The US Dollar has been on a tear off late rising against most global currencies, most famously regaining parity with the Euro last week. With the US experiencing inflation higher than most countries in the rich world, many have been surprised by this stupendous dollar rally. One explanation has been that the Federal Reserve has been the most aggressive in terms of monetary tightening – raising rates and unwinding QE compared to other central banks in the developed world. The other is the US dollar’s status of a reserve currency, an implicit perception of safety by global investors. Whilst doubts have been raised in the past around the sustainability of the US dollar’s reserve currency status with the Euro and more recently the Chinese Renminbi (or even crypto) as alternatives, none have materialised. However, the new Cold War with China reignites this doubt particularly in the context that China has been one of the largest foreign buyers of US treasuries just when the Federal Reserve is unwinding its treasury buying program. Here’s a Chinese perspective on the subject of sustainability of American debt – Yu Yongding, a former Chinese central banker and economist factors in the falling US savings rate, rising budget deficit and slowing growth to answer if the world will continue to fund America’s deficits.
“Beginning in the 1950s, private saving and investment were relatively balanced in the US. That changed after the 2008 subprime mortgage crisis, with private actors saving more than they invested – an average difference of around $1 trillion per year – from 2009 until 2020.
This “savings glut” is largely a result of fast-growing income and wealth inequality. When the Fed’s massive post-crisis quantitative-easing program drove up asset prices, the wealthy – people who own shares and properties – reaped the rewards. This group has a much higher propensity to save than lower-income households.
The savings glut might be set to decline. In the first quarter of 2022, US gross private saving and gross private domestic investment were up by 7.2 percentage points and 25 percentage points, respectively, compared with the same quarter in 2020, meaning that the gap between saving and investment has narrowed. In the relatively near term, savings might continue to decline, to the point that they exceed investment by less than 2% of GDP.
America’s budget deficit, by contrast, is set to keep growing. According to the Congressional Budget Office, the deficit-to-GDP ratio averaged 3.5% annually over the last 50 years, but 5.7% from 2009 to 2019. While it should stand at 3.9% this year, according to the CBO, it is on track to reach 6.1% in 2032. It is thus safe to assume that America’s budget deficit will average 5% of GDP annually over the next decade.
When it comes to investment income, too, the US might be on a less favorable path. So far, investment income has always been positive, despite America’s status as the world’s largest debtor country (by far). This reflects several factors, especially the high returns reaped on outward foreign direct investment (on the asset side of the international investment position) and large amounts of low-cost foreign investment in US Treasuries and bonds (on the liability side).
Based on its past record, one can assume that America’s investment income accounts for about 1% of GDP. But, in recent months, the US has done significant damage to its own financial credibility. This will probably contribute to a decline in America’s investment income.
Finally, there is economic growth – yet another area where the US might struggle in the near future. It can be assumed that annual US growth will average about 2% over the next decade. Together with the other assumptions listed above, that would mean that America’s foreign-debt burden could well reach 100% of GDP in the coming years.
Geopolitics might compound the challenges ahead. The US has avoided a balance-of-payments and dollar crisis in the past largely because Asian central banks and oil-exporting countries have tirelessly purchased US government bonds and Treasury bills. But amid rising geopolitical tensions, these buyers might decide – or be forced – to rethink their purchases.
It is against this backdrop that the Fed is pursuing rather aggressive interest-rate hikes and quantitative tightening. But increased demand for foreign capital to finance the trade deficit, together with greater reluctance by foreign investors to purchase US government bonds and Treasuries, might put America in a quandary. It can either contain inflation or maintain external sustainability – but not both, unless, perhaps, US GDP growth slows significantly.”
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