What's Left for Foreigners to Do with Dollars, But Spend Them in the U.S.?

Very often when I read about the prospects of the US economy, it seems to be from the perspective of a debtor that can't repay his debts, and therefore must fail. Otherwise the perspective is one where the analyst pretends that the debt situation is not that bad. Well, the debt levels are bad (just look at these graphs!), and the derivatives market, with its huge uncertainties - along with constant government bailouts - is not exactly making things better. I've heard estimates for total derivatives losses from only a few billion (in the very beginning) up to over hundreds of trillions of dollars.

Whatever the total losses will be, we basically have two scenarios of how it will end; either the losses stop coming fairly soon or the government is going to keep bailing out the banks and eventually the bailouts will have become so many that everyone is going to start asking questions. Then we'll have a great public indignation which would force the government to declare an end to bailouts and let the banks and the financial system finally crash, or the government will have to somehow quench the uproar. The bailout and stimulus packages already in place and the potential coming ones are going to be funded by monetization, because there's no way that the rest of the world will lend those kind of sums of money. This will inevitably devalue the dollar, which brings us to the lenders...

For the last couple of years (decades really,) all they've done is to accumulate IOU's like crazy, when the reasonable thing would have been to spend those IOU's in exchange for things from the US. Now they're sitting on these huge mountains of IOU's and they're getting worried because of the bailouts and the possible devaluation of the IOU's (or the dollar). What would be the reasonable thing to do here? Would you throw the dollars away, keep sitting on them or would you start giving them back to the debtor in exchange for something useful?

I think the answer is pretty obvious. The countries that have huge holdings of dollars will have to start spending them, and this can only mean that a lot of business is coming to American companies. If you look at the trend, it tells you that more and more dollars are pouring back into American companies. Take GE, for example, they're sucking up five billion dollars a year from China today and that number is growing. It's all very simple: If the foreigners don't spend these dollars, they're just getting into more trouble - as will the American people because they will have to default, and/or inflate away parts of the debt.

So, does this all mean that things will be honky dory? Well, one should definitely not disregard the huge significance that US consumers place on American companies, and to rebuild wealth will take some time. It really depends on how stupid the lenders and the US government are; if the lenders start spending dollars, then the rebuilding of wealth (or destruction of debt) will go a lot faster and things may well stabilize (stop going down) within two years - this assuming that the derivatives market will have stopped imploding. That really is the huge wild card here, in fact the very thing that will determine the future of the global economy.

Again, if you look at the trend, the derivatives losses are not slowing down and nobody knows where it will end. But when these losses stop coming or when the government stops paying for this garbage, then I believe it will be a good time to invest in America. But beware, not until the black hole of derivatives has gone away completely is it safe to really invest in anything related - and by related I mean economies with financial sectors exposed to these instruments. Even a company like GE, mentioned just above, has taken credit losses although they may see great growth in places like China. So, until the green light comes on, let's focus on precious metals, perhaps energy and perhaps some more independent economies.

From the viewpoint just expressed, I think it looks reasonable that things may well not go as bad as some have predicted; government can really only put the people in so much debt. I doubt that we really will see more than, at the most, another five trillion of bailout or stimulus money (which in itself is obviously a huge amountof money). But then the US government has to cut down on a lot of other spending as well, which may prove difficult, but they would not be the first country in history to have run up a huge public debt, and others in that position have prevailed. Big problems are on the horizon and the government of the US really has to do things right in order for this crisis to be resolved (globally, as well); yet so far it hasn't. Hopefully even it may start to see that the bailouts are not sustainable and that the spending has got to be cut. I may seem naive to say that politicians like the Obama-gang might actually learn something, but stranger things have happened, and we should all hope that they do learn... unless you happen to really like things post-apocalyptic?

Comments

[jay joffe:]

I'm easily convinced of too many things, but that sure seems intelligent. May work after the bailouts et cetera put u.s. wages on a par with chinese wages. If only we can get the future u.s. unemployed to become interested in things like learning to read and keep appointments. I think that's why nobody's rushing to invest in the states. Education works. And so does it's complete lack. I stopped doing business in America in 2002 when the last reliable employees reached retirement age.

Mar 16 08:53 AM

[Gem Hudson:]

Helicopter Ben can not deposit capital money. Helicopter Ben can only drop paper money. Carpet bombarding all on a low, low down next to nothing interest rate payment or jacking up the rates up on any of their installment plan measure no value but only the mood swing shift of the political economy theorst. What become paper money is printed up money and print money is nothing but that fractional reserve out from an congressional I.O.U. bonds but earned money is capital money and capital money is to sell and to produce what would sell for you. Printing up more of the money than what is earned is still inflating by any other name.

