Over the last five years (2013 to 2017), the U.S. trade deficit has averaged $500 billion per year. That means on its own: in each of these five years, U.S. external debt increased by $500 billion. By the end of March 2018, the gross external debt of the U.S. had reached a value of more than $19 trillion – the world’s highest debt of an economy.
Learn in this post whether the U.S. Dollar is a curse or a blessing and why.
In two earlier blog posts, I wrote about the anatomy of the U.S. trade deficit and the role of the exchange rate of the dollar for this deficit. Now I’ll discuss the role of the dollar in the U.S.’s high and sustained external debt.
A U.S. trade deficit automatically means that the U.S. is in debt to the rest of the world: If U.S. exports are lower than imports, the U.S. takes in less money in foreign trade than it spends. Export revenues are not enough to pay for all imports. The shortfall between export revenue and import expenditure is borrowed from the rest of the world. Borrowing increases the debt of the U.S. to the rest of the world, i.e. the external debt of the U.S. The level of additional debt is broadly in line with the trade deficit.
Normally, high and permanently growing external debt results in a decline in the creditworthiness of the economy. International investors lose confidence in the creditworthiness of the country concerned. They are no longer sure whether the country can pay its debts and the interest due for them on a permanent basis. The consequence: lenders demand a risk premium. In concrete terms, this means that interest rates for credit increase in the highly indebted country .
Rising interest rates make borrowing more expensive. This makes it less attractive for private households, companies and the state to take out a loan. This also has an impact on the balance of trade: If the demand for goods financed by credit decreases, imports fall. If no credit is taken out abroad, the trade balance is balanced.
In other words, international credit markets normally limit a country’s debt to the rest of the world. However, the U.S. with its currency is not a normal country: the U.S. dollar is currently the only global currency. This is both a curse and a blessing.
The US Dollar as a Blessing
The American economy can borrow more or less indefinitely in dollars in the rest of the world, because the dollar is a currency needed worldwide. Most international commodity purchases are paid in dollars. Many countries with weak currencies accept the dollar as an unofficial parallel currency. And international investors see the U.S. dollar as a safe haven for their savings. This has two central consequences:
- The U.S. can offer any amount of dollars on the international currency markets without fear that these dollars will be not taken from them. Even a strong expansion of the dollar supply will only lead to a slight depreciation of the dollar.
- International investors and banks have a high interest in American securities. This allows them to invest their money in the “safe haven” of the dollar and also collect interest. For American companies and the U.S. government this means: they can easily issue government bonds and borrow money in the rest of the world. This borrowing abroad is in turn a prerequisite for the U.S. to finance its trade deficit.
The US Dollar as a Curse
However, the fact that it is the only global currency is also a disadvantage for the American economy. For the rest of the world to have enough dollars, the U.S. must make these dollars available to the rest of the world. As the volume of world trade has grown considerably in recent decades, the global demand for dollars has also increased.
The U.S. can only supply the rest of the world with the necessary quantities of dollars if it 1) permanently expands the quantity of dollars available and 2) ensures that these dollars also reach the rest of the world. The latter requires an American trade deficit:
- If the rest of the world earns more dollars in trade with the U.S. than it spends, the rest of the world experiences an export surplus or trade balance surplus with the American economy. For example, if all the world’s economies sell $2,000 billion worth of goods to the U.S. and only import $1,500 billion worth of products from the U.S., the rest of the world earns $500 billion. These are then used to process other economic transactions.
- From the U.S. perspective, a trade deficit of $500 billion exists.
In short, therefore: The country that has the world currency of the globe must have a trade deficit in order to supply the rest of the world with the world currency. This statement is part of the so-called Triffin dilemma.
Economic policy consequences
As long as the U.S. remains the only nation whose currency is recognized as a world currency, a U.S. trade deficit is inevitable. Punitive tariffs to reduce imports will not change this. This situation is currently economically attractive for the U.S.:
- U.S. citizens can consume more goods and services than they produce themselves. This high level of consumption increases material prosperity.
- The U.S. has to pay relatively low interest rates: because many international investors want the dollar as an investment, they are also satisfied with extremely low interest rates.
It only becomes problematic if the U.S. dollar is no longer the sole global currency:
- If the euro or the yuan were also to reach the status of a globally accepted currency, the interest rates that the U.S. would have to pay for borrowing would rise.
- The U.S. will be limited in their borrowing ability. Instead, they would have to reduce the accumulated debt. This means that the U.S. would then need a trade balance surplus in order to repay the loans. In real economic terms, this means that U.S. consumers could no longer consume all goods and services produced domestically. They would then pay for any excess consumption by restricting consumption.
Whether and when this will happen is currently uncertain. Nevertheless, U.S. economic long-term policy planning should at least incorporate these macroeconomic interrelationships .