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 The Privilege of American Debt
By Philippe Martin
Libération

 Monday 06 February 2006

 Starting in 1982, the United States began to accumulate external deficits 
that have increased significantly during the last five years. These deficits may 
represent the greatest threat to the global economy, but President Bush was 
silent on the subject during his State of the Union speech last week. 
Accounting for these deficits is rather simple at first glance: Americans consume and 
invest more than they produce. In order to do that, they import more goods than 
they export, and every year they therefore have to borrow more from the rest 
of the world. Americans don't want to save (the household savings rate is 
negative!), and the rest of the world does it for them. For 2005, the current 
account deficit - and therefore the increase in external debt - exceeded 6% of 
American GDP. That means that in 2005 alone, external debt increased over 6,000 
Euros [$7,200] per household! The total of these accumulated deficits brings 
the net debt to the rest of the world to about 25,000 Euros [$30,000] per 
household. The natural counterpart is that practically every other country in the 
world - industrialized countries and even countries that are still relatively 
poor like China and emerging Asian countries - lends to the United States. No 
other country could allow itself to take such a debtor position without lenders 
either demanding a risk premium or packing up their bags - which would cause 
the currency to fall. It is difficult not to make a connection with the idea 
that the United States enjoys an "exorbitant privilege," the expression 
attributed to de Gaulle in 1965 (but in fact pronounced by his Finance Minister, 
Giscard d'Estaing). In a recent article (on the site www.cepr.org), Pierre-Olivier 
Gourinchas and Hélène Rey, two French economists teaching in the United 
States, have analyzed the nature of this privilege that has allowed the United 
States to go into debt without (so far) having to pay for all the consequences. One 
would expect that a country indebted to the rest of the world would have to 
pay interest on that debt. That is not the case: with the exception of the last 
trimester of 2005, the United States has always received more interest and 
dividends from the rest of the world than it has paid out. How is that possible? 
Net American debt is the difference between all foreigners' assets in the 
United States (the liability side of the US balance sheet) and American assets 
elsewhere in the world (the asset side of the balance sheet): the former 
represent about 12.5 trillion dollars, the latter 10 trillion, so a net debt of about 
2.5 trillion dollars. But the assets and liabilities differ fundamentally. US 
liabilities are mostly Treasury Bills (often purchased by Central Banks) and 
loans from foreign banks. These loans are more and more short-term with low 
interest rates. On the asset side, the predominant categories are stocks 
holdings on foreign exchanges and direct investments by American multinationals. 
Riskier, those assets have higher rates of return. Therefore, Americans borrow at 
low cost to consume, but also to invest in higher risk and more profitable 
assets in the rest of the world. According to Gourinchas and Rey's expression, 
the United states has therefore become a capital investment business and pockets 
a fat margin along the way: with the difference between the rate at which it 
borrows and the return on its investments over 3%. This margin may be 
interpreted in different ways. The first is that Americans are most gifted investors 
and enjoy unprecedented margins. In that case, the deficit is less serious than 
it seems, because the income raked-in thanks to risk capital activity reduces 
the deficits by as much. The second interpretation is that the scope of the 
phenomenon is temporary and related to weakness in global interest rates. Their 
increase will increase the United States' cost of borrowing by as much. 
Therefore, the time is not far off when the US will have to begin to pay out: in 
fact, that was already the case for the last trimester of 2005 and will 
certainly be the case for 2006.

 American privilege doesn't stop there: thanks to the hegemony of the dollar, 
they borrow in their own currency, but around 70% of their foreign assets are 
in foreign currencies. When the dollar depreciates, the net debt is 
automatically reduced. The payoff is substantial: a depreciation of 10% leads to a 
transfer of close to 6% of American GDP in favor of the United States, i.e., the 
amount of the annual trade deficit! For any other country, debt reimbursement 
would force it to consume less and produce more for the rest of the world. 
Because foreigners have agreed to lend to the United States in dollars, the 
adjustment through depreciation of the dollar is rendered less painful.

 The problem with this exorbitant privilege is that it's naturally tempting 
to exploit it. By getting too far into debt, the United States could endanger 
the role of the dollar and the stability of its financial markets, both at the 
very source of its exorbitant privilege.

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 Philippe Martin is a professor at Paris-I and a researcher at the CNRS 
[French National Center for Social Research].




Translation: t r u t h o u t French language correspondent Leslie Thatcher. 
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