Commentary by William Pesek
Aug. 27 (Bloomberg) -- Intelligence reports. Unemployment statistics. National-security estimates. Political polls. World leaders sure have their hands full digesting reams of data.
The next U.S. president should add this to his must-read list: the Federal Reserve's H.4.1 table.
Economists have long weeded through the New York Fed's weekly release. With a dry, wonky name such as ``Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,'' it's no wonder U.S. presidents aren't known to peruse its contents.
Yet it will tell the next leader -- be it Republican John McCain or Democrat Barack Obama -- how willing foreigners are to continue financing the U.S.'s way of life. Alas, there are good reasons for the U.S. to learn how to live without Asia's money.
The great stampede out of dollar assets that many analysts predicted hasn't happened. Demand for U.S. debt has been quite resilient amid a sliding dollar and a widening credit crisis. Even problems at Fannie Mae and Freddie Mac haven't yet precipitated a massive capital exodus.
The operative word is ``yet.'' The almost $10 billion drop in central-bank holdings of agency debt this month doesn't necessarily mean the flight is afoot. Yet Asia is anxiously awaiting news of how the U.S. handles troubles at government- sponsored mortgage-finance companies.
China, for example, holds $376 billion of long-term U.S. agency debt and, according to James McCormack, head of Asian sovereign ratings at Fitch Ratings Ltd. in Hong Kong, most of it is in Fannie and Freddie assets. Fannie and Freddie aren't just too big to fail -- they're too geopolitical to fail.
Catastrophic Risk
``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu Yongding, a former adviser to China's central bank, said last week. ``If it is not the end of the world, it is the end of the current international financial system.''
Even if Fannie and Freddie are bailed out, recent events mark the end of the U.S.'s financing arrangement as we know it. It's a reality for which the U.S. should now plan.
China alone will be a prickly customer to deal with. A conservative estimate would put China's U.S. agency holdings at 10 percent of its gross domestic product.
Say the U.S. opted not to repay investors on time and in full. How would China's 1.3 billion people, awash in post- Olympics confidence, respond to the wealthy U.S. leaving China with big losses? If the tables were turned, you can just imagine the public outcry for the U.S. to stop lending to China.
Asia Holds Mortgage
Those arguing the U.S. will hold its ground in these turbulent times ignore how dependent the U.S. is on Asia's money. It's often said that the U.S. built a large, productive economy over the years, and Asia holds the mortgage. Well, it's true.
It's also true that Asia has few alternatives. The magnitude of the region's trade surpluses leaves few options other than parking money in the most liquid securities and keeping currencies from rising into uncompetitive territory.
One alternative is euro assets, though diversifying out of the dollar has its risks. If investors got wind of big dollar holders such as Japan, China or Russia rushing into the euro, markets would plunge and leave central banks with major losses.
While this is a tale of co-dependency, the real issue is the extent to which the U.S. is reliant on foreign money.
The U.S. current-account deficit was $176.4 billion in the first quarter, compared with the average shortfall of $100 billion since 1993. That isn't the product of the U.S. supporting global growth; it's about Asia's money helping the U.S. live perilously beyond its means.
Fractured System
If Wall Street's woes worsen, Asia will need those reserves to ward off speculators. Even so, the dollar's gyrations over the last year will make Asians wary.
The Fed's interest-rate cuts weakened the dollar 7 percent against the euro and 5 percent against the yen over the last year, while Bear Stearns Cos.' demise dented confidence in American-style capitalism. Sovereign wealth funds that plunged billions of dollars into U.S. banks may have second thoughts.
For Obama or McCain, the challenge will be to repair a fractured U.S. financial system and to wean consumers off their habit of overborrowing. The process will be even harder as the U.S. finds itself less able to rely on financing from Asia.
How would McCain pay for tax cuts without Asia's money? How would Obama follow through on his protectionist rhetoric in a region on which the U.S. is so dependent?
All the talk from Obama or McCain about a strong America ignores how the U.S. is losing some economic-policy autonomy. Any move by Treasury Secretary Henry Paulson to restructure U.S. agency debt now has foreign-policy consequences and will need to be looked at through that prism.
There's no doubt the next U.S. leader will be a busy man. What's less in doubt is that he will have to manage with less financial help from Asia.
(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net
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