Mar 16 08:58 AM

[kelm:]

The assumption that a foreigner holding US dollars has to buy goods in the US is incorrect. Dollars can be converted into other currencies or used directly to buy goods from any country willing to accept dollars. Oil for example is denominated in dollars yet the dollars flow to the oil producing nations not the US. So no, the money does not have to come back in goods purchased here.

Mar 16 09:01 AM

[Max Meurling:]

My point is not that every foreigner holding a dollar will have to spend it in the US (SA created that headline)... but the point is that foreigners with lots of dollars will start using them and thereby many of these dollars are bound to end up in the US one way or another.


On Mar 16 09:01 AM kelm wrote:

> The assumption that a foreigner holding US dollars has to buy goods
> in the US is incorrect. Dollars can be converted into other currencies
> or used directly to buy goods from any country willing to accept
> dollars. Oil for example is denominated in dollars yet the dollars
> flow to the oil producing nations not the US. So no, the money does
> not have to come back in goods purchased here.

Mar 16 09:16 AM

[Ove Sentlig:]

Yes, the dollars may end up in the US, but maybe some big players will require that US buys them back with Euros, for example, or gold. Not goods.

Mar 16 10:43 AM

[henarl:]

And so you expect the roles of the U.S. and China to reverse with the Chinese buying American products with dollars (IOUs) instead of the other way around?
That would mean the Chinese manufacturing industry would dry up as we would now be making their stuff with our higher priced labor. What do they do after they run out of IOUs? I don't think the Chinese are as dumb as we were. More likely they will buy our businesses and our real estate while they are priced at 50 cents on the dollar. They're not stupid!

Mar 16 11:10 AM

[AndrewBaker:]

The dollar is going to fall as we all know, and as a result the price of dollar quoted goods, such as gold and oil, will rise as you will need more dollars to equal the same value in the currency of the country where the buyer is situated. China will suffer as it holds so much in dollar assets that it can't hedge away, and so the recession/depression will take another leg down. To inflate our debt away will take years, and we have deflation to get through first. Buy precious metals, being gold and silver; and go long oil, because even with lower demand, production is not high enough to cover and stocks are being slowly used up. Both allow you to spend your dollars now before they'll buy so much less.

Mar 16 11:23 AM

[Max Meurling:]

It's just a fact that large dollar-holding nations are buying lots of services/products from the US already, and the US has a lot of expertise that these countries don't have ... business with US companies can actually create jobs and wealth in China or in Saudi Arabia or wherever they may be.

The roles of China/US don't have to reverse as you see it, but there may be an increase in US business going to China and not necessarily a huge decrease in Chinese exports going to the US - there's a difference between business and just exporting easy to manufacture products

On Mar 16 11:10 AM henarl wrote:

> And so you expect the roles of the U.S. and China to reverse with
> the Chinese buying American products with dollars (IOUs) instead
> of the other way around?
> That would mean the Chinese manufacturing industry would dry up as
> we would now be making their stuff with our higher priced labor.
> What do they do after they run out of IOUs? I don't think the Chinese
> are as dumb as we were. More likely they will buy our businesses
> and our real estate while they are priced at 50 cents on the dollar.
> They're not stupid!

Mar 16 11:23 AM

[User 143167:]

How about China uses all its dollar and UST to buy out Hawaii and all other American pacific islands? or most of the natural resources in the America?
Can America decide what the Chinese want to buy?

Mar 16 11:56 AM

[APM:]

A trend emerged in recent months indicated that the Chinese have been spending their USD reserves on energy and raw material resources and productions, in Russia, in the Middle East, in Africa, and in South America.

Maybe US can offer off-shore drilling rights to a Chinese company as payment for its debt obligations. Hey, it's going to create more jobs and business for the Americans!

Mar 16 12:17 PM

[Sugar Charlie:]

I;d advise Wen Jiaobao to use his USD to buy top-quality U.S. equities at the current fire-sale prices.

Mar 16 12:22 PM

[Philip7:]

Thank you for a great column. I had thought before what you said was true but I hadn't seen anybody state it clearly (or at all). I think what is confusing a lot of people is that other countries have gotten into trouble with huge foreign debts and were unable to pay them back leading to economic crises in those countries. The difference here is that our foreign debts are priced in US dollars. The US dollar is a worthless piece of paper without the the US behind it, which is up to us, not China or India or Saudi Arabia.

Didn't you think it was amusing when the Chinese premier said he was worried about all the dollar reserves they have and hoped that Obama would maintain the creditworthiness of the US? Obviously the best way for him to help maintain our creditworthiness is for them to start buying lots of stuff from us.

