[House Hearing, 110 Congress]
[From the U.S. Government Printing Office]
FOREIGN HOLDINGS OF U.S. DEBT:
IS OUR ECONOMY VULNERABLE?
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
HEARING HELD IN WASHINGTON, DC, JUNE 26, 2007
Serial No. 110-13
Printed for the use of the Committee on the Budget
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COMMITTEE ON THE BUDGET
JOHN M. SPRATT, Jr., South Carolina, Chairman
ROSA L. DeLAURO, Connecticut, PAUL RYAN, Wisconsin,
CHET EDWARDS, Texas Ranking Minority Member
JIM COOPER, Tennessee J. GRESHAM BARRETT, South Carolina
THOMAS H. ALLEN, Maine JO BONNER, Alabama
ALLYSON Y. SCHWARTZ, Pennsylvania SCOTT GARRETT, New Jersey
MARCY KAPTUR, Ohio MARIO DIAZ-BALART, Florida
XAVIER BECERRA, California JEB HENSARLING, Texas
LLOYD DOGGETT, Texas DANIEL E. LUNGREN, California
EARL BLUMENAUER, Oregon MICHAEL K. SIMPSON, Idaho
MARION BERRY, Arkansas PATRICK T. McHENRY, North Carolina
ALLEN BOYD, Florida CONNIE MACK, Florida
JAMES P. McGOVERN, Massachusetts K. MICHAEL CONAWAY, Texas
BETTY SUTTON, Ohio JOHN CAMPBELL, California
ROBERT E. ANDREWS, New Jersey PATRICK J. TIBERI, Ohio
ROBERT C. ``BOBBY'' SCOTT, Virginia JON C. PORTER, Nevada
BOB ETHERIDGE, North Carolina RODNEY ALEXANDER, Louisiana
DARLENE HOOLEY, Oregon ADRIAN SMITH, Nebraska
BRIAN BAIRD, Washington [Vacancy]
DENNIS MOORE, Kansas
TIMOTHY H. BISHOP, New York
GWEN MOORE, Wisconsin
Thomas S. Kahn, Staff Director and Chief Counsel
James T. Bates, Minority Chief of Staff
C O N T E N T S
Hearing held in Washington, DC, June 26, 2007.................... 1
Hon. John M. Spratt, Jr., Chairman, House Committee on the
Hon. Paul Ryan, ranking minority member, House Committee on
the Budget................................................. 2
Peter R. Orszag, Director, Congressional Budget Office (CBO). 5
Prepared statement of.................................... 7
Robert D. Hormats, vice chairman, Goldman Sachs
Prepared statement of.................................... 45
Mickey D. Levy, chief economist, Bank of America............. 49
Prepared statement of.................................... 52
Kenneth Rogoff, Thomas D. Cabot professor of public policy
and professor of economics, Harvard University, and
visiting fellow, Brookings Institution..................... 57
Prepared statement of.................................... 60
Brad Setser, senior economist, Roubini Global Economics and
research associate, Global Economic Governance Programme,
University College, Oxford................................. 62
Prepared statement of.................................... 65
FOREIGN HOLDINGS OF U.S. DEBT:
IS OUR ECONOMY VULNERABLE?
TUESDAY, JUNE 26, 2007
House of Representatives,
Committee on the Budget,
The committee met, pursuant to call, at 2:04 p.m., in room
210, Cannon House Office Building, Hon. John M. Spratt, Jr.
[Chairman of the committee] presiding.
Present: Representatives Spratt, Edwards, Cooper, Kaptur,
Becerra, Doggett, Blumenauer, Berry, Sutton, Scott, Etheridge,
Hooley, Ryan, Lungren, Simpson, Tiberi, Porter, Alexander, and
Chairman Spratt. I would like to open the hearing and thank
everyone for their coming and attendance. And I have a brief
opening statement. Then we will turn to Mr. Ryan and then to
Mr. Orszag to begin our hearing today.
We are here to talk for a change about the elephant in the
room. Our subject is foreign holdings of U.S. debt and the
question is our economy vulnerable? We touched on this issue
last January when we held a hearing on why deficits matter.
Today we explore the subject further.
At our January hearing, we heard from Ed Gramlick and Ted
Truman that budget deficits are part of a broader problem, low
national savings, which diminishes the prospect of long-term
growth and, in particular, the well-being of our children and
We heard that our entire economy, both public and private
sectors, are relying to an unprecedented extent on foreign
debt, foreign capital to fund current investment and
consumption because other countries are much more diligent than
we are at saving.
We were reminded that national saving is the sum of public
and private saving and that recent budget deficits are negative
public saving and are driving down overall national savings
which is already woefully inadequate.
Our reliance on foreign capital to fund our budget deficits
has grown tremendously since 2001. Foreign holdings of Treasury
securities have more than doubled to a level of $2.2 trillion,
accounting for nearly half of marketable Treasury debt.
For every dollar of additional funds the federal government
has borrowed since 2001, an estimated 80 cents is owed to
Most economists now believe that perennially growing
deficits are unsustainable, certainly that endless growing
foreign debt is unsustainable, and that our worsening and
deepening current account deficit is unsustainable.
No one can predict exactly when our economy hits the wall
or whether there will be a soft landing or a hard landing. We
have asked today's witnesses to testify on this topic so that
we can better understand the gravity of this problem, what the
federal debt and deficit spending have to do with it, and what
deficits policy role should be to mitigate the adverse economic
We are fortunate to have an impressive panel of witnesses
today. First we will hear from Dr. Peter Orszag, the Director
of the CBO. And then we will hear from a panel of very
distinguished economists and foreign policy experts, Dr. Robert
Hormats, Dr. Mickey Levy, Dr. Kenneth Rogoff, and Dr. Brad
We thank each one of you for coming, for agreeing to
testify, and for the time you are taking. We look forward to
your testimony and the answers to our questions that follow.
Before turning to Dr. Orszag, however, let me turn to Mr.
Ryan for any opening statement he would like to make.
Mr. Ryan. Thank you, Mr. Chairman. And first of all, I want
to thank you for getting the hearings up and running here. I
think we have a number of interesting hearings and I am looking
forward to participating in those.
Clearly members on both sides of the aisle share a concern
about the effects of chronic deficit spending and the resulting
accumulation of debt that we are discussing here today. So it
is fitting we have this hearing.
It is not simply enough to rail against deficits, to rail
against debt, and then rail against the fact that foreigners
are buying it up. Yes, we have a debt and, yes, we have chronic
deficits and a considerable share of that debt is held by
foreign investors. These are the facts that are before us
The question is, and I imagine the purpose of this hearing
is, what are we going to do about it? First, we have got to
understand why we have the deficits and why we have the debt
Clearly there are some political points that are going to
be had by some who want to play the blame game, claiming the
U.S. government would be rolling in money had, say, Republicans
not squandered through our reckless tax cuts and spending the
often quoted 2001 projected $5.6 trillion surplus.
But, once again, if you go back and look at the facts, we
never actually had that money. It was a projection of what our
number crunchers thought we have if everything went according
to their assumptions. Clearly it did not.
Their assumptions did not foresee the bursting of the dot
com bubble, the eruption of corporate scandals, or the economic
slowdown and the recession that had already begun, and, of
course, the forecasters did not foresee the attacks of 9/11 and
ensuing War on Terror.
Tax relief was not the problem. Well-timed tax relief not
only helped buoy the economy out of recession, it also fostered
investment leading the way to significant job creation and
sustained economic growth that we continue to enjoy today.
That growth has fueled double digit revenue growth and has
been the key factor in not only dramatically driving down the
deficit but also to getting within striking distance of
balancing the budget.
The cause of the deficit and debt is that Congress has and
continues to spend too much money. I will be the first one here
today to acknowledge that Republicans spent too much money when
we were in the majority.
After 9/11, we said largely in a bipartisan way whatever it
takes and we deliberately spent enormous amounts and took on
debt. But we also allowed pork barrel spending to explode and
get out of control and we took far too long to get our act
together to do anything about it.
But we did not just throw up our hands and raise taxes to
make up for all that spending. We finally slowed down the rate
of nonsecurity appropriations spending and, more important, we
took a critical first step to address our largest and least
sustainable spending growth about reforming entitlements,
albeit to a small degree.
We set a plan to keep our economy growing strong and slow
down our unsustainable spending growth and we made significant
progress in the right direction. But we did not do nearly
enough and we have still got major spending problems that we
have to deal with.
Mr. Ryan. And I would like to bring up chart one if I could
at this time. We have been told time and time again that the
unrestricted growth of our nation's largest entitlements is the
chief threat to our nation's long-term fiscal health. With the
coming retirement of 78 million baby boomers, this problem is
going to get exponentially worse.
Let us take a look at where we are heading. If we do
nothing as the current budget resolution proposes, look at
Mr. Ryan. This is the debt projection we have in front of
us by doing nothing to restrain our entitlement programs. We
see the levels of debt required to meet our spending
obligations in the decades ahead will absolutely cripple this
And so this is where our conversation needs to go. We need
to be constructive to look for solutions to this issue rather
than just score political points or simply rail against the
past. We need to start with addressing the problem and the
problem is spending, and it is a problem which both Republicans
and Democrats share in the blame and a problem that we must
work together to fix.
I also think it is important for today's conversation that
we focus on another issue critical to this Committee and that
is how our choices impact our nation's global economic standing
and our ability to compete in the global marketplace.
Traditionally we have been able to attract foreign capital
and we are the world's top destination for foreign capital as
evidenced by all this debt that is being bought by foreigners.
Because we have a strong innovative economy with deep liquid
capital markets, that is the case.
But remaining attractive to investors is not simply a
given. We have got to make choices that support the fundamental
features of a successful economy, low tax burdens, strong
growth potential, and favorable legal and regulatory
environment, and prudent fiscal policies that deal with long-
Actually choosing to put our nation on the path of ever-
higher spending chased by ever-higher taxes will not only
severely threaten our economy at home, it sends a pretty dire
message to the world about our likely economic future.
And it is just not rhetoric. International economic data
confirm the fact that economies and countries with bigger
governments tend to have slower rates of real GDP growth. Let
us just take a look at France. Total government receipts in
France represent more than half of their economy, one of the
highest shares in the OECD. Not surprisingly, France has just
averaged 1.5 percent real GDP growth over the last five years.
By comparison, U.S. combined federal and state local
government receipts account for about one-third of the overall
economy and we have averaged close to three percent GDP growth
over the last five years, double the growth rate of France.
That is not a coincidence. It is the direct result of choices
we have made. It is the result of the choice that we have made
to be a country of limited government, a country that rewards
the entrepreneur and provides freedom for the individual.
And as we move forward, it is vitally important that we
continue to make these types of choices so we do not leave our
children with an economy that is weighed down by enormous
government debt, because right now with inaction, that is a
very real possibility.
