Suez, America-style

By Reuters Staff
August 26, 2008

It’s no longer any secret that the USA is deeply in hock to foreign governments, particularly China, Japan, the Petro States, and increasingly Russia. We have two very large deficits that have to be financed: a trade deficit and a fiscal deficit. Americans buy more than they sell. We consume more than we earn. To keep the process going, Americans and our government have to borrow money from abroad. At rates that are totally unprecedented.

As I.O.U.S.A. notes, foreigners today own a larger share of American society than ever before. (During WWII the U.S. government ran up much larger deficits as a percentage of GDP, but these were financed primarily by American citizens themselves.)

This leaves our economy incredibly vulnerable. But how? It’s easy to understand military vulnerabilities, not so easy to contemplate economic vulnerabilities.

The 1956 Suez crisis has much to teach us…..

Back then we were the ones wielding the financial weapon, against our friends the British. Eisenhower had a disagreement with the English about how to handle Egypt in the wake of Egypt’s nationalization of the Suez Canal. A 2004 article from The Atlantic says it this way:

The British Empire…endured the humiliating demise of its great-power status in [the 1956] clash over the Suez Canal. U.S. policymakers should take note: Britain was brought to its knees not by a military defeat but by an economic one—specifically, America’s refusal to support the British pound, which created a monetary crisis for the British government, forcing it to call off its ill-advised campaign with France and Israel to recapture the Suez Canal after nationalization by Egypt. As its international debt grows, the United States becomes ever more vulnerable to its own Suez moment.

Since that article was written in 2004, our international debt has grown substantially. Foreigners who hold our debt could sell it in large chunks. And selling dollar-denominated debt is tantamount to selling the dollar itself. In such a situation, sellers of dollars would outnumber buyers and the dollar’s price would go down. Hard.

There are those who argue that the Chinese would never deliberately spark a run on the dollar. For one thing, their foreign reserves are largely concentrated in dollars: as the value of the $ goes, so goes the value of their national savings account.

But this argument assumes China’s government will behave like a rational trader. A hedge fund with a concentrated position in a stock can’t exit the position all at once because it’ll hammer the value of its own holdings. True enough. But China isn’t a hedge fund. It’s an emerging superpower with interests that extend beyond the value of their foreign reserve accounts.

It’s also true, of course, that the Chinese economy is driven largely by exports to the U.S. A fall in the value of the dollar wouldn’t just decimate the value of their foreign reserve holdings, it would cause major disruptions in their economy as exporters are driven out of business.

And yet as its consumer class explodes, China’s own domestic market will one day be large enough to absorb most of what the country produces. No longer will the country’s economy depend on exports to survive. At that point it might even make sense for China to let the dollar collapse against its own currency. That will give the Chinese even more economic heft to compete with Americans for the world’s goods and services.

Ike’s economic power play at Suez in 1956 ended the British empire. If we can do it to the British, why wouldn’t the Chinese some day do it to us?

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