Betting With the House’s Money

Many people have been asking why the dollar hasn’t crashed yet. Will the United States ever face a bill for the string of massive trade deficits that it has been running for more than a decade? Including interest payments on past deficits, the tab for 2006 alone was over $800 billion dollars – roughly 6.5% of US gross national product. Even more staggeringly, US borrowing now soaks up more than two-thirds of the combined excess savings of all the surplus countries in the world, including China, Japan, Germany, and the OPEC states.

Foreigners are hardly reaping great returns on investing in the US. On the contrary, they typically get significantly lower returns than Americans get on their investments abroad. In an era in which stock and housing prices are soaring, the central banks of Japan and China are holding almost two trillion dollars worth of low-interest bonds. A very large share of these are US treasury bonds and mortgages. This enormous subsidy to American taxpayers is, in many ways, the world’s largest foreign aid program.

If America’s competitive position is so weak, what magic is holding up the dollar? Most sober analysts have long been projecting a steady trend decline in the dollar against the currencies of America’s trading partners, especially in Asia and emerging markets. So why hasn’t more adjustment taken place already?

The first answer, of course, is that the trade-weighted dollar has fallen – by more than 15% in real terms since its peak in early 2002. Yet the US deficits have persisted, and even risen, since then.