This chart is not only a possibility, it is the projection
and trajectory we are on right now. Entitlement programs
continue to grow at unsustainable rates and are projected to
double in size in the next 30 years. If we do nothing now to
reform them and instead put off these tough choices as the
current budget resolution does, our debt condition will be far
worse than what we are talking about today and our tax burden
will be twice as high.
So I am glad we are having this hearing today. We need to
have this conversation and we need to ensure that we are making
the right choices now both for the next year and for the next
generation so that our children can enjoy an America that
continues to thrive, that continues to produce jobs, and
continues to be the same attractive place in which to invest in
as it is today.
And with that, I yield, and I appreciate the Chairman for
Chairman Spratt. Thank you, Mr. Ryan.
At this point, let me say that all members without
objection shall be allowed to submit for the record an opening
statement at this point in the record.
Let me say also to Dr. Orszag and to all of our witnesses
that you may submit your statements for the record as well and
summarize to the extent that you find necessary.
Dr. Orszag, you are the lead witness. We are glad to have
you. We look forward to your testimony.
STATEMENT OF PETER ORSZAG, DIRECTOR,
CONGRESSIONAL BUDGET OFFICE
Mr. Orszag. Thank you very much.
Chairman Spratt, Mr. Ryan, members of the Committee, thank
you for having me back today to testify. My testimony makes
four main points.
The first is that as has already been noted foreign
holdings of U.S. Treasury debt have been rising rapidly.
Between 2003 and 2006, for example, such holdings rose by about
50 percent and their increase accounted for almost three-
quarters of total federal borrowing over that period.
Such holdings now exceed $2 trillion and account for more
than 40 percent of Treasury debt held by the public. Although
the estimates are imperfect, evidence suggests that East Asian
countries are associated with a significant share of recent
increases and at the end of last year, such countries accounted
for almost two-thirds of foreign holdings of Treasury
In addition, the increases have been disproportionately
tied to foreign official activity rather than private investor
activity. At the end of 2006, foreign central banks owned 66
percent of all federal debt held by foreign residents which is
up several percentage points from 2003. And such foreign
official purchases account for roughly or a little bit more
than half of federal borrowing since 2003.
My second point is that these increasing foreign holdings
of U.S. government debt are related to a more fundamental issue
which is the nation's substantial current account deficit. This
current account deficit must be financed by increasing
liabilities to and assets held by foreign investors.
In particular, the current account deficit expanded from
under two percent of GDP in 1997 as shown in my first chart to
more than six percent last year.
As a result of these ongoing current account deficits, the
net international indebtedness of the United States, that is
how much U.S. investors own abroad minus how much foreigners
own here, deteriorated from about ten percent of GDP, which is
shown in figure two, to about twenty percent in 2005. You see
that decline that was occurring in the late 1990s and early
So why has the current account deficit increased? There are
a variety of perspectives that can be brought to bear on that
question, but one is to examine the difference between domestic
investment and national saving.
As figure three shows, net domestic investment climbed
steadily throughout the 1990s and then declined on balance in
the early 2000s. On average, it has been about seven percent of
national income since 1990 and in the past four years. This net
domestic investment must be financed either by net national
saving or by increasing net foreign claims on U.S. assets.
Since the late 1990s, it has been financed increasingly by
foreign claims as the rate of net national saving also shown on
this chart has declined from an average of more than four
percent in the 1990s to an average of about one percent in the
past four years.
In other words, from this perspective, the increase in the
current account deficit that has occurred reflects the decline
in net national saving that you can see on that chart.
So the question then becomes why has net national saving
declined and one can in the next chart break the decline in the
rate of national saving into its components, in particular
federal and private net saving rates.
As you may be able to see from the chart, the decline in
the federal net saving rate from 2000 to 2003 accounts for much
of the decline in net national saving over that period. After
2003, however, the rate of net federal saving rose primarily
tied to increases in corporate income tax revenue which I could
discuss more during the question and answer period. But the net
national saving rate was little changed because the net private
saving rate fell.
The bottom line is that the nation's rate of domestic
investment of roughly seven percent of income or so is possible
given our low level of domestic saving only because the nation
is running a significant current account deficit and that in
turn is possible only because foreign entities have been
willing to invest significant sums in U.S. assets and
securities, including U.S. Treasury securities.
That observation leads me to my third point, which is that
economists generally agree that the current account deficit is
unsustainable because the nation's indebtedness to the rest of
the world will grow faster than its income and foreign
investors will not continue to be willing to purchase U.S.
claims indefinitely as their portfolios become more and more
concentrated in such assets.
Views differ on whether the adjustment will occur gradually
or suddenly, but there is little disagreement that some sort of
adjustment is inevitable. As the CBO has pointed out in a
recent issue brief, the more likely scenario appears to be a
gradual adjustment without severe short-term economic
consequences, but a sudden adjustment remains a risk and
possibly a growing one as the nation's net indebtedness rises.
And that leads me to my final point, which is that policy
makers can help facilitate the necessary reduction in the
current account deficit and reduce the risk of a severe
economic disruption in foreign financing by taking actions to
raise the rate of national saving.
Focusing on government saving may be particularly important
in light of the economic and budgetary outlook in the United
States over the next few decades as Mr. Ryan highlighted.
Figure five shows that most of the discussion that has
surrounded our long-term fiscal challenge has been somewhat
off. It is often described as being caused by aging and
healthcare. It is primarily tied to the rate of growth in
In particular, if over the next four decades healthcare
costs per beneficiary grow at the same rate relative to income
per capita as they did over the past four decades, Medicare and
Medicaid will rise from four and a half percent of the economy
today to twenty percent of the economy by 2050 as the top line
of that chart shows.
The bottom line shows the pure effect of aging on those two
programs and I think you can see that there is some impact
there, but that that rise, the difference on the bottom dotted
line between 2050 and today is much smaller than the difference
in 2050 between the bottom dotted line and the top solid line.
In any case, reducing government dis-saving, that is
reducing the budget deficit both today and in the future, is
perhaps one of the most reliable ways through which policy
makers could boost national saving. Such national saving could
also be increased through higher private saving, and my written
testimony discusses some of the possible policy interventions
that could produce that effect.
However it is accomplished, higher national saving is
fundamental to reducing the current account deficit which in
turn will reduce the rate at which the nation is increasing
liabilities to and assets held by foreign investors, including
[The prepared statement of Peter Orszag follows:]
Prepared Statement of Peter R. Orszag, Director,
Congressional Budget Office (CBO)
Chairman Spratt, Ranking Member Ryan, and Members of the Committee,
thank you for inviting me to testify today. Foreign holdings of U.S.
Treasury debt have grown rapidly in recent years and now are a
significant percentage of such debt held by the public. A broader issue
is the substantial deficit in the U.S. current account--which
summarizes the country's current transactions with the rest of the
world, including trade in goods and services, net income from
international investments and the compensation of employees, and net
unilateral transfers (such as gifts, pension payments, and foreign
aid). The mirror image of the nation's large current-account deficit is
foreign investors' increased holdings of a variety of claims on the
United States, including U.S. government debt as well as private-sector
securities and assets.
My testimony today makes four main points:
Foreign holdings of U.S. Treasury debt have risen rapidly.
Between 2003 and 2006, for example, such holdings rose almost 50
percent. They now exceed $2 trillion and account for more than 40
percent of Treasury debt held by the public.
Those increasing foreign holdings of U.S. government debt
are part of a more fundamental issue: The nation is running a
substantial current-account deficit, which is financed by increasing
liabilities to and assets held by foreign investors. The current-
account deficit measures the excess of the country's spending over its
income or, equivalently, of its domestic investment over its national
saving. After the depreciation of physical capital is taken into
account, the nation saved only 2 percent of its income last year, an
unusually low level for the world's leading economy. At the same time,
the nation's net domestic investment was 8 percent of its income. The
difference, 6 percent of income, was financed by increases in net
foreign claims on the United States and manifested itself in the
Economists generally agree that the nation's current-
account deficit cannot be sustained indefinitely at its current level
relative to gross domestic product (GDP) because the nation's
indebtedness to the rest of the world will grow faster than its income.
Moreover, foreign investors will not continue to be willing to purchase
U.S. claims at current rates of return indefinitely as their portfolios
become more and more concentrated in such assets. To be sure, views
differ on whether a future adjustment in the current-account deficit
will occur gradually or suddenly--but there is little disagreement that
some sort of adjustment is inevitable.
The necessary adjustment of the current-account deficit,
which requires slower growth of consumption in the future, could take
place slowly or rapidly. The more likely scenario appears to be a
gradual adjustment without severe short-term economic consequences, but
a sudden adjustment remains a risk--and possibly a growing risk as
foreign net holdings of claims on the United States rise as a
percentage of GDP. Policymakers can help facilitate the necessary
reduction in the current-account deficit and reduce the risk of a
severe economic disruption in foreign financing by taking actions to
raise the rate of national saving.
estimated holdings of u.s. government securities by foreign investors
Foreign holdings of U.S. Treasury securities have grown rapidly in
recent years. In 2003, for example, U.S. Treasury securities held by
foreign investors amounted to $1.45 trillion, and by 2006, those
holdings rose to $2.13 trillion--an increase of 47 percent.\1\ As a
percentage of total Treasury debt held by the public, foreign holdings
rose from 37 percent to 44 percent over that span.\2\ The increase in
foreign holdings accounted for about 86 percent of total federal
borrowing last year and about 72 percent from 2003 to 2006.
According to survey estimates, East Asian countries held a large
share of foreign holdings of Treasury securities last year--about 63
percent.\3\ The two East Asian countries with the largest holdings were
Japan, which held an estimated 31 percent of all foreign-held Treasury
securities, and mainland China, with 19 percent. In comparison, the
European Union held an estimated 15 percent, and oil-exporting
countries in the Middle East, about 5 percent.
Foreign official institutions have played a significant role in the
increase in foreign ownership of federal debt. Indeed, at the end of
2006, foreign central banks owned 66 percent of all federal debt held
by foreign residents, up from 63 percent at the end of 2005.
The data on ownership by country and by type of foreign entity
(official versus private) are imperfect.\4\ The surveys used to collect
the data do not always capture the ultimate owner of the securities. If
an owner entrusts securities with a custodian in a different country,
for example, the ownership of the securities is attributed to the
country of the custodian, not the owner. That ``custodial bias''
contributes to the large recorded foreign holdings of U.S. securities
in major financial centers such as Belgium, the Caribbean banking
Switzerland, and the United Kingdom.\5\ Similarly, some foreign
official purchases may be misclassified as foreign private ones because
they are conducted through private-sector traders.
Foreign investors also hold a growing share of securities of U.S.
agencies and government-sponsored enterprises (GSEs), evidently
reflecting a drive to increase the returns on their investments. At the
end of 2006, those investors owned about $1.2 trillion of such
securities, more than twice as much as in 2001. The countries with the
largest holdings were China, with about 23 percent of all such foreign
holdings, and Japan, with about 17 percent.
