What Will Stop the US from Borrowing Any More
By Jeremy Weltmer • Wednesday, May 19, 2010 4:16 pm
As difficult as it may be to believe, the United States has a debt problem. Moreover, whereas one normally borrows money for capital expenditures, the U.S. now borrows for day-to-day expenses. And while one would certainly lend money to someone to buy a car, the U.S. is now borrowing to pay for the drive-thru food. Moreover, the rest of the world lends to the U.S. at inexpensive rates and always buys the debt, at least for now.
The reasons for this stretch back to the Bretton Woods agreement in 1944, at which the world agreed to make the U.S. dollar the “currency of last resort,” in large part because of the large and stable U.S. gold reserve. So, large foreign reserves of U.S. dollars accumulated across the globe.
Then the U.S. steadily undercut all the reasons that the dollar made for a good reserve currency: in 1971, Nixon took the dollar off the gold standard; in the 1980s, the U.S. morphed from a net creditor to a net debtor; and in the 1990s and 2000s, the U.S. racked up a massive deficit and tax load.
Now, the U.S. can always borrow because when it sells Treasury bills, foreign nations buy for their currency reserves, China in particular. Thus, the U.S. will not likely face a situation like Greece’s in which nobody wants to purchase the debt; in order to trade currencies, countries must buy dollars.
With the Chinese yuan pegged to the dollar, so long as the yuan remains undervalued, the Chinese will buy U.S. debt. While the composition of China’s currency reserve holdings, the largest in the world at $2.5 trillion, remains a state secret, analysts predict and have gotten confirmation from officials that the bulk of those reserves are in U.S. dollars. But, as the Wall Street Journal reports, “[Chinese] officials have also voiced mounting concern about the U.S. currency in recent years because of Washington's growing deficits, and have said that China wants to diversify its holdings.”
“The U.S. dollar used to be the center of the earth,” says David Bloom, currency strategist for HSBC in London. “Now China is becoming a very powerful influence on the way currencies are working.” Hai Xin, a PNP Paribas executive of the group that hedges currency risks for institutional clients, says, "We've reached a junction where the dollar and yuan are equally important in Asia. Before, I'd never hesitate to say the U.S. dollar is the most important currency. Now I think it's both.”
While the dollar is still the dominant currency held by central banks as a reserve, the IMF reports that only 62% of the world’s reserves are in dollars, and that percentage is falling as some countries, China among them, transition away from the dollar. Whereas now 62% of world reserves are in U.S. dollars, even in 2001, 71% were held in USD.
For U.S. taxpayers, this means that as the globe moves away from the dollar, so will it become harder to borrow because central banks will no longer need to buy U.S. Treasuries. Likewise, in order to sell U.S. debt, the interest rates will have to increase, which will further increase the costs of servicing the U.S. debt. Then, the U.S. could conceivably be the next Greece.
There is a solution: fix U.S. finances at home so that the U.S. need not worry about the ability or cost of borrowing. By cutting spending, reducing pressures to spend by reconceiving the role of government and entitlement spending, working to reduce the debt burden, and recalibrating spending and taxes to be within the same realm, the U.S. need no longer shill its debts to the world.
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