Duncan continues, and explains that reducing our deficit is actually bad, because it wouldn’t allow the FCBs to buy all the Treasuries they need to buy with their dollars, and that would cause even more asset bubbles and push interest rates even lower. The Fed has lost control of the long end of the yield curve, so they are talking down the dollar to regain control and bring up the yield.
“Soon, foreigners will own all US debt. At present, foreign investors own approximately 50% of the $4 trillion in US government debt that is held by the public. Under the circumstances just described, within four years, foreign investors could end up owing all outstanding US government debt.
After that, they would have no choice but to invest their annual surpluses into other dollar-denominated assets, such as agency debt, corporate debt, equities, property, bank loans, etc. Such a scenario would cause extraordinary asset price inflation, directly as foreign investors bought
more and more US assets, and indirectly as their acquisition of bonds drove down interest rates, providing still more unwanted stimulus to the US economy.
Regardless, then, of whether the US government reduces its budget deficit or not, it would appear that the rapidly expanding US current account deficit has begun to undermine the ability of the Fed to determine the level, or even the direction, of interest rates in the United States.
Moreover, if the present trend in the current account deficit is left unchecked, the investment of ever larger amounts of dollar surpluses by foreign central banks into US dollar-denominated assets threatens to produce asset price bubbles and economic overheating in the Untied States over which the Fed would have no power to control.
Seen from this perspective, there is little wonder that the Fed has begun to talk down the dollar. These fears may also explain why the United States has recently launched an aggressive campaign to force China to revalue the Yuan.
Their best hope of regaining control over the situation is for the United States to force a sharp devaluation of the dollar relative to all the Asian currencies in order to reduce the US current account deficit; the European economies are simply too weak for the Euro to bear any more of the burden of adjustment. The United States has now adopted – and begun to enforce – a Weak Dollar Policy. Asia must come to terms with this fact and recognize that this policy shift poses a grave threat to its export-led model of economic growth.
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