Intelligence reports. Unemployment statistics. National-security estimates. Political polls. World leaders sure have their hands full digesting reams of data.
The next US president should add this to his must-read list: the Federal Reserve’s H.4.1 table, a statistical release from the US central bank.
Economists have long weeded through the New York Fed’s weekly release. With a dry, wonky name such as “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” it’s no wonder US presidents aren’t known to peruse its contents.
Yet, it will tell the next leader—be it Republican John McCain or Democrat Barack Obama—how willing foreigners are to continue financing the US way of life. Alas, there are good reasons for the US to learn how to live without Asia’s money.
The great stampede out of dollar assets many analysts predicted hasn’t happened. Demand for US debt has been quite resilient amid a sliding dollar and a widening credit crisis. Even problems at Fannie Mae and Freddie Mac haven’t yet precipitated a massive capital exodus.
The operative word is “yet”. The almost $10 billion (Rs43,700 crore) drop in central-bank holdings of agency debt this month doesn’t necessarily mean the flight is afoot. Yet, Asia is anxiously awaiting news of how the US handles troubles at government-sponsored mortgage-finance companies.
China, for example, holds $376 billion of long-term US agency debt and, according to James McCormack, head of Asian sovereign ratings at Fitch Ratings Ltd in Hong Kong, most of it is in Fannie and Freddie assets. Fannie and Freddie aren’t just too big to fail—they’re too geopolitical to fail.
“If the US government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,” Yu Yongding, a former adviser to China’s central bank, said last week. “If it is not the end of the world, it is the end of the current international financial system.”
Even if Fannie and Freddie are bailed out, recent events mark the end of the US’ financing arrangement as we know it. It’s a reality for which the US should now plan.
China alone will be a prickly customer to deal with. A conservative estimate would put China’s US agency holdings at 10% of its gross domestic product. Say the US opted not to repay investors on time and in full. How would China’s 1.3 billion people, awash in post-Oympics confidence, respond to the wealthy US leaving China with big losses? If the tables were turned, you can just imagine the public outcry for the US to stop lending to China.
Asia holds mortgage
Those arguing the US will hold its ground in these turbulent times ignore how dependent the US is on Asia’s money. It’s often said that the US built a large, productive economy over the years, and Asia holds the mortgage. Well, it’s true.
It’s also true that Asia has few alternatives. The magnitude of the region’s trade surpluses leaves few options other than parking money in the most liquid securities and keeping currencies from rising into uncompetitive territory.
One alternative is euro assets, though diversifying out of the dollar has its risks. If investors got wind of big dollar holders such as Japan, China or Russia rushing into the euro, markets would plunge and leave central banks with major losses.
While this is a tale of co-dependency, the real issue is the extent to which the US is reliant on foreign money.
The US current-account deficit was $176.4 billion in the first quarter, compared with the average shortfall of $100 billion since 1993. That isn’t the product of the US supporting global growth; it’s about Asia’s money helping the US live perilously beyond its means.
If Wall Street’s woes worsen, Asia will need those reserves to ward off speculators. Even so, the dollar’s gyrations over the last year will make Asians wary.
The Fed’s interest-rate cuts weakened the dollar 7% against the euro and 5% against the yen over the last year, while Bear Stearns Companies Inc.’s demise dented confidence in American-style capitalism. Sovereign wealth funds that plunged billions of dollars into US banks may have second thoughts.
For Obama or McCain, the challenge will be to repair a fractured US financial system and to wean consumers off their habit of overborrowing.
The process will be even harder as the US finds itself less able to rely on financing from Asia.
Foreign policy consequences
How would McCain pay for tax cuts without Asia’s money? How would Obama follow through on his protectionist rhetoric in a region on which the US is so dependent?
All the talk from Obama or McCain about a strong America ignores how the US is losing some economic-policy autonomy. Any move by treasury secretary Henry Paulson to restructure US agency debt now has foreign policy consequences and will need to be looked at through that prism.
There’s no doubt the next US leader will be a busy man. What’s less in doubt is that he will have to manage with less financial help from Asia.
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