Recently, Sri Lanka has become a hot spot in the world.
Under the double attack of the COVID-19 epidemic and the conflict between Russia and Ukraine, Sri Lanka's foreign exchange reserves have fallen into the dangerous situation of "reducing sources and opening up flows": on the one hand, the money absorbed from abroad continues to decrease, on the other hand, the money paid to foreign countries continues to increase. . Coupled with a series of inappropriate domestic economic policies, people's living standards have plummeted, even to the point where they can no longer afford to eat.
Sri Lankan people facing energy shortages (picture from observer.com , infringement and deletion)
In the end, under the pressure of a series of internal and external troubles, Sri Lanka, which continued to borrow money to make up for the loopholes, but owed more and more, was finally forced by foreign debt. The point where the oil is exhausted and the lamp is dry. As the country declared bankruptcy, the president also "ran away" in the past two days.
At this critical moment, many countries began to extend a "helping hand" to Sri Lanka, saying that they would provide assistance loans to the latter. Among them is the United States, the “financial hegemon”.
Regarding the actions of the United States, many analysts believe that this is a strategic means for the United States to infiltrate and control Sri Lanka under the banner of "aid". However, whether it is due to geopolitical competition or economic considerations in acquiring assets, it is not difficult to understand why rich countries invest capital in poor countries; even in relatively stable times, poor countries will invest in rich countries. Borrow or seek loans in exchange for the economic development of the country.
However, if you look at it from a more macro perspective, things don't seem that simple. According to Eswar S. Prasad, former director of the China Division of the International Monetary Fund and researcher at the U.S. National Bureau of Economic Research, in "The Dollar Trap", in the changes in global finance, rich countries are often the capital importers. , and poor countries are capital-exporting countries; In other words, rich countries have been borrowing money from poor countries.
The United States is a very typical example. As the leader of the world's advanced economies, the United States has had a huge current account deficit for many years; this means that the combined investment and consumption of the United States exceeds its output. At the same time, the United States' foreign debt has always been among the largest in the world, exceeding its GDP for many years; successive fiscal deficits are also a major "feature" of the United States.
If this is the case, why can the United States still operate normally?
In "The Dollar Trap", Mr. Prasad conducts an in-depth analysis of this seemingly bizarre issue. Which countries are paying for America’s high consumption? How does the United States use its issuance power to continuously delay its debt? Faced with inevitable devaluation, why are global investors still rushing to buy assets denominated in US dollars? Mr. Prasad has his own unique insights into the various "traps" set by the US dollar that are difficult to escape. Next, we have selected an excerpt from "The Dollar Trap" to give you a glimpse of the tip of the iceberg of the "Dollar Trap".
Not everyone can maintain debt as sustainably as the United States
(from Chapter 6 of The Dollar Trap)
Sooner or later, everyone has to pay back student loans, home mortgages, and other loans unless they declare themselves bankrupt. The reason why individuals cannot extend indefinitely is that everyone must leave this world sooner or later. Moreover, there are great legal obstacles for creditors to pursue claims against debt heirs, unless the deceased leaves an inheritance for the heirs, or the debt is borne jointly by the deceased and his heirs. In contrast, countries usually do not perish, and their debts tend to exist in perpetuity. A series of factors also prompt other countries to endlessly finance the accumulation of US debt.
The speed at which a country's debt scale changes depends on the following four factors: the current scale of the debt, real interest rates adjusted for inflation, the growth rate of the country's economy, and the primary budget surplus, which is government revenue minus interest on debt. including government spending. When a country's market interest rates are higher than its economic growth rate, its stock of debt increases; that is, the economy grows and creates output faster than the interest payments required to accumulate the debt.When the basic budget balance is positive, it means that government revenue exceeds expenditure. Therefore, the government can use excess revenue to repay debt. At this time, the stock of debt will decrease. This simple formula of
has huge implications. If the U.S. government can borrow cheap funds, for example, if the real interest rate adjusted for inflation is close to zero, and at the same time the average annual growth rate of the U.S. economy is 2% to 3%, then the U.S. can maintain basic economic conditions for a long time. budget deficit without leading to an increase in the debt-to-GDP ratio. In the process of financing these debts, the United States has correspondingly increased its indebtedness to other countries, and other countries are also unwilling to pay endlessly for the U.S. deficit. But technically speaking, there is no reason for the United States to completely pay off these debts. Of course, the impact of increasing debt and the sustainability of this debt will largely depend on whether the funds to meet this debt come from domestic savings or foreign investors. Japan has a high savings rate, and savers are willing to invest in Japanese government bonds. Therefore, Japan can run a larger budget deficit and maintain a high level of debt without worrying about debt unsustainability. In comparison, the United States is more likely to make foreign investors feel uneasy because its domestic savings rate is so low.