Examining only the securities of the Treasury Department and of
agencies and the GSEs that are held by foreign investors, however,
obscures the broader and more fundamental issue: the rising net foreign
claims on the United States that result from the nation's current-
account deficit. The specific distribution of those foreign claims
among different types of assets (U.S. government debt, equities, real
estate, and so forth) may be important for considering some questions
(for example, the potential for short-term disruptions in specific
financial markets), but the overall level of those claims is more
important in weighing other issues (for example, the vulnerability of
the U.S. economy to adverse economic shocks). It is therefore important
to emphasize that Treasury and other agency debt held by foreign
investors represents only a portion of the total claims on the United
States owned by the rest of the world.
According to the Bureau of Economic Analysis, the total amount of
claims on the United States held by foreign investors in 2005 amounted
to $13.6 trillion--9 percent more than in 2004 and 52 percent more than
in 2000. A little more than 17 percent in 2005 was U.S. government
securities, up from about 13 percent in 2000 (see Table 1 below). As
noted, much of the rise in the share of U.S. government securities was
associated with increased holdings by foreign governments, rather than
by foreign private investors. The key point, though, is that however
the claims are allocated among different asset types and foreign
owners, the broader issue is the overall rise in net foreign claims on
the United States assets; that rise is necessary to finance the
nation's current-account deficit.
the fall in the u.s. current-account balance
The current-account balance fell from -1.7 percent of GDP in 1997
to a record 6.1 percent last year (see Figure 1 below). At the same
time, the outstanding amount of net international assets (holdings of
claims on foreign entities by U.S. investors minus holdings of claims
on the United States by foreign investors) fell from about -10 percent
of GDP to about -20 percent in 2005 (see Figure 2 below).
To examine why the deficit in the current-account balance has
increased in recent years, it is useful to examine trends in both net
domestic investment and net national saving.\6\ Net domestic investment
climbed steadily throughout the 1990s and then declined, on balance, in
the early 2000s. On average, it has been 7 percent of national income
since 1990 and in the past four years (see Figure 3 below).
Net domestic investment can be financed either by net national
saving or net foreign claims on U.S. assets. Since the late 1990s, it
has been financed more and more by foreign claims, as the rate of net
national saving has declined from an average of 4\1/2\ percent in the
1990s to an average of 1 percent in the past four years. From that
perspective, the low level of national saving has been responsible for
the elevated level of the current-account deficit.
The decline in the rate of national saving in the 2000s largely
reflects movements in both federal and private net saving rates (see
Figure 4 below). The decline in the federal net saving rate from 2000
to 2003 accounts for much of the decline in the net national saving
rate over that period. After 2003, however, the rate of net federal
saving rose, but the net national saving rate was little changed
because the net private saving rate fell. Although federal saving and
national saving do not move in lockstep, there is generally a close
relationship between changes in federal saving and changes in national
saving. Put simply, the more the federal government saves, the more the
nation tends to save as a whole.
From another perspective, the elevated level of the nation's
current-account deficit has been driven by the willingness of foreign
investors to provide capital to the United States. In other words, the
nation's rate of domestic investment is possible, given the rate of
domestic saving, only because foreign entities have been willing to
invest significant sums in U.S. assets and securities. From this
perspective, inflows of capital from abroad affect the current account
by raising the exchange value of the dollar and asset prices in the
United States. The strong dollar encourages purchases of imports by
U.S. residents and discourages purchases of U.S. exports by the rest of
the world. Higher asset prices and correspondingly lower interest rates
encourage consumption and investment.
The willingness of foreign investors to buy U.S. debts and assets
reflects the attractiveness of the United States as a destination for
international investment because of its stable political environment,
developed legal institutions, deep and liquid capital market, and
strong banking and financial system, among other advantages. Moreover,
because the U.S. dollar is the major medium of international
transactions, it is less susceptible to extreme and sudden
depreciation.\7\ Indeed, the longevity of the large U.S. current-
account deficit can be viewed as reflecting a sequence of events that
caused demand for U.S. assets to grow even faster than the supply.
Between 1997 and 2000, a host of developments--financial globalization,
a succession of financial crises (the 1997-1998 Asian crisis, Russia's
default of 1998, and the Brazilian real crisis of 1999), and weaker
economic growth in other industrial countries than in the United
States--all added to the demand for U.S. assets.\8\ By propelling the
dollar and U.S. asset prices higher, those developments contributed to
widening the current-account deficit.
A significant share of the nation's overall external financing has
been from foreign governments in recent years, as suggested by the
trends in foreign ownership of U.S. government debt (see Table 2
below). In 2006, for example, net official inflows (purchases of claims
on the United States by foreign governments net of purchases of claims
on foreign entities by the U.S. government) were $448 billion, more
than half of the $811 billion current-account deficit. Net official
inflows also have grown rapidly in the past few years; in 2000, for
example, net official inflows were only $42 billion. Almost all
official purchases of U.S. assets were made by a handful of Asian
governments, particularly China, which did so in order to keep its
currency from appreciating outside of the band specified by its managed
exchange rate policy. The Japanese government was also actively making
purchases to keep the yen from rising before the spring of 2004.
the unsustainability of the current-account deficit
Regardless of whether its financing is provided by foreign
governments or foreign private investors, the large U.S. current-
account deficit, analysts generally agree, cannot be sustained
indefinitely at its present high level relative to GDP. The United
States--like any other country--cannot continue accumulating debt at a
rate faster than its ability to repay it. If policy actions or other
economic developments do not reduce the current-account deficit, at
some point foreign investors will become less willing to keep adding to
their holdings of U.S. assets.
To be sure, net U.S. international assets have changed little
relative to GDP in recent years despite the large current-account
deficit, but that situation is unlikely to continue over the long run.
Movements in asset prices and in the exchange rate have raised the
dollar value of U.S.-owned foreign securities and direct investments
overseas by more than that of U.S. securities and investments held by
foreign investors, offsetting the consequence of the current-account
deficit. However, such favorable effects of valuation cannot be relied
on in the long term, and sooner or later net U.S. international assets
will begin to fall rapidly relative to GDP if the large U.S. current-
account deficit persists.
A persistently large current-account deficit will, over time, make
foreign investors less willing to provide low-cost financing for it. To
date, foreign demand for dollar assets has not yet weakened
significantly, in part because the dollar is still the major
international reserve currency. However, once investors accumulate
enough dollar assets to facilitate international transactions and to
meet their other needs for holding reserves, they are likely to slow
down their purchases of dollar assets for those purposes and
increasingly will buy or sell dollar assets on the basis of the
expected returns. For example, the Chinese government announced in
March this year that it would establish an investment agency to more
``profitably'' and ``efficiently'' manage a portion of its foreign
reserves, which exceeded $1.2 trillion in the first quarter of this
year.\9\ Thus, to the extent that investors and governments believe
that the U.S. current-account deficit will cause the dollar to
depreciate, which reduces the expected return on dollar assets, the
demand for dollar assets will fall.
Once foreign demand for U.S. assets begins to grow more slowly than
the supply, there will be growing downward pressure on the dollar and
U.S. asset prices. A lower dollar raises the prices of imports and
reduces U.S. residents' purchasing power at home and abroad, and lower
asset prices make U.S. residents poorer. As a result, U.S. residents
will be less able and willing to borrow and spend, thereby lowering the
current-account deficit; the exchange rate and asset price adjustments,
in other words, will facilitate the reduction in the current-account
deficit. As long as foreign demand for dollar assets does not drop too
suddenly, the adjustment in the current account will be a gradual one.
In that case, growth of the U.S. economy is likely to remain on track.
The gradual rise in exports and decline in imports will entail more
production and employment in sectors that export and sectors that
compete with imports, helping to offset the negative effects of the
gradual adjustment in asset prices, interest rates, and the prices of
How bumpy the adjustment of the U.S. current account will be thus
depends on what happens to foreign demand for U.S. assets. If short-
term factors boost the growth in the demand for U.S. assets above the
growth in supply, the U.S. current-account deficit may temporarily
widen further. However, it seems implausible that foreign demand for
U.S. assets will be boosted repeatedly by short-term factors. Once
long-term downward pressures on demand begin to outweigh temporary
supports for dollar assets, they will push down the dollar and those
asset prices, facilitating the decline of the current-account
Various factors may mitigate the risk of the type of sudden
collapse in foreign financing that would be associated with a
relatively rapid adjustment of the current account. For example, the
unique role of the U.S. dollar as the world's main reserve currency
should help to reduce the probability of a sudden stop of foreign
financing, at least in the near future (although some analysts have
warned that the dollar's role as a primary reserve currency cannot be
taken for granted over the long run). Furthermore, nearly all U.S.
international liabilities are denominated in dollars, and about
twothirds of U.S. holdings of assets abroad are equity assets,
denominated in host countries' currencies. Therefore, a large
depreciation of the dollar would lower net U.S. liabilities to foreign
investors not only by lowering net imports but also by boosting the
dollar value of U.S. assets abroad. Consequently, the depreciation
would not necessarily feed on itself and become a fullblown dollar
crisis, unlike the effects of a sharp drop in the currency of a country
with a large amount of debt denominated in foreign currencies.\11\
Thus, the more likely scenario appears to be a gradual adjustment,
in which the current account falls gradually over time.\12\
Nonetheless, given the likelihood of a continued decline in the United
States' net international assets as a percentage of GDP, a risk remains
that adjustments in the foreign exchange rate and the current account
will occur more rapidly than anticipated and that the effects of a
rapid adjustment on the economy will be much more severe than with a
gradual adjustment. That risk probably increases as the nation's net
international assets fall as a percentage of GDP.
Because the current account is equal to the difference between
national saving and investment in the United States, policies that
influence saving or investment will affect it. Although the current-
account deficit could be improved by reducing investment, that outcome
would be undesirable. With less investment, the U.S. capital stock
would grow more slowly, which would reduce the growth of productivity
and real wages over time. Therefore, the more desirable options for
reducing the current-account deficit are those that would raise
Focusing on national saving may be particularly important in light
of the economic and budgetary outlook in the United States over the
next several decades. Rising federal health care costs, in particular,
will place mounting pressure on federal spending, and if revenues
remain at their current shares of GDP, the federal budget deficit is
projected to grow rapidly, which could substantially reduce national
saving.\13\ Over the past four decades, Medicare's and Medicaid's costs
per beneficiary have increased about 2.5 percentage points faster per
year than has per capita GDP. If those costs continued growing at the
same rate over the next four decades, federal spending on those two
programs alone would rise from 4.5 percent of GDP today to about 20
percent by 2050 (see Figure 5 below). Indeed, the rate at which health
care costs grow relative to income is the most important determinant of
the long-term fiscal balance; it exerts a significantly larger
influence on the budget over the long term than other commonly cited
factors, such as the aging of the population.\14\
National saving can be increased in a number of ways that could
involve higher government saving and/or higher private saving. Raising
government saving through deficit reduction is one of the most reliable
ways through which policymakers could boost national saving. That goal
could be achieved through higher taxes, lower spending, or both.\15\
Given the nature of the nation's long-term fiscal challenge,
controlling the growth of federal health care costs seems a key
component of deficit reduction over the next several decades. A variety
of evidence suggests that opportunities exist to constrain health care
costs both in the public programs and in the overall health care system
without adverse health consequences, although capturing those
opportunities to reduce costs without harming health outcomes involves
National saving could also be increased through higher private
saving. In evaluating policies to raise private saving, it is important
to include their effects on government saving. For example, general tax
incentives for private saving financed through higher budget deficits
might not generate enough additional private saving to offset the
higher budget deficits. Consequently, even if such policies increased
private saving, they might not raise national saving. By contrast,
deficit-neutral policies that encouraged private saving would work to
raise national saving (because the increase in private saving would not
be offset by a reduction in government saving).
