Wednesday, September 10, 2008

America’s Huge Debt To Foreign Countries Leaves It Vulnerable

We talk a lot about how huge America’s debt is (about $9.7 trillion), but what doesn’t often get addressed is the ramifications of holding this debt. Rather than focus on the obvious ones, like enormous debt service payments, and the impact on the dollar, I am going to talk a little bit about the foreign dependence side of things. Americans as a whole don’t save much, if anything. In fact, recently we actually dipped into a negative savings rate as populace, spending more than we earned. Since Americans have been saving less and less, this means that we are leaning more and more on foreign countries to fund our expenditures.

More than 25 percent of the national debt is held by foreigners, according to the U.S. Treasury website. It is not outlandish to think that this could potentially pose a serious political problem. If, say China or Japan--the top two holders of U.S. debt--were to attack an ally country of ours, even though we would want to step in we might instead do nothing for fear that the attacker might take actions to damage our currency or economy. Think of it as a card that these countries have in their hats which they could play whenever it benefits them.

Another potential problem that arises out of this is our dependence on foreign countries. We need them in order to function as a country right now. If, for whatever reason, foreign governments decided tomorrow that they were going to stop buying U.S. debt, we would be in a world of hurt. While it is unlikely that this would happen overnight, as our debt load increases and more alternative options become available elsewhere, it is not outlandish to think that slowly but surely, foreign governments will start moving away from U.S. treasuries. This is already happening to some extent as more and more foreign governments are diversifying into Euros and other higher-performing assets via sovereign funds.

America’s dependence on foreign countries to fund our debt is concerning without a doubt, but at least in the immediate future it is not an insurmountable problem. We as a country need to acknowledge that there is a problem and take steps to correct it. To slow down the increases of foreign debt we need to start cutting back on imports and increase our exports. Obviously this is easier said than done, considering how we have become addicted to low cost imports, but it is necessary in order to balance the equation out.

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