For countries like Greece , the practical effect of the above formula is a triple whammy. As the debt crisis broke out, Greece had to face high borrowing costs and its economy turned into negative growth. In addition, Greece is also under pressure from a primary budget deficit. As you can imagine, Greece's debt situation seems unsustainable. It’s no surprise that Greece’s debt situation is destined to be difficult to resolve, as getting it back on a sustainable path will require revising every element of the formula.
Uncle Sam "Arrogant Privilege"
Facts have shown that the special features of the United States are far beyond what any data can explain. A considerable portion of the U.S.'s foreign debt is in the form of fixed-income investments. On the one hand, 55% of the United States’ external liabilities are bonds and bank loans. According to this form of debt, fixed interest must be paid regardless of the economic status of the debtor country; on the other hand, the corresponding form of assets in the United States’ external assets Only 31%. This means that there is a complete mismatch between the United States’ overseas investment and the structure of foreign investors’ investment in the United States. About 50% of the external assets of the United States are foreign direct investment and securities investment portfolios. The risk level of this kind of investment is indeed high, but when the market is in an upward channel, investors can enjoy the benefits brought by the rise of the market . Typically, the overall risk of such investments is higher, and therefore, their average expected return is also higher. At an aggregate level, the rate of return on U.S. investments abroad should be higher than the interest paid on overseas debt.
In fact, there is little obvious evidence to support the above hypothesis. Pierre-Oliver Gingrich of the University of California, Berkeley, and Helen Rey of the London Business School have presented evidence supporting this hypothesis through research. In addition, they further pointed out that part of the reason why U.S. investors’ returns are higher than those of investors in other countries is the structural difference between U.S. overseas assets and external liabilities. Remarkably, they found that for every type of investment, including bonds, stocks and loans, U.S. investors earned higher returns than foreign investors achieved by investing in the United States.
Francis Warnock of at the University of Virginia has questioned these results in a co-authored article. He has always believed that such results stem from a misreading of the data. Warnock's research concluded that, in general, U.S. investors' returns on specific investment categories are no higher than those of foreign investors. Even if we do not take into account the structural differences in different investment types of external assets and external liabilities, the United States’ overseas assets and liabilities are still in a favorable position in terms of currency composition. On the one hand, the United States’ foreign debt is all denominated in U.S. dollars, which is obviously an incomparable privilege for the country that prints U.S. dollars. On the other hand, the United States' external assets are mainly denominated in foreign currencies. If other countries' currencies depreciate relative to the U.S. dollar, U.S. investors will have to bear the risk of a reduction in investment value.
What would happen if foreign investors pulled all their money out of the United States, causing the dollar to plummet against other currencies? U.S. debt will not depreciate in value, but the value of its dollar-denominated assets will rise. Therefore, the depreciation of the local currency of and will give the United States a windfall. This is the gift that the "arrogant privilege" bestows on the world's major reserve currency issuing countries.
...
The United States is pulling more and more foreign investors, especially the central bank of emerging markets, into its own trap. Considering its status as the issuer of the world's basic reserve currency, the United States can always use its monetary policy to attract foreign investors. If the United States floods the global financial system with dollars, other countries will have to face a dilemma: either allow their currencies to appreciate against the U.S. dollar, or purchase U.S. debt to restrain the appreciation of their currencies. Obviously, both options are equally unbearable for them. If they allow their currency to appreciate, their export competitiveness will be greatly reduced, so they must accept the loss of existing dollar assets. If they curb the appreciation of their currency by buying U.S. government bonds, they will have to further increase their holdings of U.S. Treasury bonds. However, the expectation of a depreciation of the dollar will eventually come true, so they will have to accept greater losses.
Therefore, the choice the United States offers other countries is simple: Either make the inevitable losses a reality by proactive choice now, or choose later. Emerging markets, on the other hand, can only choose the lesser of two evils: postpone the pain until the future, accept losses on reserve assets at some point in the future, and be willing to live in a trap in order to maintain export growth. To this end, the choice they made was to intervene in the foreign exchange market to accumulate foreign exchange reserves and create a self-insurance mechanism. However, this choice will only worsen the profligacy of the US fiscal year and further strengthen the dominance of the US dollar in the global monetary system. It's easy to imagine the awkward position of emerging market policymakers. They certainly want to spare no effort to escape the trap, but resisting is tantamount to openly launching a currency war.
According to the book, although the U.S. dollar has an inevitable depreciation trend, the privilege of the United States to issue its own currency and the advantages of its financial and legal systems have made it difficult for the international financial system penetrated by the U.S. dollar to get rid of this problem for the time being. Both hurting and protecting their currency. Faced with this confusing situation, where should the future of international finance go?
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