By Niall Ferguson (New York Times, April 20, 2003)
Can a global hyperpower also be a global hyperdebtor?
Debates about the cost of occupying Iraq and reconstructing its burnt-out economy tend to duck this question. It is as if such costs were simply an item on the federal government's military budget. In reality, direct government spending on aid and reconstruction is unlikely to amount to much. Having won the war on a shoestring ($79 billion is less than 1 percent of the annual output of the American economy), the Bush administration apparently hopes that the reconstruction of Iraq will soon be paying for itself. A trifling $2.4 billion has been allocated to the postwar Office for Reconstruction and Humanitarian Assistance.
Yet history strongly suggests that Iraq's reconstruction will require a kick-start of substantial foreign capital, particularly to modernize the antiquated oil industry.
Can the United States provide the necessary cash, even in the form of private-sector money? The answer is yes - so long as foreign countries are willing to lend it to the United States. For the fact is that America is not only the world's biggest economy. It is also the world's biggest borrower. Its muscular military power is underwritten by foreign capital.
This is an unusual circumstance. In the prime of the European empires, when the British ran much of the MiddleEast, the dominant power was supposed to be a creditor, not a debtor, investing large chunks of its own savings in the economic development of its colonies. Hegemony also meant hegemoney. Britain, the world's banker before 1914, never had to worry about a run on the pound during its imperial heyday.
But today, as America overthrows "rogue regimes," first in Afghanistan and now in Iraq, it is the world's biggest debtor. This could make for a fragile Pax Americana if foreign investors decide to reduce their stakes in the American economy, possibly trading their dollars for the increasingly vigorous euro.
Foreign investors now have claims on the United States amounting to about $8 trillion of its financial assets. That's the result of the ever-larger American balance-of-payments deficits - totaling nearly $3 trillion - since 1982. Last year, the balance-of-payments deficit, the gap between the amount of money that flows into the country and the amount that flows out, was about 5 percent of gross national product. This year it may be larger still.
The Wall Street Journal recently asked: "Is the U.S. Hooked on Foreign Capital?" The answer is yes, and this applies to the government even more than the private sector. Foreign investors now hold about two-fifths of the federal debt in private hands - double the proportion they held 10 years ago, according to the Treasury Department.
At a recent press conference, Kenneth S. Rogoff, the chief economist of the International Monetary Fund, referred to American financial dependence on foreign investors, saying he would be "pretty concerned" about "a developing country that had gaping current account deficits year after year, as far as the eye can see, of 5 percent or more, with budget ink spinning from black into red." Of course, he hastily added, the United States is "not an emerging market." But, he concluded, "at least a little bit of that calculus still applies."
Serving as an engine of global growth, aspiring to be a liberal empire and yet acting like an emerging market: it's quite a combination. Is it sustainable?
It is useful to contrast the present and the past. When the United States sought to exercise power by financial means with its dollar diplomacy of the 1920's, substantial American capital was exported to the rest of the world.
People tend to think that after World War I the United States retreated into isolationism. In reality, American investors lent billions of dollars to foreign economies, particularly in Latin America and Central Europe. By 1938 the gross value of American assets abroad amounted to $11.5 billion. Having bankrolled the victors of both world wars, the United States bankrolled the reconstruction of the losers in peacetime, too.
The most famous example of America's capital export was the Marshall Plan, which did not lend but gave $11.8 billion to revive the dilapidated postwar economies of Europe. American lending continued to fuel the world's economic recovery for two decades. From 1960 to 1976, the United States ran balance of payment surpluses totaling nearly $60 billion.
Then things began to change, most noticeably in the Reagan years, though the "current account deficits" - a comprehensive measure of the net flow of goods and services between the United States and the rest of the world - that he ran up look piddling today.
Some economists argue that this transformation from creditor to debtor is nothing to worry about. Capital flows into the United States, they say, simply because it is a great place to invest and foreigners want a piece of the action. In any case, the foreign investors seem ready to settle for markedly lower returns when they invest in the United States than the returns Americans get when they invest overseas. That is the only way to explain why the United States consistently receives higher investment income from its investments abroad than it pays out to foreigners who have put their money into American assets.
This might lead to the conclusion that Mr. Rogoff of the I.M.F. has little to worry about. But while being a hyperdebtor may not matter in economics, it can matter in the realm of strategy.
When the last great English-speaking empire bestrode the globe a hundred years ago, capital export was a foundation of its power. From 1870 to 1914, net capital flows out of London averaged from 4 to 5 percent of gross domestic product. On the eve of World War I, the capital flows reached an astonishing 9 percent. This was not only an extraordinary diversion of British savings overseas. It was also a remarkable attempt to transform the global economy by investing in commercial infrastructure - docks, railways and telegraph lines - in what we now call less developed countries.
From 1865 to 1914, nearly as large a proportion of total British savings went to Africa, Asia and Latin America as remained in Britain. Critics of colonialism may carp about the wickedness of empire, but the one undeniable benefit of British hegemony was that it encouraged investors to risk their money in poor countries.
It also gave the British real leverage over the rest of the world. British rule in Egypt did not begin with military occupation in 1882. For years before, British investors had been building up their holdings of Egyptian assets (most famously the Suez Canal).
This could prove a crucial difference between the days when Britain wielded power in the Middle East and today, when the United States aspires to recast the region. First, little in the current geographical distribution of American overseas investment suggests a natural predisposition to sink dollars into the desert. More than half of all American foreign direct investment is in Europe, compared with a paltry 1 percent in the Middle East.
SECOND, there can be no guarantee that foreign investors will be willing indefinitely to put such a large chunk of their savings in American government bonds and other low-risk securities. Right now they seem to be content with the prospect of a third year of disappointing returns on Wall Street and the lowest yields in Treasury bonds since 1962. But will they stay content?
Not so long ago, from 1984 to 1987, dollars were being dumped on the currency markets. Another crisis of confidence is not impossible to imagine, especially if all those foreign holders of bonds worry about the Bush administration's combination of increased military spending and decreased taxation.
Since the creation of the euro, investors have a whole new range of securities in which to invest. European bonds might look attractive if foreigners, and not just Americanophobic French millionaires, start to think of the euro as safer than the dollar. Al Jazeera recently ran a cartoon of Uncle Sam weeping as the euro was run up a flagpole in place of the once-mighty dollar.
There is, however, a glimmer of comfort. The good news is that in the past one great empire did rely on foreign loans. The bad news is that it was czarist Russia, which depended on a succession of huge foreign loans - largely from French investors - to modernize its military.
The only catch was that Russian dependence on French capital led the czarist government to heed advice from Paris - for example, about how many rail lines to build from Moscow to the Prussian border. Look where that ended: Russia was the first European empire to collapse - first militarily, then politically - as a result of the costs of World War I. You might call being a debtor empire the Nicholas II method.
Thus President Bush's vision of a world recast by military force to suit American tastes has a piquant corollary: the military effort involved will be (unwittingly) financed by the Europeans - including the much reviled French - and the Japanese. Does that not give them just a little leverage over American policy, on the principle that he who pays the piper calls the tune?
Balzac once said that if a debtor was big enough then he had power over his creditors; the fatal thing was to be a small debtor. It seems that Mr. Bush and his men have taken this lesson to heart.
Niall Ferguson, the author of "Empire: The Rise and Demise of the British World Order and the Lessons for Global Power" (Basic Books), is a professor of history at the Stern School of Business, New York University, and a senior research fellow at Oxford.