Keeping the US afloat

They say that if you owe the bank $1,000 you cannot repay, you are in trouble; but if you owe the bank $1 billion and you cannot repay, the bank is in trouble.

Think of the rest of the world’s central banks who hold dollar reserves as the bank and the US as the creditor who is in danger of defaulting. It puts the US in a very interesting position — it can take a lot of folks down if it starts to drown. The rest have a very good incentive to keep the US afloat.

That thought was triggered by a Council for Foreign Relations special report by Brad Setser “Sovereign Wealth and Sovereign Power: The Strategic Consequences of American Indebtedness“. (Your for only $10.) [Hat tip: The Acorn.]

The abstract follows:

America’s current account deficit is financed by foreign purchases of such assets as Treasury securities and stakes in U.S. firms. A good deal of these purchases today are made by the central banks and sovereign wealth funds of countries that do not share many American political values and foreign policy goals.

Some argue that this is no cause for concern. But Brad W. Setser makes a compelling case that the U.S. deficit matters for economic and strategic reasons alike. The United States may have more to lose than its creditors if they sell American assets or stop accumulating them at their current pace. This gives creditors potential leverage over U.S. policy. Setser also argues that indebtedness limits America’s ability to influence other countries’ policies, for example through sanctions and lending arrangements.

The problems associated with U.S. indebtedness cannot be addressed overnight. But the report proposes ways for the United States to guard against the effects of a disruption in foreign financing, such as consulting with allies who hold dollars and encouraging other creditor countries to spend and invest surpluses instead of accumulating reserves. It also suggests measures to reduce the need for financing in the first place, such as working to balance the U.S. budget and, most importantly, taking steps to reduce U.S. oil imports.

Sovereign Wealth and Sovereign Power raises the potential strategic implications of U.S. indebtedness, challenging the sanguine view that global economic interdependence guarantees prudence. The report is a significant contribution to the debate on America’s political and economic position in an age of globalization.

Moral of the story: If you have to borrow, be the biggest borrower in the world.

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