and firms.
It's true that if something makes foreign investors decide that T-bills are risky, the interest rate paid by the U.S. government will go up. But that fails to fit Ed Schultz's scenario in two different ways.
First, he was thinking in terms of foreign governments trying to put pressure on us because they didn't like our policies, not of foreign investors observing U.S. behavior and deciding T-bills were a risky investment. In his case, where the reason country X has decided not to let its citizens hold U.S. securities is political, other investors will see that as an opportunity, not a warning.
Second, he was talking about the effect on the interest rates paid by ordinary citizens. But foreigners deciding that T-Bills are risky doesn't have much to do with that--it just means that the U.S. government would stop being able to borrow at relatively low rates. Your mortgage isn't an obligation of the U.S. government.
David,
What the hell are you doing listening to Ed Schultz?
Ed Schultz should be listening to YOU.
"To begin with, Japan and China aren't people and can't "decide to divest." It isn't the Japanese government that owns that fraction of our debt, it's individual Japanese and firms."
One thing about your comment - you only called out Japan, where yes, US debt is owned by individual Japanese and Japansese businesses.
You left China dangling, where most US debt is bought by Chinese "firms" which are, to my understanding, controlled by the central government to differing degrees. In other words, in China, US T-Bill investment is managed by the Communist Party.
They HAVE to buy T-Bills or otherwise invest this money. They can't repatriate all their foreign earnings from exports to China... if they did, they rapid money supply increase would cause inflation inside China as the supply of money outstripped the demand for money. This further inflation on top of what they're seeing now would increase the pressure to revalue or float the Chinese currency even more than they are experiencing currently. The ChiComs would fear that inflation would affect internal Chinese political stability, IE their monopolistic political control.
China can't sell all their US bonds - they'd have to do something else with the money since they can't repatriate it to China. They would invest it elsewhere, where we again hit David's fungible capital argument.
They can't sell it off all at once - it's owned by various entities in china, albeit under central control - and there is no one buyer big enough for it. They'd have to sell the bills on the international funds markets, and again, the fungible capital argument comes into play.
Besides that, destroying the market for T-Bills might not be so bad.
There is an alternative solution to increasing the interest rates for t-bills to make them more attractive. That solution is to reduce the need to sell debt instruments in the first place by shrinking the size, scope, and thus rapacious hunger of big government for funds.
Radical concept, eh?
Adam
Phoenix, AZ
Isn't this situation at least partly linked to our enormous expenditures in the Iraq war?
Much the same mistake is made by those who explain the Iraq War as an attempt by the U.S. to make sure it can get enough oil. Oil, too, is a fungible commodity with a world market. Middle Eastern countries that depend on oil revenue are unlikely to stop pumping and selling it, whoever runs them. If Iraq decides to sell to France instead of to the U.S., that frees up whatever oil France would otherwise have bought for our use.
I thought we were in Iraq to make sure oil remained fungible for dollars. Saddam switched to Euros in 2001 or so. Iran and Syria are said to be considering a similar switch. I guess it's just a coincidence they're next in line for regime change administered by Uncle Sam, eh? ;-)
"Wasn't there a movie about 20 years ago with just this same kind of doom scenario as the basis for it's plot?"
I believe you're referring to Rollover, although The Crash of 79 by Paul Erdman had some similarities (granted it was a book, not a film).
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