In the last year and a half, world banks amassed $1 trillion in foreign-exchange reserves, two thirds of which are in U.S. dollars. It took about a decade before that to build the previous $1 trillion of reserves. This shows to what extent net-exporting countries have come to rely on America’s debt-fed consumption and to what extent Americans are over-consuming relative to what they are producing.
Americans have to borrow about 75 percent of the entire world’s surplus savings to keep spending at the current level!
This imbalance in the global economy cannot be sustained. The dollar’s decline is a symptom of the market forces at work to correct the imbalance.
As a result, countries are losing confidence in the dollar. For years, this magazine has warned of foreign-capital flight. Now it’s happening! Most of the foreign reserves in the central banks of China and Japan have long been held in U.S. Treasury bills, notes and bonds—but China’s support for the dollar has slacked off significantly. In the first three quarters of 2004, China’s foreign-currency reserves grew by over $111 billion, but only about 14 percent of it ($16 billion) was in U.S. dollar holdings!
Meanwhile in Japan, a senior member of the ruling party warned the White House that it risks “enormous capital flight” if the dollar’s weakness is not remedied. At the same time, a senior official in Japan’s Ministry of Finance stated that higher U.S. interest rates (to compensate for the dollar’s decline) will be required to keep the money flowing in from Japan.
Also, the Bank of International Settlements has recently revealed that opec nations have shrunk their dollar deposits from 75 percent to less than 62 percent. The central banks of Russia and Indonesia have recently announced that they too are considering reducing their dollar reserves.
Continued massive U.S. deficits that exacerbate the imbalance in the global economy could ultimately cause the dollar to collapse and bond yields (interest rates) to rise rapidly—leading to a commensurate rise in mortgage rates and a housing bubble bust, followed by a dearth of consumer spending and a deep global recession.