Remember, foreigners have to recycle their trade surpluses back in USDs in order to settle global trade and hold enough currency reserves in their central banks.
(Historically they have done so by buying US Treasuries since these are considered risk-free assets)
This is an easy way to earn yield on a massive amount of USDs that have built up on their balance sheet.
After the 2008 GFC the US government borrowed a lot to fund TARP and increase unemployment benefits. The majority of this borrowing was backed up from foreign creditors purchasing the US Treasuries who bought around 70% of the new debt issued, the Fed bought most of the rest.
However, since 2015 foreign banks have eased up on their purchasing of US treasuries and foreign purchases flatlined and no net increases for several years.
This is surprising given that the trade deficits were still increasing, so the US was still sending out more dollars into the world than it received.
US debt ballooned to $9trillion but foreigners only bought 14% of that from 2018-2022.
This was a drastic decrease from their buying in previous years.
America has taken on too much debt and at the time rates were too low, so foreign banks did not buy their usual amount of US treasuries.
But they still had to recycle their dollar surpluses effectively, so they bought assets denominated in USD. (Equities, real estate etc)
So they have started massively investing in US assets.
US owns 29trillion in foreign assets while foreigns own 42trillion in US assets. This represents a whopping 60% negative NIIP and has fueled the creation of a massive stock and real estate bubble domestically.
All this has boosted growth in the past but also creates systemic risk.
With foreigners owning so much in US assets it means a large proportion of wealth creation is being siphoned off overseas and doesn't recycle back into America communities.
This contributes to wealth inequality all over the globe and creates the potential for a massive rug pull on the American economy.
If foreigners began to lose confidence in the US economy they could essentially begin a run on the dollar.
This would begin by massive selling of US treasuries but could spread to stocks and real estate causing widespread deflation much worse than 2008.
The FED would then be faced with the grim choice of either letting $42trillion of US assets be fire sold into a new great depression or ramp up QE to bride the assets on sale.
Untold trillions of dollars would need to be printed. This would make the current QE program look like a joke in comparison.
Most foreigners don't want to invest in US assets especially treasuries, but are forced to die to the structure of the system and the fact there is no good alternative for now...
Replies (5)
For geopolitical rivals of the US, they view this system as an extremely potent force to help maintain the US status as an economic superpower.
Look at the world or the US from the position of China. What makes America a superpower? Military? Partly. Nuclear weapons? Not so much. What really gives us leverage is the position of the dollar as the base currency.
We escaped the last GFC largely by printing money.
Other countries cannot get away with that without causing massive inflation.
Viewing the US Treasury printing money from Beijing, this has the effect of exporting inflation to other countries. We borrow money by selling treasuries to finance our wars and then pay them off in essence by printing dollars.
The dollar is a uniquely powerful lever one that is rarely thought of in terms of national security. But nothing is more important.
If we lose it, we will have lost our position as the last superpower.
These rivals, particularly Russia, China, and Iran have been hit the hardest by US sanctions and economic warfare.
They are not alone, even allies like UK, India, Germany, and others are tired of being exploited by this system.
The exorbitant privilege created by Triffin's Dilemma means these countries have to work hard to produce goods and services that are swapped for the US dollar which we can print out of thin air.
They then have to exchange these dollars for US assets instead of investing in their own countries.
We get cheap goods and cheap debt, fueling our overly consumerist culture, while they get more inflation and less investment in their own economies.
The ill effects of this dilemma are building up and corroding the very system which provides the US with so much economic dominance.
In 2015, foreigns stopped buying US treasuries essentially they decided to stop funding growing US deficits. Which means the US is on the hook for any new government spending that occurs since there is no, or very little, lending coming into the US from global central banks.
We then had to source it ourselves.
This began with structural changes money market funds and bank capital requirements. (Basil 3 and Dodd Frank)
This forced institutions to buy treasuries for their balance sheets
These money market funds doubled from 0.8trillion to 2.1trillion from 2014-2016 and then 4.9trillion by 2020.
These MMFs almost exclusively bought short term maturity t-bills, essentially becoming a large new lender for the government.
However these institutions only have so much money so it could only buy a limited amount of time.
Beginning on March 2020, the government began massive fiscal expenditures to deal with the fallout of Covid.
This time was different, since global banks weren't lending to the US, our government had to print the difference.
The FED had to step in and back stop the Treasury US fiscal deficits which hadn't mattered in 40 years, now began to matter.
The FED directly purchasing treasuries is harmful to the system and is directly inflationary to the United States instead of allowing other global central banks to print and inflate their own currencies.
That's not how a global reserve currency is supposed to work.
That is like a chef eating her own cooking more than her customers do.
In ONE YEAR the FED went from owning half as much treasuries as foreign central banks to more than ALL OF THEM COMBINED.
