The Economy; THE OUTLOOK: Could Overseas Financing Hurt the U.S.?
AS THE U.S. has grown ever reliant on foreign central banks to finance its trade and budget deficits, the question arises: Could foreign governments, like China's, one day use this clout to influence U.S. foreign policy? Most experts say it's far-fetched. But some look at history and the state of modern markets and are worried.</br></br>"There is surely something odd about the world's greatest power being the world's greatest debtor," Lawrence Summers, Harvard University president and former U.S. Treasury secretary, said in a recent speech. He calls it "troubling" that the U.S. depends so much on "inevitably political" entities to finance its foreign debts.</br></br>Last year, the U.S. ran a $542 billion deficit in its current account -- the balance of goods and services between the U.S. and the rest of the world -- which had to be financed by selling stocks, bonds, and other assets to foreigners. The U.S. has run such deficits for years, but most of the time they were financed by private investors and their purchases were seen as a sign of confidence in the U.S. economy. But in recent years, private inflows haven't kept pace with the growth in the current-account deficit and foreign central banks have stepped into the breach, buying more than $200 billion of U.S. assets, mostly Treasury bonds and bills, last year. They do this to hold the dollar's value up against their own currencies, which makes their exports more competitive.</br></br>Foreign central banks, led by China's and Japan's, now hold close to $1 trillion of Treasury bonds and bills, almost a quarter of publicly held U.S. debt. That serves their economic interest, but it also gives them a potential financial lever.</br></br>IMAGINE A standoff between the U.S. and China over Taiwanese independence. What would happen if China stopped buying U.S. bonds, or sold them outright? As bond prices fell, their yields, which move in the opposite direction, would rise. Mortgage rates would rise, depressing home sales and weakening the economy.