February 23, 2005


The Overstretch Myth (David H. Levey and Stuart S. Brown, March/April 2005, Foreign Affairs)

Would-be Cassandras have been predicting the imminent downfall of the American imperium ever since its inception. First came Sputnik and "the missile gap," followed by Vietnam, Soviet nuclear parity, and the Japanese economic challenge--a cascade of decline encapsulated by Yale historian Paul Kennedy's 1987 "overstretch" thesis.

The resurgence of U.S. economic and political power in the 1990s momentarily put such fears to rest. But recently, a new threat to the sustainability of U.S. hegemony has emerged: excessive dependence on foreign capital and growing foreign debt. As former Treasury Secretary Lawrence Summers has said, "there is something odd about the world's greatest power being the world's greatest debtor."

The U.S. economy, according to doubters, rests on an unsustainable accumulation of foreign debt. Fueled by government profligacy and low private savings rates, the current account deficit--the difference between what U.S. residents spend abroad and what they earn abroad in a year--now stands at almost six percent of GDP; total net foreign liabilities are approaching a quarter of GDP. Sudden unwillingness by investors abroad to continue adding to their already large dollar assets, in this scenario, would set off a panic, causing the dollar to tank, interest rates to skyrocket, and the U.S. economy to descend into crisis, dragging the rest of the world down with it.

Despite the persistence and pervasiveness of this doomsday prophecy, U.S. hegemony is in reality solidly grounded: it rests on an economy that is continually extending its lead in the innovation and application of new technology, ensuring its continued appeal for foreign central banks and private investors. The dollar's role as the global monetary standard is not threatened, and the risk to U.S. financial stability posed by large foreign liabilities has been exaggerated. To be sure, the economy will at some point have to adjust to a decline in the dollar and a rise in interest rates. But these trends will at worst slow the growth of U.S. consumers' standard of living, not undermine the United States' role as global pacesetter. If anything, the world's appetite for U.S. assets bolsters U.S. predominance rather than undermines it. [...]

At the peak of its global power the United Kingdom was a net creditor, but as it entered the twentieth century, it started losing its economic dominance to Germany and the United States. In contrast, the United States is a large net debtor. But in its case, no plausible challenger to its economic leadership exists, and its share of the global economy will not decline. Focusing exclusively on the NIIP obscures the United States' institutional, technological, and demographic advantages. Such advantages are further bolstered by the underlying complementarities between the U.S. economy and the economies of the developing world--especially those in Asia. The United States continues to reap major gains from what Charles de Gaulle called its "exorbitant privilege," its unique role in providing global liquidity by running chronic external imbalances. The resulting inflow of productivity-enhancing capital has strengthened its underlying economic position. Only one development could upset this optimistic prognosis: an end to the technological dynamism, openness to trade, and flexibility that have powered the U.S. economy. The biggest threat to U.S. hegemony, accordingly, stems not from the sentiments of foreign investors, but from protectionism and isolationism at home.

And it is precisely the isolationists and protectionists, of Left and Right, who always insist that decline is imminent even as we keep rising.

Posted by Orrin Judd at February 23, 2005 8:15 AM

Imagine if the trade situation were reversed, and we were pumping out hundreds of billions more each year than we were taking in? Both in manufacturing and services? Could that be sustained for more than just a few years (i.e., less than 10 or 15)?

In which case are we more vulnerable?

Posted by: ratbert at February 23, 2005 5:37 PM

I like the point about the security inherent in being in debt to others.

Sort of like, if you owe the banks a lot of money, won't they do their best to make sure you can pay them back? (Though I suppose owing money to loan-sharks is another story.)

Though certainly, in this case the US is trusted to pay back its debt, or at least to continue to make further purchases. Other countries might not be trusted.

It seems to create an interesting, and rather robust, balance.

Contrast this with the precariousness of being the owner of a lot of IOUs and being powerless to demand the money (attested to by so much of Jewish history in the middle ages).

Posted by: Barry Meislin at February 24, 2005 4:54 AM