In 2008 when the FED did this the money had stayed in the banking system due to the nature of QE, however this time it was the government and entire US economy that needed to be bailed out, so that is where the dollars had to flow. This led to a massive influx of dollars into the real economy and thus the recipe for a large surge in inflation in the coming years.
With fiscal deficits at 2.8trillion in 2021 and foreign central banks financing almost none of it, that means there is 2.4trillion in US treasuries that need to be bought.
There is no surprise that foreign leaders have seen those writing on the wall and have begun to pull support for US treasuries.
Would you want your hard earned taxes being invested in a reserve asset that's losing 7.5% of its value annually and is projected to lose even more as the debt payments come due?
Triffin's Dilemma:
The reserve currency country must run persistent current account deficits in order to provide the rest of the world with reserves denominated in its currency.
In doing so, it becomes more indebted to foreigners until the risk-free assets ceases to be risk-free. The elites understand this issue perfectly.
But the reason the system did well for so long is because US debt levels were manageable and structural advantages the US had that helped it immensely including a deep and liquid bonded stock market, large population, and a large percent of global trade.
But they also understand that Triffin's Dilemma is the final nail in the coffin and every past reserve asset country has only lasted 80 years on average.
The USA needs to decide whether to not print dollars and import goods which halt global trade causing defaults for third world countries with debt denominated in dollars or..
It has to decide to run current account deficits to keep the global economy running at the expense of burying itself in debt and de-industrializing the heartland resulting in the US eventually having to print their way out.
Which will kill the US dollar as a global reserve currency.
March 2020, the FED printing trillions which caused inflation which they then swore to fight this they then began hiking interest rates on March 16th 2022 and began QT later in the summer.
QE has stopped new money from flowing out into the system which had constant demand for them. Worse yet, they were hiking completely blind.
Although the FED are very far behind the curve, other countries are even further behind.
This is the basis for the Dollar Milkshake theory.
The US has built-in demand for its currency. No other Fiat currency has this. This comes from foreign central banks that need dollars for foreign exchange reserves and import/export firms that need dollars to settle trade invoices and sovereign wealth funds that need a secure/liquid place to invest their capital.
As the dollar rises, a vicous feedback loop emerges where countries need to dump increasing amounts of their own currency to get their hands on USDs.
This rise in DXY increases borrowing costs for countries and businesses with debts denominated in dollars which puts severe strains on economic growth and forces more capital to flee to the US to seek safe harbor.
Worse yet, the more the FED raises rates the more strain it exerts onto the system. By hiking domestic rates above foreign rates (Japan is at 1% and Euro zone at 4%) the FED is incetivizing what's called Carry Trades.
Since there is a spread between the Yen and Dollar in terms of interest rates, it is profitable for traders to borrow in Yen and then buy Dollars which can earn interest.
DXY rises and the Yen falls in a vicous feedback loop thus capital flows out of Japan and into the US.
America sucks up the Dollar milkshake draining global liquidity. This has seriously dangerous implications for the global financial system.
Everytime the FED stops printing money and hikes rates too quickly, it causes havoc on global trade as seen in the currency markets because not enough dollars are flowing out to satisfy demand from the carry traders.
This was evident in the currency crisis of the Yen, Euro, and the Pound in September 2022.
The FED must then restart QE and open up dollar swap lines unless it wants to sour a collapse on a global scale.
Remember, all these countries need to buy, borrow, and trade on a currency that they cannot print.
The largest factor by all is their desperate need for dollars. The FED knowingly or not is basically in charge of the global financial system.
When they raise rates, they trigger a margin call on the entire world. They need to bail them out by then supplying fresh dollars to stabilize their currency.
In other words, the FED has to run the loosest and most accommodating monetary policy worldwide in the long run. They must keep rates as low as possible and print as much as possible in order to keep the global financial system running.
If they don't do that, sovereigns begin to blow up. If this happens they will not only need to bail out the US but virtually every global central bank.
The money needed for this would be easily in the dozens of trillions.
Post Bretton Woods, the US has become and empire and essentially created financial colonies in most of the third world by forcing them to use US dollars these counties subordinate their economies to support the value of the US dollar allowing America to borrow and spend recklessly without immediate consequence.
By using USDs, these foreigns are routed through the US banking system and subject to US foreign policy even policies that are not supported by the United Nations.
The US can essentially extend its jurisdiction over much of the global economy and cut off trade for those countries who protest.
But this power comes with a cost.
By exporting jobs, wages deflate across the US and wealth inequality worsens. Political polarization quickly follows along with the destabilization and corruption of institutions. The system requires ever increasing flows of dollars to satisfy demand and the FED will be forced to respond with a river of fresh greenbacks. Inflation that the US has now exported is a latent risk in the form of treasuries held by foreigners.