money on my mind
by arlene winkler

How about that US dollar? Anyone who picks up a newspaper knows that the current administration has been actively driving the value of the US Dollar down against other currencies. On a personal level, it means that we pay more of our dollars than we used to, for foreign produced goods like Italian shoes, French wine and Japanese televisions. But in a global economy based on international trade, luxuries such as these are not the real story. Think China, think outsourcing—and before you say another word of complaint—think Wal-Mart.

For several years, manufacturers in Japan, China, South Korea and Taiwan have been selling us far more than they buy from us. As a result, these countries have built up vast quantities of foreign exchange, which they’ve been using, for the most part, to buy American government securities.

The effect of these massive investments has been to help keep our interest rates low and maintain the relative strength of the dollar, which allows us to borrow cheaply and fill our shopping carts at Wal-Mart with well-priced goods imported from …you guessed it… Asia. In addition, and not insignificantly, the low interest rates make it easier for Washington to finance the gaping budget deficit.

But as U.S. borrowing from abroad continues to soar, to a record $620 billion in 2004, a full 5.7% of overall economic activity, other countries are showing signs of reluctance to accumulate dollars at the same pace. In effect, it leaves the central banks in Asia holding America’s purse strings. At $817 billion, Japan’s has the largest pot of foreign currency in the world, but China, with about $600 billion, is rapidly catching up. Along with Taiwan and Korea, these countries hold the bulk of their reserves in the Treasury bills, notes, and bonds that finance our federal budget deficit, leaving American consumers and companies free to invest in more promising ventures.

But officials at the State Administration of Foreign Exchange in Beijing have also been seeking higher yields— plowing billions of dollars a month into mortgage-backed securities, bonds backed by mortgages on houses across the United States. By helping to keep our mortgage rates from rising, China has come to play an enormous and little-noticed role in sustaining the American housing boom.

So let’s see, as a result of the cheap dollar, we get low interest rates, cheap manufactured goods, and backing for our housing boom. What’s wrong with this picture? I don’t know about you, but all this reliance on foreign money and the investment decisions of bankers halfway around the world makes me uncomfortable about the future of the U.S. economy. I can’t help wondering what would happen if they decide to deploy their deep investment pool somewhere else, in Europe, maybe, or in their own countries.

Those in the know say that Japan and China hold too much American debt to be able todiversify discreetly. Any attempt on their part to unload American treasuries will trigger a world-wide sell off, which would destroy the value of their portfolios. For now, they’re urging the Bush administration to get the American budget into better balance and clean up their fiscal act..

The question for me is, what will they do next?

Arlene Winkler is a freelance financial writer, specializing in institutional finance, who has learned from experience, that when something sounds too good to be true, it probably is.