Various options for raising private saving in such a manner have
been proposed--for example, establishing automatic aspects for 401(k)
and similar savings plans. Currently, many such plans leave it up to
the employee to choose whether to participate, how much to contribute,
which investment vehicle offered by the employer to select, and when to
pull the funds out of the plan and in what form. Workers are thus
confronted with a series of financial decisions, each of which involves
risk and a certain degree of financial expertise. Many workers shy away
from those decisions and simply do not make them, and the result is
often a lack of participation. Research has suggested that
participation and contribution levels can be substantially affected by
changing the defaults at each of those points of decision. Indeed, one
of the strongest empirical findings from behavioral economics is that
automatic enrollment--that is, enrolling workers in a plan unless they
opt out, as opposed to requiring them to sign up in order to
participate--boosts the rate of participation substantially.\16\
Legislation enacted last year makes it easier for corporations to offer
401(k)-type plans with automatic enrollment and other automatic
features, and researchers have proposed ways of expanding the same
logic to individual retirement accounts.\17\ If such proposals were
financed in a deficit-neutral manner, so that any gains to private
saving were not offset by decreases in government saving, they could
increase national saving. However, even if they were implemented in
that manner, they would probably generate only a fraction of the saving
needed to close the current-account deficit.
However it is accomplished, achieving a higher level of national
saving also entails drawbacks. In the end, policies that raise national
saving have one thing in common: They reduce consumption of goods and
services and/or leisure. What makes the policies different is how they
affect specific households and how they affect the economy at large.
Therefore, choosing the appropriate saving policy inevitably involves
balancing the economic effects of alternative policies with their
Despite those various trade-offs and however it is accomplished,
encouraging higher national saving probably represents the most
effective step that policy-makers can take to facilitate the necessary
reduction in the current-account deficit and reduce the risk of a
severe economic disruption in foreign financing.
\1\ Budget of the United States Government, Fiscal Year 2008:
Analytical Perspectives, p. 235.
\2\ Although not strictly comparable, the percentage of federal
debt held by foreign investors was estimated to be 32 percent in 1997
and 15 percent in 1985.
\3\ Department of the Treasury, Federal Reserve Bank of New York,
and Board of Governors of the Federal Reserve System, Report on Foreign
Portfolio Holdings of U.S. Securities, as of June 30, 2006 (May 2007).
\4\ See Department of the Treasury, Frequently Asked Questions
Regarding the TIC System and TIC Data, available at www.ustreas.gov/
\6\ Those net measures account for depreciation of the existing
\7\ The dollar's status as the major reserve currency has meant
that foreign demand for dollar assets has increased as other economies
and international transactions have grown.
\8\ Financial globalization has allowed private foreign investors
to participate in the U.S. capital market more fully. See Congressional
Budget Office, The Decline in the U.S. Current-Account Balance Since
1991 (August 6, 2004).
\9\ The announcement did not specify how much of the reserves would
be managed initially by the new agency, but Chinese officials and the
press have suggested an amount of up to $300 billion.
\10\ The trade-weighted dollar exchange rate relative to currencies
in major industrial countries, computed by the Federal Reserve Board,
declined about 9 percent between November 2005 and May 2007.
\11\ For such an indebted country, its currency's depreciation
necessarily raises the domesticcurrency values of its international
debt and interest payments on that debt but may not have a significant
effect on the value of its trade surplus (especially if its exports
rely significantly on imported materials). Thus, its net debt could
become higher even as its currency depreciates, putting greater
downward pressure on its currency.
\12\ See Congressional Budget Office, Will the U.S. Current Account
Have a Hard or Soft Landing? (June 11, 2007).
\13\ See Congressional Budget Office, The Long-Term Budget Outlook
\14\ See Statement of Peter R. Orszag, Director, Congressional
Budget Office, Health Care and the Budget: Issues and Challenges for
Reform, before the Senate Committee on the Budget (June 21, 2007).
\15\ In evaluating alternative ways to reduce the budget deficit,
it is important to be mindful of the potential effects of those
policies on private saving. Some policies could reduce private saving.
However, although the impact would depend on the nature of the policy
change, reductions in private saving, if they occurred, would probably
not be large enough to completely offset the gains to national saving
from lower budget deficits.
\16\ See, for example, Brigitte Madrian and Dennis Shea, ``The
Power of Suggestion: Inertia in 401(k) Participation and Savings
Behavior,'' Quarterly Journal of Economics, vol. 116, no. 4 (November
2001), p. 1160.
\17\ See J. Mark Iwry and David John, Pursuing Universal Retirement
Security Through Automatic IRAs (Washington, D.C.: Retirement Security
Project, February 2006).
Chairman Spratt. One of the questions we pose to all of the
witnesses is what is the risk of a hard landing as opposed to a
soft landing? Is there any way you can predict, number one,
when will it approach the limits, when we will be in danger of
really hitting the wall and suffering the consequences, the
dire consequences that all of our witnesses paint out here, and
what is the risk that the landing will be hard, abrupt, and
difficult to adjust to as opposed to a smooth glide-path
Mr. Orszag. As I noted in both my oral testimony and my
written testimony and as the recent CBO issue brief argues,
again, the more likely scenario for a variety of reasons is a
gradual adjustment in which things operate smoothly, but there
is some risk, and I would not want to quantify it, that cannot
be ruled out of a more disruptive and sudden adjustment that
And I think the key point is that the policy response to
either kind of scenario is basically the same, which is that
ultimately something has to change and you may as well start
now to be raising national saving, getting the budget deficit
further under control.
So regardless of whether you put that risk of a severe
disruption at, you know, this level or at that level, the
policy response is quite similar.
Chairman Spratt. There was a commission, I cannot recall
when it was appointed, but fairly recently, five or six years
ago, on the balance of payments. And its members divided about
four to three or five to two on the issue of hard landing
versus soft landing versus hard landing.
Those who came out fearful of a hard landing said their
biggest concern is the problem of asset holders dropping assets
that are declining in value, that once an asset holder sees
that his assets are declining rapidly in value, he does not
want to be the last person holding that particular asset.
Is that a risk and is there some way we can protect against
Mr. Orszag. Again, I would come back to first in terms of
protecting against risk. Taking action sooner rather than later
is the best possible step. I think the problem becomes that in
these kind of scenarios that you are discussing, which, again,
I would put lower probability on but not zero relative to a
gradual adjustment, things can go wrong in an amazing array of
ways. And you just do not want to find yourself in that
And I have written academic papers or other papers
delineating some of the ways in which things can go wrong, but
I think the point is they can go wrong in multiple ways and
temporary phenomenon can feed on itself and become particularly
Chairman Spratt. What about exogenous inflation, if you had
factors in the world economy beyond our control and run-up in
resource prices, oil and other resources, maybe different kind
of different things that created inflation and caused foreign
holders of our debt to fear that the dollar may be inflating
away its value?
Mr. Orszag. I think the people who are concerned about a
sudden adjustment are particularly worried about some dramatic
decline in demand for U.S. assets which could be prompted by a
whole variety of different potential contingencies, including
potentially the view that, however it arose, that inflation in
the United States would take off and that the Fed would not be
able to contain it.
Chairman Spratt. What I am getting at----
Mr. Orszag. That would just be one of many possible
scenarios that could engender the type of concern that some
analysts have identified.
Chairman Spratt. What I am getting at is that foreign
capital thus far has been a cushion. It has helped us absorb
what otherwise could be adverse economic effects of a big run-
up in national debt by buying and funding a lot of that debt.
But it is also it seems to me a precarious way to finance our
Would you agree? We were all, not all of us, there were
some brought up on Friedman, others of us were brought up on
Samuelson, to believe that the national debt was not so bad
because we owed it to ourselves. Now we have a debt that
increasingly is owed to others.
Would you agree that a debt owed to ourselves is less
problematic than a debt that we owe to foreigners?
Mr. Orszag. I think I would come back to the fundamental
driver here, which is that the reason that we are accumulating
those claims to foreigners is that we are saving such a low
level of national income.
It is highly unusual for the world's leading economic power
to be saving only one or two percent of its national income and
that is the fundamental driver of a lot of----
Chairman Spratt. The fact that it aggravates the savings
rate, the domestic savings rate?
Mr. Orszag. Well, necessarily it will mean that you are
either only investing one or two percent of your income
domestically, which then robs workers in the future of
productive equipment and other things that will improve their
standard of living, or it means that you are investing more
than that and financing it by increasing claims on your assets
Chairman Spratt. I have got lots of other questions, but
there are lots of other members who want to put a question to
you, so let me turn next to Mr. Ryan.
Mr. Ryan. Thank you. I have a lot of questions, too, but I
will try and keep it limited as well. You could go down so many
I wanted to get into the twin deficit theory with you, but
I think I will not belabor that.
Dr. Orszag, our capital markets are very attractive,
correct, to foreign investors?
Mr. Orszag. Yes. If you look at observed behavior, that
would appear to be the case, yeah.
Mr. Ryan. Right. So the hard landing theory, obviously we
do not want a hard landing here. We could precipitate a hard
landing if we do things in our economic policy that makes the
U.S. capital markets less attractive to investment, correct?
Mr. Orszag. That would be a risk associated with making our
capital market significantly less attractive, yes.
Mr. Ryan. Right. So if we want to have a soft landing as we
use this vernacular, it is important that our economic policy,
the things we do, whether it is how we regulate capital flows,
how we tax capital, those all speak to our attractiveness of
our capital markets to foreign capital and whether or not we
are going to have a soft or hard landing if and when we have a
Mr. Orszag. The key determinate of the speed of adjustment
is foreign demand for U.S. assets and there are lots of things
that affect that, including the attractiveness of our capital
Mr. Ryan. So one of the more important things for us to do
in our own interest is to make our capital markets as
attractive as possible. You would agree with that, correct?
Mr. Orszag. There are obviously tradeoffs involved. Again,
one of the factors that affect continued foreign demand for
U.S. assets is the relative attractiveness of U.S. financial
Mr. Ryan. Right. Right. So the one thing we can reach
consensus on is we are spending too much money. I think you
would agree with that.
Mr. Orszag. Well, we are not saving enough money, yes.
