June 21, 2012

Frank Newman's Six Myths -#1: Asian nations are bankrolling the U.S.

Charles Perrottet
Partner

Today we examine the first “myth” from Frank Newman’s book Six Myths That Are Holding Back America – the idea that Asian nations are bankrolling the U.S.

 

The key to understanding the impact of foreign purchases of U.S. Treasuries is that, except for the very small amount of cash physically carried by tourists, cash never leaves the country.  Money is never “used up”.  It merely changes ownership.  A deficit in the U.S. balance of trade creates a call on U.S. dollars by foreigners.  This in turn results in a transfer of dollars from one account to another, but both accounts must be in U.S. chartered banks.  The holder of the newly transferred dollars may be foreign, but they can only use those dollars to purchase goods or services priced in U.S. dollars.  They could use the dollars to purchase some other currency – say Euros – but then the seller of the Euros would possess those dollars, with the same restricted set of choices.

Mr. Newman notes the following additional misconceptions that flow from the bankrolling myth:

  • High savings in Asia can increase the U.S. money supply Since a currency must first be converted to dollars to invest in the U.S. there is no change in the money supply.  While dollars are transferred among owners, the total does not change.
  • China should use its dollars to help its poor U.S. dollars can only be spent on U.S. goods and services; they cannot be used to pay Chinese doctors.
  • The U.S. is too dependent on foreign holders of Treasury bills While foreigners own nearly $20 trillion of U.S. assets, Americans own over $20 trillion of foreign assets.  Also, the daily trading in U.S. Treasuries is over $500 billion.  It would take very large sales to impact interest rates.
  • America pays its bills by borrowing from abroad When Americans buy foreign goods they transfer dollars to foreign accounts  - held in U.S. chartered banks.  The owners of these accounts must use these dollars to buy dollar-denominated goods or services.  At the end of the array of choices is U.S. Treasuries, which is the safest investment available.

In summary, countries that sell more to the U.S. than they buy from it end up with trade surpluses that must be held in U.S. dollar assets.  This is simply the result of the inexorable logic of financial transactions.  This of course does not mean that bad things cannot happen as a result of foreign ownership of U.S. dollar assets ; there are multiple scenarios of how the current imbalances might play out. (We might suggest that the best way to play those out would be to engage a seasoned scenario consulting firm; but that might be seen as self-serving.)

Next myth: “Treasuries ‘crowd out’ private sector financing.”

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Patrick Marren
A quote from a Chinese official in the book "The End of Influence" by Cohen and DeLong: "We know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do."

Thoughts?