"The United States’ current reliance on other governments for financing represents an underappreciated strategic vulnerability…The longer the United States relies on central banks and sovereign funds to support large external deficits, the greater the risk that the United States’ need for external credit will constrain its policy options,” says a new Council Special Report, Sovereign Wealth and Sovereign Power. It says reducing this dependence on foreign governments should be an important priority for the next president.
Although some argue that this is no cause for concern, CFR Fellow for Geoeconomics Brad Setser says the United States deficit matters for strategic as well as economic reasons. Setser also warns that nations that do not share U.S. political values and policy goals could use large holdings of U.S. assets as political and economic leverage. "This does not mean foreign creditors are certain or even likely to use their financial assets as a weapon. It does mean that they could do so if they want," says Setser.
Setser recommends ways for the United States to guard against the effects of a disruption in foreign financing, such as consulting with allies who hold dollars, supporting policy changes abroad that would reduce the buildup of assets in state hands, reducing the U.S. budget, and most importantly, taking steps to reduce U.S. oil imports.The report’s recommendations include:
Reducing U.S oil imports
"If the United States succeeded in bringing down the world market price for energy, the savings surplus of the emerging world would likely fall along with the U.S. deficit: oil-exporting economies would be likely to scale back the growth of their central bank reserves and sovereign funds rather than scale back their own spending. That would contribute to global adjustment on both sides of the ledger: surpluses abroad would fall alongside the U.S. deficit."
Consulting with allies"The next U.S. administration should… initiate a dialogue with important U.S. allies to review potential joint responses to a sudden shift in the financial portfolio of a major U.S. creditor. In the absence of a previously negotiated commitment, other central banks might opt to sell—not out of a desire to put pressure on the United States, but rather out of a desire to protect the value of their reserves. U.S. allies have an incentive to respond favorably to U.S. diplomacy on this issue. Large dollar sales are not just a threat to the United States."
Supporting policy changes abroad that would reduce the buildup of assets in state hands
"Rather than encouraging oil-exporting countries to build up assets in sovereign wealth funds, the United States should encourage the oil-exporting economies to use surplus oil revenues to pay a variable ’oil dividend’ to all its citizens. The United States should also encourage a new multilateral push for greater exchange rate adjustment in the world’s large creditor countries. Undervalued exchange rates…contribute to large current account surpluses…and reduce the incentive for private investors in the country with an undervalued exchange rate to hold foreign claims, concentrating the management of the emerging world’s surplus savings in state hands."
Reducing the U.S. budget deficit over time
"The U.S. fiscal deficit is rising with the U.S. slowdown. However, it is still not all that large relative to the fiscal deficits of many other countries. But that is the wrong metric. It is large relative to the United States’ very low level of private savings. Restoring balance to the federal budget does not imply abandoning countercyclical fiscal policy, only reducing the average fiscal deficit over the economic cycle."
Full text of the report, including recommendations, is available on the CFR’s website at www.cfr.org/sovereign_wealth
Brad W. Setser is a fellow for geoeconomics at the Council on Foreign Relations (CFR). He most recently was a senior economist for RGE Monitor, an online financial and economic information company. In 2003, he was an international affairs fellow at the Council, where he wrote, with Nouriel Roubini, Bailouts or Bail-Ins: Responding to Financial Crises in Emerging Markets (Peterson Institute), a book examining International Monetary Fund policy toward crises in emerging market economies.
Council Special Reports (CSRs) are concise policy briefs that provide timely responses to developing crises or contribute to debates on current policy dilemmas. CSRs are written by individual authors in consultation with an advisory committee. The content of the reports is the sole responsibility of the authors.
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