What if foreigners quit lending the US so much money?
One of the bugaboos of the financial doom-and-gloom crowd is the worry that foreigners (China in particular, but also oil exporting countries in the Middle-East, and others) might quit buying so many US Treasury securities. If that happened, they say, the value of the dollar would plummet, interest rates would soar, and the US economy would be in terrible trouble. I say: Bring it on!
I'm not the only person who isn't worried about this. Quite a few people take some comfort in the idea that dumping Treasury paper would hurt the major foreign holders worst of all, and that they'd never shoot themselves in the foot that way. The doomsters retort that, given the inflation rate, the exchange rate, and the prospects for the US economy, it may well amount to the same thing either way, but that by selling, foreign holders of US paper could at least get something.
My own take is that the whole analysis is wrong.
What would happen?
Remember that the US isn't a bank--the government sells bonds, it doesn't take deposits. Foreign holders of dollars can't show up and demand their money back. All they can do is sell the securities they've got. (And, of course, quit buying more.)
Obviously, if major holders started unloading their treasury paper, the prices would plummet and interest rates would soar. That would make it expensive for the US to borrow new money, but it wouldn't affect the government's cost for the money they've already borrowered. In any case, borrowing large amounts of money is just a policy decision by the Bush administration and the Congress. As recently as 2000 the US government was running a surplus. With the economy slipping into a recession, it would be harder to run a surplus now, but the current large deficit is entirely optional.
Besides making it expensive for the government to borrow large amounts of money, higher interest rates would make it more difficult for everyone else to borrow money as well. On the other hand, it would make it quite profitable for people to save and invest money. In fact, once the government got its fiscal house in order (something that wouldn't really be optional in this scenario), we'd see the exact reverse of what the doomsayers predict--treasury paper would become a highly prized asset. People who bought it cheap when foreign governments dumped it would make huge profits.
You'd see similar results in the foreign exchange market. The value of the dollar would drop, making imports more expensive, but making exports more competitive.
The US (because it is large and well-endowed with both natural resources and skilled workers) could actually produce most of what it needs domestically. The only reason it doesn't do so is that imports from low-wage countries are so much cheaper.
Of course, producing more of what we use would cost more--the consumer has had it great over the past 30-odd years of globalization, getting all sorts of cheap stuff that would cost a lot more if it weren't imported from low-wage countries.
The result would be lower standards of living, but it wouldn't be a catastrophe. And, there would be winners as well as losers. Manufacturers would come out ahead, as would farmers and workers.
As the US dollar falls, the price of everything that trades in global markets (for example, corn, wheat, and soybeans) rises. (We see that already.) Since we grow a lot of those commodities, we benefit in about equal measure to our losses--the raw materials cost more, which means the stuff we buy costs more, but the producers earn more, so they have more money to spend.
One major exception, of course, is oil, where we use far more than we produce. The price of oil would obviously soar in this scenario, hurting everybody. But that's going to happen anyway.
I don't think this is a likely scenario, simply because (as I described at the beginning), dumping treasury paper would hurt the foreign holders of it most of all. Still, it's not an impossible scenario, so it's worth looking at how you'd want to position yourself against such an eventuality.
- First, you'd want to be sure not to be in debt, especially not variable-rate debt. Interest rates would shoot up, making debt even more expensive than it is now.
- Second, you wouldn't want to be in a business that depended on cheap imports. (At the moment that's most businesses. Some, though, could quickly move to local sourcing of their inputs, while others would find that difficult or impossible.)
- Third, you'd want to minimize your household's dependence on the sort of imports that would become much more expensive. The hard one here is fuel. (Your house or apartment is probably full of imported goods, but you've already got them and won't be harmed if their price soars.) I've talked before about preparing for higher fuel prices.
- Finally, expect a lower standard of living. Americans have enjoyed a high and rising standard of living for years, through a combination of individual borrowing (especially against homes), government borrowing (which has let the government fund an expensive war while lowering taxes), and globalization (importing goods from low-wage countries). This scenario would just mean that they'd come to halt abruptly, but they're coming to a halt in any case.
Regular Wise Bread readers will have noticed that these are generally the same recommendations that we make anyway. That's the reason for my somewhat flippant call to "bring it on!"--we're already ready.
A quick transition to a world where everyone had to live within their means would be rough--homes would be lost, jobs would be lost, businesses would be lost. But we're heading there anyway, so it's just a matter of whether the transition will be fast or slow. As individuals, we have the opportunity of starting the transition now--ahead of everyone else.
I suggest you make the most of it.