The Unmightly Dollar
By Clyde Prestowitz
22 March 24, 2003
(Copyright (c) 2003, Newsweek
A costly war could drive more foreign investors away from the United States, hurting living standards and our influence abroad
As America prepares for war, all eyes are fixed on the capabilities of
its troops and high-tech weapons. Less noticed is an Achilles' heel
that is likely to be made a lot more tender by the war, with important
negative implications for future U.S. living standards-and influence.
WHILE THE UNITED States is the greatest power the world has ever seen,
it is also the greatest debtor, living beyond its means and heavily
dependent on foreign lenders. For years America has been importing more
than it exports. These "current account" deficits have now reached an
annual rate of $500 billion, or about 5 percent of GDP and 50 percent
more than the United States spends on defense. America has been paying
for the difference by borrowing. In this case, the money has to come
from foreign lenders because the buying that generates the deficits is
done abroad. The debt America owes abroad has now reached about $2
trillion, or about 20 percent of GDP. At its current growth rate, total
U.S. foreign debt could easily top 65 percent of GDP by 2010. Even with
interest rates of only 3 percent, it would take nearly $200 billion
annually for the United States simply to finance the debt.
The deficit ultimately arises because America saves far less than other
countries, and the war is about to make that situation a lot worse.
Economist Martin Wolf has conservatively estimated the cost of the war
and of rebuilding Iraq over a 10-year period at $156 billion to $755
billion. Other estimates have run as high as $3 trillion. In the 1991
gulf war, most of the cost was paid by other countries. This time, the
United States will have to bear most of the burden itself. Without new
taxes, this will greatly increase the U.S. budget deficit.
For a long time it has been relatively easy to get the foreign funds as
overseas investors have rushed to buy U.S. stocks, bonds, real estate
and companies. During the tech bubble of the 1990s America became the
location of choice for investors from countries with large
international reserves, such as China, Taiwan, Japan and Western
Europe. The flood of money buoyed the dollar and stocks, allowing
Americans to live beyond their means by consuming more than they
More recently, however, there has been a significant change in the flow
of the foreign funds that is as critical to U.S. economic health as the
flow of oil. Over the past year, private foreign investment in the
United States has fallen dramatically. It has been partially offset by
increased buying of U.S. Treasury notes by Asian governments. But, at
the same time, some governments like Russia have also begun to shift
some of their reserve currency holdings from dollars to euros. As a
result, we have seen the dollar fall in value against the euro by about
25 percent. That kind of a decline occurs when foreigners decide to put
their money someplace other than the United States. U.S. international
debt is getting so large, foreigners become nervous about their
holdings and cut back on buying.
Thus, the biggest casualty of the upcoming war with Iraq may be the
U.S. economy. A dramatic increase in debt could result in a fall of the
dollar that would reduce U.S. living standards while significantly
increasing the cost of projecting U.S. power abroad. The only way to
avoid this scenario is by raising taxes, something that will also
reduce living standards. Another option is to become more dependent on
lenders like China and Saudi Arabia. Either way, U.S. power may not
loom nearly so large as many now imagine.
Prestowitz is president of the Economic Strategy Institute and author of the forthcoming book "Rogue Nation."