Mr. Ryan. And saving rate, as we calculate our savings
rate, when we overspend, meaning we have chronic deficits and
chronic debt, that negatively affects our savings rate. I
wanted to ask you a question about your last chart.
Jose, if you could bring up his last chart, the healthcare
Can you walk me through this one more time because I find
this of all your observations the most fascinating. The dotted
line on the bottom is if healthcare inflation tracked with
regular inflation. What is that exactly?
Mr. Orszag. In particular what it is is that if the so-
called excess cost differential, that is healthcare costs per
beneficiary minus income per capita, were zero in the future,
it isolates the pure effect of demographics. The only reason
that that line is rising is that there are more beneficiaries
on Medicare and Medicaid and they are growing older.
Mr. Ryan. Right. But it is not rising at a precipitously
high pace if the costs are increasing with the rest of income
in society, right?
Mr. Orszag. And, therefore, the pure effect of aging on the
budget is much smaller than it is often portrayed as.
Mr. Ryan. Right. So what you are trying to say here is the
root cause of our future budget dilemma is healthcare
Mr. Orszag. The long-term fiscal challenge basically
collapses to the rate at which healthcare costs grow relative
to income per capita, yes.
Mr. Ryan. So healthcare inflation is----
Mr. Orszag. Healthcare cost growth, I would----
Mr. Ryan. Okay. Okay. And if we can do things that bring
healthcare cost growth in line with other cost growth, this you
are saying can generally take care of a vast majority of our
budget and fiscal problems with respect to our healthcare
Mr. Orszag. If you could bend that curve, the more you bend
that curve, the degree to which you bend that curve is
basically the degree to which you are getting the long-term
fiscal challenge under control. There would be further steps
that are required, but that is the key determinate.
Mr. Ryan. Okay. So where we ought to be focusing our
efforts in your opinion, would it be on tackling these
healthcare entitlements which represent the largest portion of
our present value unfunded liability? Should we be focusing our
efforts on attacking the cost increases of healthcare in
America and our healthcare entitlements if we want to get the
biggest bang for our buck in order to reduce future
Mr. Orszag. If your concern is the long-term fiscal
imbalance facing the nation, trying to bend this curve is
perhaps the most auspicious step that you could take.
Mr. Ryan. Do you think we can bend the curve by going after
just changes to Medicare and Medicaid law without addressing
underlying healthcare reforms or is the better path to take in
order to get better results for Medicare and Medicaid cost
growth and, therefore, indebtedness to go after the healthcare
marketplace and the way it works right now and the inflation
rate that it produces?
Mr. Orszag. I do not think it is going to be plausible to
bend this curve for Medicare and Medicaid while healthcare cost
per beneficiary and the rest of the health system continues at
the same rate without creating massive access problems.
Mr. Ryan. Have you taken a look at cost differentials
between different kinds of products that are offered in the
marketplace vis-a-vis insurance, whether it be, you know,
traditional low co-pays, low deductibles, first dollar type
coverage plans versus higher deductible, more consumer-based
plans? Have you looked at that and have you done any modeling
Mr. Orszag. Yes, we have. We put out a report last December
that goes into some detail about the effects of different kinds
of plans along the lines that you are discussing.
Mr. Ryan. Do you believe that to the extent that an
individual with a policy who has a fiscal incentive, a shopping
incentive to save more of their own money while they go out and
purchase health insurance has more of a likelihood to be more
cost conscious and, therefore, contribute to lowering the cost
increases in healthcare?
Mr. Orszag. There are steps that can be taken on both the
provider side and the consumer side to try to bend this curve.
On the provider side currently, Medicare in particular is
paying largely on a fee-for-service basis and the evidence
suggests that when we pay more, we do not necessarily get
On the consumer side, one of the things that has happened
over the past three or four decades is the share of healthcare
costs that come out of pocket has actually declined markedly
and the evidence does suggest that that has played a role in
increasing healthcare costs.
Mr. Ryan. So axiomatically on the reverse, if the more
share comes out of pocket, you will lower the cost increases?
Mr. Orszag. You would at least lower cost to some degree,
Mr. Ryan. Okay. All right. I do not want to chew up too
much more time. I have a lot more questions, but maybe if we do
Chairman Spratt. Mr. Edwards.
Mr. Edwards. Thank you, Mr. Chairman.
I find it interesting that we are holding this hearing
today on the impact of foreign-held U.S. national debt on the
same day on the front page of the Washington Post, there is a
third part of a four-part series talking about Vice President
Cheney, who is the architect of the Bush economic policies that
led to the largest deficits in American history.
One of my hopes is that today's hearing will debunk Mr.
Cheney's flat out wrong statement or declaration that deficits
do not matter. I think while we disagree on the origin of the
deficits, I would hope there would be bipartisan agreement that
deficits do matter, that Vice President Cheney, the architect
of the Bush economic policy, was dead wrong in his declaration.
Mr. Ryan talked a little bit, Dr. Orszag, about the basis
of the deficits. He made a statement, and I wrote it down, tax
relief is not the reason for deficit.
Let me ask you a question. Based on your analysis for
fiscal year 2007, what percent of this year's deficit is the
result of tax cuts passed since 2001 approximately?
Mr. Orszag. I would have to give you the exact number later
and it depends how you do the accounting. But the revenue
effect of the 2001 and 2003 tax legislation is roughly one and
a half percent of GDP, which is about the size of the federal
Mr. Edwards. So put that in lay terms. Had we not had the
tax cuts passed since 2001, according to CBO analysis, the
deficit would be how much smaller?
Mr. Orszag. If you just do a simple accounting exercise
that takes that estimated revenue effect from the Joint
Committee on Taxation and compare it to today's deficit, it
would roughly eliminate the deficit, but I would have to get
back to you to give you that exact figure.
Mr. Edwards. Okay. So----
Mr. Ryan. Would the gentleman yield?
Mr. Edwards. The gentleman has had a lot of time. In round
two, I think it would be healthy to have a discussion on this,
but the gentleman has had quite a bit of time. I would like to
Mr. Ryan also said entitlements are the biggest problem and
I agree with him on that. I would like to point out the fact
for the record, and let me put this in terms of a question.
Since Medicare was created in 1965, has there been any
single increase in expenditures for the Medicare program larger
than that passed in the Republican Congress on Medicare Part D?
Has any other increase in the history of Medicare been larger
in its increase and expenditures than that passed in wee hours
of the morning with a lot of arm twisting by the Republican
Majority in the House and the Congress, or is that the largest
increase in Medicare entitlement spending in the history of
Mr. Orszag. I would have to check with regard to ESRD, but
I believe that the Part D expansion in terms of the long-term
fiscal impact was the largest since 1965.
Mr. Edwards. And I think that is a fact. I think Mr.
Cooper, my colleague, says the total liability of that long
term is $8 trillion. So those who decry entitlement spending
were actually the authors as a party, as the Majority in the
Congress, the largest increase in Medicare entitlement program
in the history of that program, even as we talk about how it is
healthcare expenditures that are going to be a threat to future
Let me ask also in terms of the foreign-held debt, in light
of our difference with Mr. Cheney that deficits do not matter,
I know the debt has increased, foreign-held debt has increased
dramatically since the Bush Administration has taken over. I
think over $1.4 trillion or so.
China holds 23 percent of that foreign-held debt. Japan
holds 17 percent. What are some of the other three or four
other countries that hold significant U.S. debt?
Mr. Orszag. There are European countries, the UK in
particular. I would note that some of the allocations by
country can be----
Mr. Edwards. I understand.
Mr. Orszag [continuing]. Difficult to allocate.
Mr. Edwards. Does Venezuela hold any U.S. debt?
Mr. Orszag. I am sure it holds some, yes.
Mr. Edwards. Okay. Let me ask you, what would be the--we
have about 50 seconds remaining--what would be the economic
impact on our economy if China announced today that it was
going to cash in a substantial amount or let us go the full
way, if China announced today they were going to cash in all of
their U.S. debt holdings, what would be the economic impact on
the American economy?
Mr. Orszag. Well, again, without commenting on the
probability of that happening, the result would depend in part
on the response of other financial participants, but that is
the kind of thing that those worried about the risk of a sudden
adjustment with severe economic dislocations that would concern
Mr. Edwards. Okay. Severe economic dislocations. Is that
similar to devastating to the American economy under most
Mr. Orszag. Again, I think it is difficult to play out all
of the ways that things could go wrong should they do so.
Mr. Edwards. Thank you.
Chairman Spratt. Mr. Lungren.
Mr. Lungren. Thank you very much, Mr. Chairman.
It has been kind of fun sitting here. I do not know how Mr.
Orszag feels there, but you are kind of reminding me of a
tennis ball and we just keep hitting lobs to you and we are
lobbing you back and forth seeing if we can make some points
When I was here before, I remember Nancy Reagan was blamed
for everything and now it is Dick Cheney. I served ten years
with Dick Cheney and, frankly, if most members would vote the
way Dick Cheney did on spending, we would not have this
Oftentimes he and I were out there being one of twenty-two
or thirty against spending, but we were told by the other side
that deficits did not matter. I do not know what has happened
to Dick. I think he must have had just a bad moment. He was
probably quoting one of his friends from across the aisle.
I would like to ask a question about the chart we were
talking about, the medical inflation, and try and understand
that a little better. And the reason is this. I recently had a
conversation with a friend of mine and he talked about open
heart surgery that he had. I remember my dad had open heart
surgery when he was 57 which allowed him to go back to work as
a practicing physician until he was 70. He then had a redo when
he was 70 some years of age that allowed him to live until he
This fellow mentioned that his dad had an open heart
surgery done when he was 80 years old and he lived until he was
94. In both those cases, I know for a fact my dad would not
have lived as long as he did and this gentleman's father would
So I am trying to figure out what the medical inflation
means on this. Those are two people who would not have been
alive had they not had the procedures. The procedures cost
money, that they were procedures that were not done, well,
probably five years before my dad has his. And while I want to
see us do what we can to bend that curve, what does that
medical inflation mean with respect to those kinds of things,
that is procedures which are additional procedures than what we
used to do that are not really a trade-out for something that
was already there, but actually extends the lifetime of these
individuals and presumably causes them to continue to receive
Social Security benefits and causes them to be subject to other
medical procedures in the future? How do you distinguish from
that and bending the curve from inflationary aspects of the
Mr. Orszag. Well, as the designated tennis ball, let me
take a crack at that.
Mr. Lungren. Yes, sir.
Mr. Orszag. I think there is a wide variety of evidence
suggesting that technological advances in medicine have on
average produced significant improvements in life expectancy
and standards of living.
But there is also a significant amount of evidence that
technologies are often applied in very low return settings or
negative return settings and that if you look, for example,
across different regions of the United States, cost per
beneficiary in Medicare with the same technologies vary
substantially by a factor of two or three in ways that do not
reflect underlying riskiness to the patients and do not
generate better health outcomes in the higher spending regions.
And I think, therefore, there is a significant opportunity
for looking, it is going to be hard to capture, but looking for
better value rather than just higher cost healthcare. That is
the real challenge.