Mar 16 01:55 PM

[Howard_T:]

So GE is sucking billions out of China. I wonder what the Chinese are buying from GE. Do you think it's washing machines or toasters? Hell no! It's jet engines and other high-technology items. Once they've bought enough for their immediate needs, the Chinese (and whoever else wants to) will reverse engineer the technology and begin producing their own. Once that happens, and our manufacturing help is no longer needed, we will no longer have any manufactured goods of value to sell. The picture is not all bleak. Instead of paying a lot of tax money for our local schools, we can put our children to work at the looms and sewing machines to produce illegal copies of branded clothing to sell to the Chinese. Think of all the dollars we can save on taxes and college tuition when our kids learn such a useful skill.

Mar 16 02:11 PM

[kiers:]

the US is in hock! they will have to offer the chinese somehting they really want from the US (not madonna/michael jaxon records, not tom cruise, not chryslers) Possibly: missile navigation systems, sonar, stealth radar technology, anti-missile etc.

we are SOoooo toast.

Mar 16 04:19 PM

[mkreisel:]

The rest of the world is dependent on US for food. How long can a country survive without sufficient food supplies?

Mar 16 06:01 PM

[pacman1947:]

Max,
You argument boxes in our trading partners. These guys think out of the box, too. They can trade our bucks for any currency or group of them on the exchanges. They can buy commodities anywhere with bucks and sell them for any currency if they wish.

The point: Money is a medium of exchange. As long as people want dollars for something, the US buck has value. The traders don't need to spend them here.

Mar 16 06:29 PM

[Dirk McCoy:]

Philip7, I wrote an article called "let's just say it, print more money" where I said that dollars are redeemable for US goods and services as well as foreign goods and services that accept dollars- which is just about everyone.

The problem is massive credit deflation. Most of it has been absorbed by housing and equities, but the negative wealth effect has been brutal. Obama now understands the need to counter this, but without significant reflation (recreditization) this downturn will last a long while.

The dollar fell by a third for much of this decade as the global economy boomed- so people shouldn't be so sad about resumed devaluation, unless they're sitting on more cash than productive capacity. But they're the ones who've benefited the past year while global economic activity has begun to die...

Mar 16 09:59 PM

[Darrell:]

The dollar is accepted as legal tender in most countries in this world. The world has gone capitalist. Allowing the individual and/or institutional capitalist to drive the creation of goods, services and other things needed to keep the economy moving.

The only problem with the dollar being used as international legal tender is that our federal reserve has sole authority to determine how many dollars should be produced; China, European Union, Swaziland, Switzerland, Russia or any other nation are welcome to use their currency as international legal tender and try to replace the Federal Reserves leadership role.

If we want to pay off our debt all our Federal Reserve leaders have to do is produce more dollars and use these dollars to buy the debt; after all the US debt is denominated in dollars.

The dollar has been used as international legal tender since the beginning of the cold war; more than 50% of all dollars are held by foreign investors, foreign institutions, foreign central banks, and the list continues. I doubt very seriously that these dollar holders will replace their dollars with some other currency; as long as they can continue to make profits from the use of the dollar.

As Max so well put, we are in the drivers seat. So don’t sweet the small stuff.

Mar 17 12:17 AM

[IronMeteor:]

Good write-up.

For anyone who thinks inflation is coming, this is a critical step in the process. Internal inflation is DOA, only external purchases of US assets or goods via foreign dollar holdings can create inflation in the next few years. So if your prediction is for inflation in the US, foreigners will need to start converting those dollars into products, whether raw or finished. Trading dollars amongst themselves will not do it.
Weimar Germany couldn't suffer from hyper inflation unless the repatriation money came home and bought German goods and assets. If the French had kept the money or bought goods from England (and the English kept the Marks in their banks), Germany wouldn't have had any inflation.

If this did happen, it could lead to a massive rally in stocks regardless if its used for actual stock purchases or just finished products. Either way, asset inflation will follow. Hopefully its controlled and not the hyper variety. But its a long term thing, I doubt 2009 sees anything from this. Fear and the recession are king right now.

Mar 17 02:22 AM

[Ned S:]

Yes, the USD remains the default global currency. But the world is no longer totally convinced that status quo will hold ad infinitum. Nor is the world convinced that America's retention of its position of world leadership in all things of a financial nature is their preferred future - Except for Brittain perhaps. And maybe Japan. Both of which are sounding like bits of basket cases. But certainly not Germany or France or China or Russia.
Those are the vibes I'm picking up anyway.
So if I'm correct, expect to see the world to continue moving away from its reliance on the US and the USD - Slowly of course - In the quickest possible way.
It's just called hedging risk.

Mar 17 03:57 AM