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September 06, 2003

The Hashimoto Factor
by Willett / Alway

"There is no precedent to go by, for there has never been a reserve-currency issuer that turned into a profligate debtor." - Marshall Auerback

On June 23, 1997 former Japanese Prime Minister, Ryutaro Hashimoto, sent a chill through the global financial markets after he wondered aloud' what would happen to the U.S. economy if Japan began to sell some of its $300 billion in U.S. Treasury Securities and began buying gold. Following Hashimoto's remarks the Dow Jones Industrial Average plunged by 192 points - the largest single day point loss for the Dow since the Crash of 1987.

Although the Hashimoto incident has long been forgotten - especially since chaos on the Asian markets led to a 554 point Dow drop later in 1997 (Oct 27) and Japan never did sell its Treasuries - what should not be forgotten is the potential political and economic leverage, both indirect and direct, which foreign ownership of U.S. Securities entails. To be sure, whether it is an off the cuff remark/threat from Hashimoto (aides to Hashimoto were quick to say that the comments were not intended as threatening) or rumors that China is retaliating to Yuan revaluation pressures by curtailing its Treasury purchases (a rumor neither confirmed nor denied) it is the supporting players in the U.S. Treasury market saga that are increasingly proving to be director, producer, and General of the U.S. future.

That the U.S. economy is increasingly slipping into a condition of foreign dependency requires some elaboration. To this end, consider the possible effects of foreign dependence along two fronts, one passive and one active. Along the passive front there is no requirement for any specific action on the part of foreign governments for U.S. dependency to be realized. In fact, all that is required is that foreign holders express disinterest in U.S. Treasury offerings - either because interest rates are not considered attractive enough or for 'other' reasons. Since the U.S. must take in roughly $1.3 billion a day in foreign investment to finance its current account deficit, a mere abstinence from further Treasury purchases is enough to produce dramatic consequences for the U.S. economy. If the current account is not balanced by capital inflows, U.S. interest rates would have to rise and the dollar would fall. This would affect economic activity not only directly by making domestic borrowing more expensive, but also indirectly by increasing the cost of imports from countries whose currencies are increasing versus the dollar (i.e. inflation). The fear is that this could turn into a self-perpetuating crisis: as the dollar declines and/or interest rates rise, a global run out of U.S. assets could precipitate.

The possible cost becomes even more apparent when one considers that the current U.S. economic expansion has been fueled in large part from declining interest rates - in particular through mortgage refinancing. That many are already fearful that the recent jump in interest rates threatens to de-rail the recovery speaks volumes about the lengths to which the U.S. administration would be willing to go in order to prevent major capital flight. Action, or more accurately re-action, would have to be taken. In any event, if the administration is forced to align its economic decisions with foreign investors in mind, specific domestic considerations may be forced to take a back seat.

Moreover, the repercussions of this dependence are not only economic but political: major foreign purchasers need to be kept on good terms, must have their chief concerns assuaged if the U.S. deficit machine - a machine which assembles not only domestic programs but overseas interests - is to be kept oiled. Should foreign investors become "disillusioned" with the benefits of holding U.S. debt, the costs to the U.S. could be greater than any potential political trade-offs.

'Other Reasons'

"For 20 years the rest of the world has been willing to invest in the U.S. and that could end in tears." Jeffrey Frankel, professor of economists at Harvard University

Of course the issue surrounding the foreign ownership of U.S. assets can hardly be reduced to the daily capital needs of the American economy or to the passive potential of foreign investors. Rather, the larger related issue is with the possible impact that an activist foreign government could have on American policy latitude. Documenting the increasing magnitude of foreign investment as a percentage of total assets allows us to open up this "active" front. Put more simply, the real nightmare is not simply that the foreign penchant for U.S. assets will wane, but that foreign governments will actually begin to sell what assets they already own in order to realize some ulterior policy objective. The potential for damage here is much greater than at any time in recent history for two reasons: 1) foreign interest in the spectrum of U.S. assets (data sets below) has increased dramatically over the last two decades - much more dramatically than U.S. interest in foreign assets (Excel). 2) These assets are concentrated in new regions of the globe - Asian countries are estimated to be in control of more than 70% of global currency reserves, or more than $1.2 Trillion in U.S. dollars. Accordingly, any significant attempt at disinvestment by a major holder of U.S. debt - China, Japan - or concerted sell-off by a collection of lesser players - Hong Kong, Korea, Taiwan, Thailand, and Singapore (which hold more in U.S. Treasuries combined than Mainland China) - would invariably produce a precipitous decline in the greenback. Under such a scenario the U.S. economy would threaten a complete collapse regardless of any attempted stimulus measures from the Fed or government.

To be sure, as foreign ownership - particularly Asian ownership - of U.S. assets and greenbacks has increased, so too has the United State's reliance on this steady inflow of capital. To some extent, of course, this has been a deliberate and desired policy goal - capital inflows allow certain policy objectives to be achieved without unduly taxing the domestic economy. The post-Bretton Woods United States thus enjoyed an unparalleled capacity to fund its empire by attracting foreign capital into its coffers - even if this meant that that foreign capital was thereby made unavailable for local development purposes. However, in what can be coined a classic tug of war, the question becomes at what point does foreign ownership of U.S. assets undermine rather than support U.S. policy objectives? When does neo-imperialism elide into dependency?