Mr. Lungren. The reason why I bring that up is it is
awfully difficult for us to attack the issue if the public and
we believe it is the first type of thing that I talked about
versus what you have suggested. And I do not care, Democrat,
Republican, who you are, it is easy to demagogue from the first
part and interfere with us to try and get to that second part
that you referred to. And that is probably the largest
challenge I see on the fiscal side for us for the next ten
On the charts that you had with respect to savings, does
that savings that you have of private savings, does that
include value of homes because many Americans, whether it is a
good thing or bad, see a much higher percentage of their
savings reflected in what they have in their houses today
versus what they had ten, twenty, thirty years ago?
Mr. Orszag. No, it does not. This is the national income
and product account definition of saving and it is the relevant
definition for the funds available to finance domestic
investment. So that is for this purpose why----
Mr. Lungren. It is for that purpose, but I was just
thinking. We have higher home ownership percentages today
across the board than we had, I think, at least in my lifetime
and perhaps a large amount of that is as the result of tax
policy which drives people to have homes because of the tax
benefits they get in addition to the fact of proud home
And, yet, we do not count that. And I understand why we do
not count that in terms of what you are talking about, but I
just wonder if we would want to necessarily alter individuals'
decision making in that regard.
Mr. Orszag. Well, there are various different parts of the
question. In terms of the measured saving rate in the national
income and product accounts, the housing price appreciation
that has occurred likely did have some downward effect on that
measured rate of private saving.
Another question is what the mortgage interest deduction in
particular does to home ownership and there I think there is a
range of views among economists about the degree to which it
actually does succeed in significantly boosting home ownership
or not. And we could have a longer discussion about that.
So there are a couple of different components to your
Chairman Spratt. Mr. Lungren, we have got to move on.
Mr. Lungren. Thank you very much, Mr. Chairman.
Chairman Spratt. Yes, sir.
Mr. Blumenauer. Thank you, Mr. Chairman.
I would like to take up just on part of the previous
discussion you have been having. While we are not taking home
values per se, there has been a lot of capital flow that has
been resulting from the securitization of home finance
It looks like there might be a lot of air in some of these
funds, domestic and international, that may be the result of a
housing bubble that may be about to burst or is bursting or a
huge shift in the subprime market.
And I am trying to get a sense of the extent to which you
have any thoughts about the softness in these transactions and
these hedge-fund investments may have in the overall
availability of capital in this country.
Mr. Orszag. CBO is very closely monitoring developments in,
for example, the subprime market and when we come out with our
updated economic projections as part of our August update, I
will have more to say at that time on our view of developments.
Mr. Blumenauer. Okay. Good.
Mr. Orszag. You would like more now.
Mr. Blumenauer. No, no, because I am not interested in your
torturing the data and I am not interested in more of the ping-
pong game. I think certain obligatory charts and lines have
been put on the table and I am, frankly, eager to hear the next
four witnesses as well.
But I would just give you one more chance to help us sketch
what might be the implications if there is a lot of air in, A-
I-R, in these portfolios, what that might mean in terms of the
impact of our net savings rate, capital expansion, what has
fueled a run-up in corporate profits and activity or at least
shielded people from other economic realities if, in fact, this
is squishy. I am not asking you to put parameters around it
now, but if you can just talk about the implications.
Mr. Orszag. Sure. First with regard to implications, one of
the factors that is likely to increase private saving over the
next several years is sluggishness or softness in the housing
market. That is just the reverse of what I was delineating
I think a big question with regard to the subprime market
in particular is how much it spreads to other financial
products and the rest of the housing sector. And that was the
part where I was being a little bit cautious about what CBO
would or would not be saying.
Mr. Blumenauer. Mr. Chairman, this is an area of particular
interest to me. And I appreciate this hearing and I will be
quiet and we can move on. But at some point, our circling back
and having a hearing on the implication of what has been
happening in the housing market which has been a critical part
of our economic growth over the last ten years, I think all of
us can agree to that, whether we think it is healthy or not,
whether we are from areas where there has been a run-up,
whether we feel squeamish about some of the industry practices
and people that have been shoved into the subprime market maybe
who did not need to be there.
But I think this has very profound implications on really
the underlying health of our economy and might give us some
early indicators of where things might go. And if you and our
certified smart people on the staff would consider it, I think
it might be useful to be able to have some discussion about
where we are and where we are going with that.
Chairman Spratt. Okay. We will take that up later.
Now Mr. Simpson.
Mr. Simpson. Thank you, Mr. Chairman. I am glad to be here
and listen to this and the China doomsday scenario and all that
sort of stuff that Mr. Edwards proposes.
I would like to ask if we are going to call this the Bush-
Cheney deficit, if we could call it the Bush-Cheney economy
seeing as how it happens to be one of the strongest economies
we have had in quite some time. So if you do that, I would
appreciate both that.
The other thing I would like to know is, you know, we
always ask these questions, these doomsday scenarios and stuff,
and then we like to go down on the floor and we say we have had
testimony that it would be devastating to our economy, that it
would destroy it, that we would all essentially might have a
nuclear bomb would be better off than that, even though the
scenario that they propose does not make sense.
Would it make sense for China to call in all the debt and
what would it do to China's economy?
Mr. Orszag. China has a significant disincentive to do
that, which is that it would, to the extent that some of these
processes that we are describing actually happen, it would
impose costs on China also.
Mr. Simpson. Is this like economic mutually assured
Mr. Orszag. I would not use that kind of wording, but----
Mr. Simpson. We tried that with the nuclear era. But I
mean, it would make no financial sense or economic sense for
China to do that; is that right?
Mr. Orszag. There would be a disincentive to China doing
that. But what I would say is that because so much of this is
associated with foreign official activity, the motivations of
an official body may differ from those of a private investor.
Mr. Simpson. Let me ask you another question. On your chart
where you list net private savings, net federal savings----
Mr. Orszag. Yes.
Mr. Simpson [continuing]. How do you determine net private
savings? Congressman Lungren was asking whether housing was
included. What exactly is included in that?
Mr. Orszag. That is a measure of your current income
excluding capital gains minus how much you spend. That is the
measure of savings that the Bureau of Economic Analysis uses
for this purpose.
Mr. Simpson. We have always assumed, and I agree, there is
legitimate disagreement about whether tax cuts pay for
themselves, whether they make sense or not and in the long run
whether they pay for themselves or not, and the argument on our
side of the aisle has always been that it increases economic
activity which increases the tax revenue which comes back to
the federal government.
Do we know, even though it is probably none of our
business, do we know what the American people did with their
tax cuts over the last few years, the reduced federal taxes
that they had to pay?
Mr. Orszag. There have been a few empirical studies done,
not very many. What I would say is that the overwhelming bulk
of the evidence suggests that while there is some offsetting
impact on economic activity, tax cuts do not come close to
paying for themselves.
Mr. Simpson. Do we know, though, what the consumers did
with their savings? I noticed in your chart on private savings
that after 2001, there was an uptick in savings.
Mr. Orszag. There have been, again, just a few studies
done. There was one, for example, done on what households did
with the rebates that were associated with the original
legislation. We could respond in writing. I do not want to try
to characterize it.
One of the difficulties is that it is hard to parse out,
money is fungible, it is hard to parse out, you know, that this
money went to that purpose basically.
Mr. Simpson. It would be interesting to know and would help
us when we try to determine federal policy, but I have a hard
time coming up with your net private savings, how you come up
with that when there are investments that make sense that would
be considered savings. Ask any farmer where their savings is.
Their savings are in their land.
Mr. Orszag. This is the definition that has been embodied
in the national income and product accounts, it is not a CBO
definition, basically since the national income and product
accounts were created, and it reflects a notion of saving that
is appropriate for evaluating how much is available to finance
domestic investment by corporations, for example, and things
like computers and buildings.
Mr. Simpson. And every commercial I see on TV that
investment in higher education returns a net increase to the
Mr. Orszag. And if you wanted to----
Mr. Simpson. My wife invests in clothes.
Mr. Orszag. The semantics here can get difficult. If you
wanted to classify, for example, expenditures on higher
education as investment, that would change both the saving rate
and investment rate, but it would not change the difference
between the two.
Mr. Simpson. I thank you and I look forward to the panel.
Thank you, Mr. Chairman.
Chairman Spratt. Thank you, Mr. Simpson.
Ms. Sutton. Thank you, Mr. Chairman. Thank you so much for
being here to talk about this extremely important issue.
You know, massive holdings, foreign holdings of U.S. debt
has had a palpable effect. It is not theoretical. It has had a
palpable effect on workers. Where I come from, it has had a
palpable effect on our economy.
The Economic Policy Institute recently estimated that while
exports to China supported 189,000 jobs here in the U.S.,
imports displaced production that would have supported six
times as many.
The jobs displaced by the increasing trade imbalance have
largely been in the manufacturing sector. And, in fact, in my
home State of Ohio, we have lost over 200,000 jobs since 2001
in the manufacturing sector under the Bush-Cheney economy.
So, Dr. Orszag, could you discuss the link between China's
investment in treasuries and the trade deficit that is causing
us to lose American jobs and just talk about how currency
manipulation plays into that?
Mr. Orszag. Let me try to again break that down in a couple
Ms. Sutton. Sure.
Mr. Orszag. First, I want to say CBO is doing a significant
amount of work on various forces that are affecting a broad
array of American families, including relatively sluggish real
income growth in significant parts of the income distribution,
including high levels of economic volatility, that is, for
example, earnings volatility, a lot of which gets sort of
associated with international trends perhaps incorrectly, but
kind of gets wrapped up together. So I just wanted to note that
CBO does a lot of work in this area.
The second thing I would say is I would be again more
focused on overall levels of net national saving and what is
happening there because that is tied to the nation's overall
current account deficit than a particular bilateral trade or
current account and trade imbalance in particular.
And then finally, it is the consensus view among economists
that at least over the long term, international trade may
affect the types of jobs that we have but not the number.
So this is coming back to my first point. I think the
fundamental issue for most American families is what is
happening to their income. Is it becoming more or less
volatile? Is it too volatile? Is it growing at a sluggish rate
and what can we do practically to improve their standards of
Ms. Sutton. Okay. Would you more specifically address the
issue of currency manipulation?
Mr. Orszag. What I would say about that is that there are a
variety of estimates suggesting that the Chinese currency is
undervalued relative to the dollar, that the estimates vary
depending on the model, that perhaps evidence--well, that there
is a variety of estimates out there again, and that I would not
necessarily use terms like the one that you used in conjunction
with currency that is potentially misaligned relative to its
Ms. Sutton. Okay. And, Dr. Orszag, you sort of alluded to
this a little bit earlier in one of your responses about
motivating factors that might be at play when foreign
governments make investments in our debt.
