Why Dollar Worries May Be Just a Distortion

Experts have big worries about the U.S. economy. Predictions abound that the dollar will collapse and interest rates will soar, bringing on a wracking recession and a long-term reduction in living standards.

At first glance, the numbers are chilling. The U.S. is running large budget deficits and huge trade deficits. It depends on $4 billion a day -- almost $1.5 trillion a year -- in foreign investment in U.S. Treasury bonds and in the stocks and bonds of U.S. companies to finance its debt. The net foreign holdings of U.S. assets, beyond what the U.S. government, companies and individuals own in foreign assets, is $2.4 trillion. That is, this country has “borrowed” $2.4 trillion from foreigners who might decide to pull out and leave Americans holding the impecunious bag.

That sounds like the plot of a summer horror movie. And like all scary flicks, it’s an exaggeration and distortion, with misleading words like “borrowed” littering the script.

There’s some truth in even the most outlandish Hollywood story line, and there are disquieting facts in this one too. But as it plays out, it’s important to remember that the main reason for the $500-billion trade deficit and much of the U.S. debt is that the U.S. economy is the engine of the world. It pulls developing countries into the modern economy by buying their imports and investing in their new industries. The U.S. started on this path in the aftermath of World War II, when it practically single-handedly financed Japan’s economic recovery by purchasing its goods, and it has generally served this country well.


Remember something else: The government banks of China and Japan alone hold more than $700 billion of U.S. Treasury bonds and aren’t interested in dumping them. Why? Because that would drive down the value of the U.S. dollar, and a strong dollar is key to their ability to export to U.S. consumers and industry.

True enough, the consequences of relying on foreign investment in U.S. Treasury securities are two-edged.

On the one hand, the fact that investment money flows into Treasury bonds allows the U.S. economy to enjoy lower interest and mortgage rates, more home building, more consumer goods and lower prices. On the other hand, as the U.S. pays out interest on Treasury bonds to other countries, the ability of this economy to grow and provide advanced living standards for Americans is reduced.

And the very smart people who are worried right now aren’t all wet. The burden of driving the global economy may be sapping the U.S. economy’s strength as China slows its rampant growth and no other economic engine is on the horizon.

Among the expert worriers is Peter G. Peterson, former secretary of Commerce and co-founder and chairman of Blackstone Group, the largest private equity investment firm in the U.S. He laid out his fears last week in Los Angeles as he introduced his book “Running on Empty” (Farrar, Straus & Giroux).

Peterson, a lifelong Republican, says rising budget deficits, made worse by continued tax cuts, “could cause global investors to lose faith” that the U.S. will ever rein in its deficits. And this, he says, “can easily lead to a run on the dollar.” Such runs have occurred, he notes, in four separate two-year periods in the last three decades.

Peterson is hardly alone. Investor Warren Buffett, in a special bylined article in March in Fortune magazine, bemoaned the fact that U.S. “net worth” is being transferred abroad as Americans must work to pay the interest on the country’s net borrowings.

Buffett wrote that for the first time in his investing life, he was placing some of Berkshire Hathaway Inc.'s funds in securities and assets denominated in other currencies.

“To hold other currencies,” Buffett wrote, “is to believe the dollar will decline.”

So it has: Its value has slipped in nine of the last 10 weeks. Foreigners are emulating Buffett, putting money elsewhere, explains currency expert C. Fred Bergsten, head of the International Institute of Economics, a Washington think tank.

They are suddenly buying fewer Treasury bonds, investing instead in securities denominated in euros or in gold. The Treasury Department on Friday reported that foreign purchases of U.S. bonds fell 25% in May, the fourth straight monthly drop. And in U.S. stock markets, foreign investors have sold more than they have bought for three months straight.

“The pattern is worrisome,” Bergsten says, because the net debt position of the U.S. is increasing rather than shrinking.

But Bergsten isn’t anxious about major holders of Treasury bonds, such as the government banks in China and Japan. They have pegged their economies to the U.S. market, and the only imminent change in that relationship is a move to even greater interdependency.

In fact, China is prepared to start investing more directly in the U.S. economy, buying all or parts of American companies to help it hold on to consumer markets here and to aid the development of its own economy. Chinese industrialists are seeking stakes in U.S. oil properties and oil companies, for example, which can give them the expertise to develop petroleum in their own country.

(Japan, by the way, made a similar move two decades ago when its automotive companies began large-scale car production in Kentucky, Tennessee, Ohio and other states, creating U.S.-based jobs.)

To make such investments, China will start to make its currency convertible.

“China will begin to liberalize its currency next year and do more within the next three to four years,” says economist Charles Wolf of Rand Corp., the Santa Monica think tank, who advises the Chinese government as a participant in joint economic research projects with leading Chinese scholars.

We should welcome the Chinese. Their investment here will reduce fears of sudden sales of U.S. bonds and stocks, and so will tend to strengthen the dollar. And it will strengthen the relationship that is making developing China -- with an economy only one-eighth the size of the U.S. gross domestic product -- a huge customer of American companies that supply it with all manner of goods, whether electric generators, cellphones, autos or toothbrushes.

Fears are to be expected amid the rapid globalization of the U.S. economy in an interdependent world. But we should leave the horror stories to the movies.

James Flanigan can be reached at jim.flanigan For previous columns go to /flanigan.