As the dollar weakens, attention is increasingly focused on the contradiction between the persistence of the dollar as the world’s reserve currency and the loss of global economic leadership of the US. Underlying that contradiction is an imbalance of much relevance. Even while the US has been transformed from a net exporter of capital to the rest of the world to a net recipient of capital from the latter, its expenditures abroad to sustain and expand its “empire” continue to rise.
The fact that the US is a net debtor of substantial dimensions is often traced to its loss of economic leadership, reflected in the rise of its trade and current account deficits. The decline in US competitivenes relative to its trading partners resulted, since the early 1990s in particular, in a widening of the deficit in the trade in goods which could not be neutralised by the gradual increase in the surplus the US earned from the export of services. As a result, the current account deficit of the US which had to be financed with capital inflows has risen continuously since 1991 and touched 6 per cent of GDP in 2006 as compared with 0.17 per cent in 1982. More recently, as a result of the slowdown in growth and the depreciation of the dollar it stood at a smaller but still large 4.89 per cent of GDP in 2008.
However, the US needs capital for other reasons as well. Under normal circumstances, when the deficit on the current account of a country widens, its excess expenditures abroad are curtailed since it needs to import capital to finance even current, let alone capital, expenditures. This constraint does not of course operate on a country which is the home of the reserve currency that is considered “as good as gold” by the rest of the world. That country has the option of just printing more currency and spending it abroad. Put simply, the United States has exploited the “mint in its backyard” to finance its excess expenditures.
A large share of those expenditures reflect what have been termed “the costs of empire”. The most obvious of these are the military expenditures the US incurs in its efforts to police the world and ensure its hegemony. Even considering balance of payments items that are only a partial reflection of such costs, America’s defense related expenditures abroad have soared in recent years becaue of its engagement in Iraq and Afghanistan. There are three items on the balance of payments—Transfers under US military agency sales contracts, Direct defense expenditures and US government grants—that are fully or partially in the nature of defense expenditures. Such expenditures, which rose from $14 billion in 1976 to $44 billion 2000, touched $95 billion in 2008.
But this was only one component of the expenditures related to sustaining the US empire. The less aggressive one was the sharp increase in foreign direct investment which expanded the presence of American transnationals abroad and sustained their competitive position, when the US economy itself was in long-term decline. Net foreign direct investment rose from around $39 billion in 1990 to $399 billion in 2007.
This expenditure has resulted in the peculiar situation where if we examine the net international investment position of the US since the mid-1970s, we find that while it has been characterised by a net outflow on the direct investment account, which has been rising in recent years, there is a huge and rising net inflow in the portfolio investment account. Foreigners have been increasing their ownership of financial assets in the US at a much faster rate than the acquisition of assets abroad by US residents and the US government. Thus, what we have is a situation where global investors were not only holding on to the dollars accumulated abroad during the period of the gold exchange standard but acquiring more dollar-denominated financial assets to sustain America’s profligate spending abroad. American excess delivers the surpluses to the rest of the world, a part of which it then lends to the US at relatively low rates of return to finance that excess. It is this peculiar form of global economic integration that explains the paradox of persisting dollar hegemony in a world in which US economic power is on the decline.
It needs to be noted that not all of this inflow of portfolio investment was on account of the investment of foreign exchange reserves accumulated by central banks. While the increase in foreign official assets in the United States did contribute a tidy sum over the last six years, even during that period it was in most years well below a third of the total increase in foreign owned assets. This implies that two-thirds of the portfolio investment in the US came from “non-official” or private sources. In sum, America’s empire is increasingly sustained by its growing indebtedness not just to government but to wealth holders abroad. They too are keen that the dollar holds and their wealth retains its value, at least till they find ways of diversifying their portfolio.