And you, I believe, if I understand you correctly, you were
talking--the question was raised about China's best economic
interest. Is it in their best economic interest to continue to
invest so heavily in our treasuries? And I guess the question
that is begged is what are the other factors that might explain
why its government or entities like that would have made such
massive investments in U.S. treasuries or may continue to do so
even though it is not in their best economic interest?
Mr. Orszag. Well, there are a variety of factors driving
this investment by foreign official institutions. One is the
overall current account deficit that we have which necessitates
as a mirror image capital in-flows.
The second is with regard to China in particular its effort
to manage its exchange rate which requires purchasing dollars
and selling domestic currency in order to achieve that
objective. And the result is a significant accumulation of
And then the question is, what are those dollar assets
invested in. And for a foreign official entity that is
concerned about safety and liquidity, U.S. government debt
becomes a particularly attractive investment vehicle.
So the question then becomes, is that always going to
continue. And I think, again, the view is that at some point,
the portfolio even of an official entity becomes saturated in
dollar assets and there may be some diversification out of
Chairman Spratt. Let us see. Mr. Alexander, is he here?
Mr. Porter. You go.
Chairman Spratt. Mr. Tiberi.
Mr. Tiberi. Thank you, Mr. Chairman. Your comments there
are fascinating. If I could follow-up on that.
I had a conversation recently with an economist over this
same issue and was challenging him on this concept of China
investing in U.S. treasuries. And the challenge that he had
back, and you just kind of mentioned it, if you could expand
upon it, is part of the reason why others invest in us is that
there is not a safer investment in terms of if you look around
the world in terms of a government, in terms of an economy, in
terms of our laws in the world.
Can you further comment on that in terms of if you were in
another country looking at investing in foreign debt? If you
are looking at Europe and Asia and the Middle East and Africa
and South America and Central America and the Far East and the
United States, what would you look for in terms of investing in
bonds and treasuries?
Mr. Orszag. Well, again, I mentioned security yields
associated with the risk return, tradeoffs, and liquidity. And
consistent with your comment is the fact that roughly two-
thirds of official reserves globally are still invested in
dollar assets suggests that we continue to be a preferred
vehicle for such investments.
But I would note that that is a privilege or a benefit that
is not guaranteed to continue forever and ever. It depends in
part on what we do and what happens abroad.
Mr. Tiberi. The benefit of U.S. treasuries you are saying?
Mr. Orszag. The benefit of the fact that foreign official
entities have chosen and continue to choose to invest such a
large share of their reserves in dollar assets.
Mr. Ryan. Mr. Tiberi.
Mr. Tiberi. Yes.
Mr. Ryan. Could I ask just a follow-up?
Mr. Tiberi. I will yield to the gentleman.
Mr. Ryan. What proportion of our foreign-held debt in China
in particular is callable versus noncallable debt?
Mr. Orszag. By callable, again, U.S. Treasury debt is not
like private debt.
Mr. Ryan. Yeah. But there are callable instruments we have
and then the vast majority of them have fixed mature rates,
Mr. Orszag. The vast majority have fixed maturities.
Mr. Ryan. Right. So the vast majority of the debt could not
be called tomorrow by the Chinese? Most of it, it would just
expire when it matures, correct?
Mr. Orszag. Yes. But one can obviously----
Mr. Ryan. They buy in fixed ten, twenty, thirty-year notes,
Mr. Orszag. One can move your portfolio out of a bond by
steps other than just redeeming the bond. You can sell the
Chairman Spratt. They do not call on the Treasury. They
sell it in the open market.
Mr. Orszag. You have to have a buyer.
Mr. Tiberi. That is why I was confused by that.
Mr. Ryan. But the idea that tomorrow they could cash in all
of the debt and crash the system would require that they would
be able to do that and it does not sound like they could; is
Mr. Orszag. No. Again, we are going down a hypothetical,
but it is not necessary to literally redeem a bond in order to
have an effect on the market. You can sell the bond and that
affects the pricing and the yield on the bond.
Mr. Ryan. Thank you, Mr. Tiberi.
Mr. Tiberi. Thank you.
Can we have chart one up, Minority chart one?
Yeah, that is it. Back to the entitlement issue, Dr.
Orszag. This chart speaks for itself. When you do your scoring
with respect to taxes and spending on entitlement, let me give
you a question that was asked to me and see how you would
answer it. I had difficulty answering it.
This is from a physician, a heart physician in Columbus,
Ohio. And this was during the debate on Medicare, the Medicare
drug benefit. And he said to me, you guys have it all wrong in
the sense that the Medicare system then did not allow him to
regulate a patient's heart, did not pay for it, but, yet, paid
for him cracking open the chest to repair the heart, which cost
tens of thousands of dollars, and said that if you allow me to
regulate this person's health through tests, through a drug,
there will be less of a cost and a better patient outcome than
if you would keep the system currently in place where you pay
for me to repair the heart.
But, yet, the scoring does not indicate that. And I
explained that to him. And he said, well, that is what is wrong
with the federal government. You do not take into real-life
situation where me as the doctor on the ground is actually
seeing these patients and can actually save the federal
government money and keep the quality of life of the patient
How would you respond to that, to that physician, that
heart surgeon who asked that question to me?
Mr. Orszag. That CBO continues to monitor the evidence on
what works and what does not, that this is one of the various
different approaches that are being discussed.
But, for example, there is a pilot project in the Medicare
Program, the so-called Coordinated Care Demonstration Project,
which tries to provide a sort of centralized process for the
various different medical interventions that are warranted for
someone with a severe chronic condition. The evidence suggests
that those programs are not paying for themselves, let alone
actually reducing cost.
Mr. Tiberi. Well, your assumption is, though, according to
this doctor, just if I could just finish this question, but
your assumption is that you assume that every single patient is
going to still have the open heart surgery despite the
prevention because you do not take into account the savings
according to this doctor of not having the heart fixed.
Mr. Orszag. Where there is evidence of offsets like that,
so you do X and then you reduce cost over here, we take that
into account. So conceptually we try to take it into account,
but it is often the case that the evidence in favor of many
propositions, including on preventative medicine and including
on disease management, it is not as strong as some
practitioners make it seem.
And, again, we are always looking for additional hard
evidence on what works and what does not and then that would be
reflected in the scoring process.
Chairman Spratt. Mr. Doggett.
Mr. Doggett. Thank you, Mr. Chairman.
And thank you for your excellent testimony. I thought that
Mr. Edwards made some important observations earlier in his
questions about the devastating impact of these Bush-Cheney
economic policies supported by Republican Congresses on our
families. I think that has to be put, of course, into
historical context of folks that talk like deficit hawks, but
Under President Reagan, we hit almost a trillion and a half
dollars in deficits. Under President Bush the first, we only
got a little over a trillion dollars in deficits. Under
President Clinton, of course, we achieved about $62 billion,
$63 billion in surplus. That was the result of true fiscal
And now, of course, under President Bush, the biggest
talker and preacher against deficits and excessive spending and
in favor of fiscal responsibility, but the all-time top hitter
in achieving almost unlimited deficits, we are hitting on $2
trillion. He has not quite gotten there yet, but the kind of
irresponsible policies he has had take us in that direction.
And I want to yield back to Mr. Edwards to make further
observations about what the impact of these irresponsible
policies are on the typical American family.
Mr. Edwards. Mr. Chairman, I want to respond. Mr. Simpson
had asked if we are going to call this the Bush-Cheney deficit
and the Bush-Cheney debt, which it is, largest in American
history, we should also call it the Bush-Cheney economy.
I want to agree with him on that and I would like to
submit, if I can send to the Committee, a report done by the
Center on Budget and Policy with data from Commerce and Labor
and Federal Reserve.
Compared to a response to coming out of previous recessions
over the last 30 years, the Bush-Cheney economic impact was
less in GDP growth, less in consumption growth, less in
investment growth, net worth, less in wages and salary growth,
less in employment growth.
There is one area the Bush-Cheney economic policy has
worked. That is it has had huge increases in corporate profits.
But in every other way, it has been worse than our response to
recessions in the last 30 years.
And median household income of the nonelderly population
has gone down by nearly four percent under the Bush-Cheney
economic program while aggregate national income and corporate
growth have gone up.
Mr. Doggett. Dr. Orszag, let me then inquire of you about
one aspect of these perhaps consequences of some of these
policies that has not yet been explored and that is the direct
impact on the private sector of the acquisition of private
assets by foreign owners.
As you know, within the last year, there has been concern
expressed about the Chinese purchasing a major oil company
here. There is concern that was expressed about one of the Gulf
states taking over our ports.
I noticed within this last week, perhaps a little less
strategic, the acquisition of Barney's in New York by Dubai.
And I believe the Russians are getting plenty of petro dollars
also and may be looking at the United States. I guess they will
not be buying any media outlets since they are basically in the
business of shutting down media outlets at home.
But what is likely to be the consequence as far as foreign
acquisition of private assets of continuing the same policies
that you are talking about today?
Mr. Orszag. Well, again, if you look at the net impact,
there are lots of shifts in portfolios that are always
occurring, but the net impact of running a current account
deficit is that foreign claims on U.S. assets increase. In
recent years actually, those have been disproportionately in
government securities and disproportionately from foreign
And if you look at some of the subcategories, for example,
direct investment, that is foreign purchasers buying more than
ten percent of a domestic firm, we are actually now
experiencing net capital outflows in that subcategory of the
capital account rather than net capital inflows.
Mr. Doggett. Is Chinese acquisition a part of Blackstone an
indication of any potential future shift of Chinese investment
and purchasing of U.S. investments?
Mr. Orszag. Again, what I would say is that over the past
several years, the net impact of capital inflows have been
disproportionately in government securities as opposed to some
of these other higher-profile, if you will, portfolio decisions
and, again, disproportionately coming from official entities.
Beyond that, there are lots of shifts of portfolios in
particular investments that go on all the time. And I am not
reading too much into that particular one.
Mr. Doggett. Thank you.
Chairman Spratt. Thank you, Mr. Doggett.
Mr. Smith from Nebraska.
Mr. Smith. Thank you. I appreciate this discussion here
today and it is quite enlightening as a new member. And I have
been trying to follow the issues over the past few years.
But in light of the discussion about Medicare Part D, were
there competing measures that would have cost more than the
Republican adopted Medicare Part D plan?
Mr. Orszag. There were a variety of proposals floating
around at the time and I have not gone back and checked, but I
am sure that some of them were more expensive than the enacted
Mr. Smith. Okay. Thank you. And I realize CBO, I guess the
rules, if you will, stipulate that the scoring is done not in a
dynamic fashion, but perhaps a static fashion.
But would you agree that an increase in the capital gains
tax would create a disincentive to make a relevant sale or
economic transaction and would that be good for the economy?
Mr. Orszag. An increase in the capital gains tax would
temporarily reduce the incentive for realizations. The longer-
term effects are more complicated and the bulk of the evidence
suggests that changes in capital gains taxes do not have a
substantial effect on either the sort of net realization rates
or the broader economy.