At first, it may seem unduly alarmist to argue that the U.S. economy is destined to suffer the type of panicky capital outflows which befell Thailand, Korea, and numerous others in the late 1990s. Similarly, it might seem overly xenophobic to suggest that Asian countries such as Japan and China - two of the largest holders of U.S. Treasury securities - would suddenly bite the hand that feeds their exporters a steady stream of revenues. After all, so the argument goes, we now live in a more interdependent, globalized world. Why would foreign governments take policy actions which could potentially damage their own economy?  Are such concerns not increasingly anachronistic?

A quote from Norman Angell's The Great Illusion, published shortly before the outbreak of two of the most violent conflagrations in human history (1909) is perhaps illustrative of why such views are historically myopic:

"It is assumed that a nation's relative prosperity is broadly determined by its political power; that nations being competing units, advantage in the last resort goes to the possessor of preponderant military force, the weaker goes to the wall, as in the other forms of the struggle for life. The author challenges this whole doctrine. He attempts to show that it belongs to a stage of development out of which we have passed, that the commerce and industry of a people no longer depend upon the expansion of its political frontiers; that a nation's political and economic frontiers do not now necessarily coincide; that military power is socially and economically futile, and can have no relation to the prosperity of the people exercising it; that it is impossible for one nation to seize by force the wealth or trade of another -- to enrich itself by subjugating, or imposing its will by force on another; that in short, war, even when victorious, can no longer achieve those aims for which people strive..."

Leaving the realm of hyperbole that the above quote might suggest, there are some specific and on the surface quite minor 'other reasons' which might explain why Asian countries would intentionally opt to dump U.S. assets in order to leverage some other political goal. These can be captured by one word: retaliation.

Suffice it to say, more than 6-years ago Japanese Prime Minister Ryutaro Hashimoto sent out a warning shot heard round the financial world (if only for a moment) because he believed that the United States was not doing enough to keep the dollar/Yen exchange rate stable. Flash forward to today: the U.S. is trying to force China to revalue the Yuan, Japan is endlessly trying to deflate the Yen, and the Euro is all over the map. Is it really that difficult to imagine similar Hashimoto-type threats being offered desperately during the next currency crisis?

Conclusion: The Hostage Situation

Aides would later say the media 'misinterpreted' Hashimoto's comments.

Japan's bargaining power with the United States today isn't based upon its ability to absorb the inflationary pressures that would otherwise be produced by the American labour market - China suitably fills that role. Rather, it is the country's unmatched and ever escalating holdings of U.S. Treasuries. Getting back to China, while Japan's $441 billion in Treasury's is the most significant trump card, China is quickly catching up.

In short, since other countries continue to mirror Japan's penchant for U.S. debt, since foreign ownership of U.S. assets has reached unprecedented (from available data) levels, and since burgeoning U.S. dollar reserves are stocked inside Asian central banks, the dynamics of the U.S. backed neo-liberal order have, seemingly suddenly, been altered. This doesn't foretell of fire and brimstone raining down on the U.S. economy at any moment - ratios such as debt/GDP, and current account deficit/GDP are hardly absolutes in predicting near term capital movements, and economists like Krugman have been arguing that "the dollar is vulnerable" and "foreigners are reluctant to make long-term financial commitments to the U.S. economy" since 1991 (or before the real explosion in foreign investment arrived) but it does show a crack in the foundations of the American empire. Quite frankly, should current trends continue the consent of foreign governments will be the main force holding the U.S. world order together - reversing the hostage situation the U.S. previously and currently imposes on many economies. In the future, the U.S. rather than its former dependants may be the one subject to the "austerity" measures demanded by bondholders.

As Snow heads to Asia this week with the mandate of trying to strengthen the trading band of the Yuan, every dollar watcher is on the edge of their seats. Will Snow bring back an unpegged Yuan, or will China successfully resist another Plaza Accord because of their potential to undermine U.S. economic policy? Whatever the case may be, the Hashimoto factor should not be forgotten. The United States needs foreign investment now more than ever before, and this is unlikely to change at any point in the foreseeable future. The U.S. economy and the bubbles inherent to its financial markets are only sustainable so long as foreign capital (and those who control it) is placated.

Foreign Ownership of U.S. Treasury Securities: What the Data Show and Do Not Show
www.ny.frb.org/rmaghome/curr_iss/ci4-5.pdf

United States Transactions with Foreigners in Long-Term Securities
www.treas.gov/tic/ticsec.html
www.bondmarkets.com/Research/tsyhold2000.shtml
www.ustreas.gov/tic/mfh.txt

The US Economy; A Changing Strategic Predicament. - Levy
www.levy.org/docs/stratan/stratpred.html

Brady Willett & Todd Alway
BWillett@fallstreet.com
www.wallstreetwishlist.com

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