Tuesday, November 18, 2008
the foundation of american exceptionalism
for some time, it appeared to many that the fall might be limited to a foreign policy comeuppance and the obviation of the unipolar worldview. but we should now see that the hubris of what might be seen in retrospect as the reaganite period ran far deeper than a cartoonish foreign policy. the most powerful vehicle of american empire is, as with any empire, not its armed forces but its currency. empires are primarily political and economic constructs, and when the integrity of economic policy particularly is compromised there is no army which can subsequently maintain the integrity of empire.
nouriel roubini has already addressed this point. but today there are others -- via barry ritholtz an anonymous author here, and further at vox eu carmen and vincent reinhart.
i have recently highlighted the plight of iceland, and further passed on the ruminations of willem buiter as he considers -- here and here -- whether the UK isn't already in a very similar triple crisis of banking, sovereign debt and currency. the reinharts further reiterate what it is exactly that differentiates the united states -- which is nearly as well positioned for such a disaster as the united kingdom -- and what could erode that difference which has made the dollar a surprising safehaven.
If this had happened to any other government in the world whose national financial institutions were in as deep disarray as those of the US, investors would have run for the hills – cutting off the offending nation from global capital markets. But for the US, just the opposite has happened.
Rather than facing prohibitive costs of raising funds, US Treasury Bills have seen yields fall in absolute terms and markedly in relative terms to the yields on private instruments. This has been called a “flight to safety”.3 But why do global investors rush into a burning building at the first sign of smoke?
The answer lies in part with the exchange market practices of key emerging market economies.
but resentment is now clearly building in the provinces.
it is becoming clearer to all that what hubristic fools of the last three decades once took as a military, philosophical or even spiritual foundation for american exceptionalism was all along really an economic foundation -- one whose basic manifestation was and remains the dollar and the treasury debt denominated by it. as these pillars erode, so does the american empire wane. reinhart's warning is that what remains of those pillars must now be treated with great care, lest the bulwark that has kept the united states from meeting an awful fate be breached and the prognostications of the anonymous author come to pass.
UPDATE: brad setser on the flight from dollar risk:
Normally, this kind of fall-off in foreign demand would be associated not just with a credit crisis but also with a currency crisis. A country cannot finance a trade and current account deficit without financing, and two big sources of financing for the US deficit — foreign purchases of Agencies and US corporate bonds — has disappeared. The US, though, isn’t a normal country. The fall in demand for risky US assets was offset by a rise in demand for Treasuries and the sale of foreign assets by Americans. ...
The notion that sovereign investors are always and at all times a stabilizing force in the market should be put to rest. China has clearly kept the RMB dollar stable — and been a big source of demand for Treasuries. But it has been a seller of other assets in a time of stress. ...
Of course, Treasuries aren’t entirely risk free. I don’t believe that there is a real risk the Treasury would default. Buying credit-default swap protection on the US is something by colleague Paul Swartz calls an end-of-the-world trade. But foreign investors holding long-term Treasuries are clearly taking a lot of currency risk — especially if they are buying in now, after the dollar has rallied …
The US is taking a risk too. The rising stock of short-term bills held abroad does potentially leave the US more exposed to a rollover crisis.