Mr. Smith. Okay. We are going to see, I guess I would
predict, the expiration of several tax relief measures. Do you
have any concern about consumer behavior in those last six
months, those last twelve months, what the relevant case might
be and the long-term impact of those changes in behavior?
Mr. Orszag. Again, if you are running up against a
significant change, especially in something like a capital
gains tax rate, you often get a significant amount of shifting.
So, for example, if the capital tax gains rate is about to
go way up, shifting realizations into the period in which the
capital gains rate is lower and we would anticipate that that
Mr. Smith. And do you have a concern about that creating
somewhat of a false economy or false revenue outlooks?
Mr. Orszag. That kind of phenomenon has happened in the
past and I am not sure that I would associate a significant
concern with it as opposed to just recognizing that it does
Mr. Smith. Okay. But as we look to the future and try to
predict as your office often does, are you looking at
adjustments there? Is it sort of all formula driven?
Mr. Orszag. No, no. Maybe I can answer the question what is
the CBO's analysis of what would happen if the tax legislation
expired as scheduled. And there are a variety of effects. Over
time, one of the effects is that the budget deficit is smaller
than it would otherwise be. That boosts long-term economic
On the other hand, marginal tax rates are higher than they
would otherwise be and on net, that impairs long-term economic
performance. And CBO's analysis suggests that the net impact is
relatively modest from those two forces.
Mr. Smith. Okay. And another question that I have is we
have talked about government spending here today as well as
personal savings or lack thereof. Which do you think is a
bigger concern, government spending or lack of personal
Mr. Orszag. I do not know that I would want to parse it
that way. What I would say is I think the evidence suggests
that the biggest, from a policy perspective, the biggest impact
that you all can have is through public saving.
Efforts at boosting private savings through policy
interventions have often not succeeded that well, although I
would note my written testimony delineates that encouraging
automatic saving, that is that you are in a 401k or you are in
an IRA unless you opt out, appears to have a significant effect
on contributions and participation rates.
Mr. Smith. Okay. Thank you, Mr. Chairman.
Chairman Spratt. Mr. Becerra.
Mr. Becerra. Dr. Orszag, thanks for being with us. Thank
you for your testimony.
Let me make sure I have this correct. We see the share of
our debt being more and more held by those who are foreigners,
China, Japan. Oil exporting countries are buying up our
As we try to figure out how to finance our government's
operations, we are putting our bonds, our treasuries out for
market and more and more the people who are buying or the
entities that are buying are foreign partners or in some cases
foreign competitors, correct?
Mr. Orszag. That is correct. A rising share of our
publicly-held debt is held by foreigners.
Mr. Becerra. And more and more, it is not United Kingdom
that is buying our debt or even Japan, which has become a
friendly nation towards us over the last 50 years, but China,
some of the same oil exporting countries that we continue to
claim, as the President said, we want to remove ourselves from
this addiction to oil.
They are the ones that are buying more and more of our debt
that we put out there, correct?
Mr. Orszag. In terms of trends, that is correct.
Mr. Becerra. Now, right now we have experienced fairly low
interest rates, historically low interest rates for quite some
time. But if all of those foreign buyers of our debt were to,
for whatever reason, decide not to buy and we could no longer
sell it so easily, that would cause us to have to raise the
interest we offer on those treasuries that we are trying to
sell which would cause the rest of the markets around the
nation to have to offer interest rates that are higher as well.
Would that not be the consequence?
Mr. Orszag. That is indeed the case.
Mr. Becerra. Okay. So if I keep following this logical
train of thought, in the housing market, we continue to hear
about people having to give up their home because of
foreclosures. They can no longer afford to pay the payment on
their mortgage because the interest rates have gone up on these
adjustable rate mortgages and now they are having to give up
their homes. They are losing them on foreclosure.
If for whatever reason, China or one of these oil exporting
countries decided to play politics with us, say China decided
to take over Taiwan finally and we said, no, you cannot do
that, we are going to defend Taiwan and they said you are going
to do what, maybe we are not going to buy any more of your
What could happen to something like our home ownership
rates, our housing market in America if interest rates were to
become volatile and increase dramatically?
Mr. Orszag. Upward pressure on interest rates would
discourage home ownership and also discourage various other
types of consumption, both of which would tend to--well, the
net effect of which, by the way, would also be to increase the
private saving rate.
Mr. Becerra. You say it in such a neutral tone.
Mr. Orszag. Yeah. I am trying.
Mr. Becerra. The sky would fall on those who try to own a
My other concern is this as I continue to hear this play
out. We are right now still in the midst of a War in Iraq where
160,000 American troops are still based in a country where we
were told we would fight a three to six-year battle, war, with
the cost at no more than about 50 billion.
Now we are well beyond a half a trillion dollars in cost,
unclear when the President would even consider having us come
out even though this Congress has tried to push to have an end
date. We are financing this principally through debt. We are
deficit spending to pay for the war because we are in a deficit
to begin with.
So the question is this. In our 230-year history, can you
think of a time where at the same time that we are spending
hundreds of billions of dollars on a war when we are in
deficit, have we ever faced a similar circumstance while we
have been in war while we have also at the same time cut the
taxes on the wealthiest Americans in this country?
Mr. Orszag. I do not believe that is the case. I actually
think we may have had a previous exchange on a similar topic. I
had asked CBO staff to look into whether there had ever been a
revenue reduction during a time of war. And if my memory serves
me correctly, there was an engagement with Mexico in the late
19th century in which we also reduced a tariff rate at
approximately the same time. And that was the only time in
history that the CBO staff could uncover.
Mr. Becerra. So a tariff rate versus what we have seen to
the tune of several trillion dollars in tax cuts that have gone
principally to those at very highest income levels and we have
a deficit that has grown to historic levels. And at the same
time, we are finding our foreign competitors are buying up our
And it just seems like this vicious cycle does not end, but
at the same time, it does not seem like at the White House
there is any control over how we spend our money.
So whether it is because we want to maintain home ownership
rates at high levels or whether it is because we want to try to
do right by the men and women who are serving us in the
military who are in Iraq abroad, I would think that what we
would try to do is heed what you are saying and try to have
more fiscal responsibility and that is perhaps why Congress has
decided to go with the PAYGO system in operation so that we
will no longer continue to increase the size of the deficit.
So no question there other than to say thank you for your
testimony and for your comments that you have always provided
to this Committee.
Chairman Spratt. Mr. Etheridge.
Mr. Etheridge. Thank you, Mr. Chairman. Let me thank you
for holding this meeting and let me thank you for leading this
Committee through the PAYGO system to get us back on track
because I think it is important.
Dr. Orszag, thank you for being here. Your testimony today
You know, we are seeing record deficits and the policies
that have been put in place in the last few years got us here.
And it has made it very difficult for us, I think, this year
for us to meet some of the pressing needs and I will talk about
that in a minute.
But too often in this town, the debate dissolves into
soundbites and some talking points that are repeated over and
over and over again and we get charts that try to make our
points. And the truth is I want to get to something that I
think is important that hopefully gets to where the American
I do not understand all this stuff sometimes, but most
folks understand that have a bill to pay what the interest is
on it. And I want to follow-up what my colleague was just
talking about. I happen to disagree with the Vice President.
Deficits do matter.
And with that, let me ask you this question. Do you
remember what the amount of interest we were paying in 2000,
the actual interest on the national debt and how much interest
we will pay this year on the national debt given that we are
keeping the interest rate down to the point we are? I will not
go into what will happen when it would balloon, but what those
numbers actually are in the millions of dollars.
Mr. Orszag. Luckily I do not have to rely on my memory
since I brought the CBO budget and economic outlook. In fiscal
year 2000, net interest payments were $223 billion.
Mr. Etheridge. All right.
Mr. Orszag. And in 2006, they were $227 billion.
Mr. Etheridge. Say it again now.
Mr. Orszag. In fiscal year 2006, net interest payments were
Mr. Etheridge. Two hundred and twenty-seven billion. And it
was how much in 2000?
Mr. Orszag. Two hundred and twenty-three.
Mr. Etheridge. It only went up $4 billion?
Mr. Orszag. One of the things that has happened in the
meanwhile is that there has been an evolution of interest
rates. We have exceptionally low interest rates now in the
Mr. Etheridge. Okay. Now, my question, the question is that
as we have seen this tremendous growth in deficits being bought
by and large overseas, it means that the dollars that
historically in World War II and all those times we were
running deficits was paid through the America citizens which in
effect meant that money was turning over in the American
Those dollars now are being bought overseas. What portion
of our debt, our total debt is bought overseas? The reason I
ask this question, of the $227 billion, it could grow very
rapidly. It is no longer enriching our country. The interest is
going somewhere else, to China. As you have said, about a 500
percent increase, which means not only are they buying debt,
they also are part of the balance of payment deficit we have.
And what was that balance of payment with China in 2000
versus the balance of payment in 2006? Do you happen to have
Mr. Orszag. Yeah. Let me answer this in two parts. So with
regard to the publicly-held debt, again somewhat above 40
percent of the nation's publicly-held debt is now owned by
Chairman Spratt. How much?
Mr. Orszag. Slightly above 40. It is 42 or 43. With regard
to the nation's current account deficit with China according to
our data, and the numbers are a little different in their data,
that was a little bit above $200 billion last year. And,
actually, I will have to get you the number from 2000. I do not
want to misquote it.
Mr. Etheridge. Okay. That being said then, roughly of the
$227 billion in debt, we can figure 42 to 43 percent of that
interest is going outside the United States that is no longer
available within our economy that would turn over to generate
economic activity. And that would no longer be savings in the
American economy which could be turned into education, to
healthcare, to a host of other issues, more savings for the
Mr. Orszag. Again, I do not have the data on the maturity
structures, et cetera, but roughly speaking about 40 percent of
net interest payments----
Mr. Etheridge. Whatever that number may be.
Mr. Orszag [continuing]. Would be flowing to foreigners.
Mr. Etheridge. Okay. Thank you.
I think, Mr. Chairman, the point is, and I thank you for
holding this hearing and I thank you, Dr. Orszag, because, you
know, these things are important.
I remember asking the question to the Treasury Secretary
Paulsen about whether or not deficits bothered him and whether
it kept him up at night. And he said it did not.
Well, I think these numbers ought to bother all of us and I
am glad we have started on a track now to start getting back to
a balanced budget because I think these debts being held by the
people who are not necessarily going to be working in our best
interest are important for us to get on better ground.
Thank you, Mr. Chairman. I yield back.
Chairman Spratt. Thank you, Mr. Etheridge.
Mr. Cooper of Tennessee.
Mr. Cooper. Thank you, Mr. Chairman.
Dr. Orszag, as you know, Standard & Poors of New York has
projected that by 2012, the U.S. Treasury bond will lose its
triple A credit rating. Furthermore, they have projected that
by 2015, the United States of America will have the same credit
rating as Greece or Estonia.
By 2020, they say that our credit rating, if things do not
change, will be that of Poland or Mexico. And by 2025, they say
that the U.S. Treasury bond will be below investment grade,
junk debt, on par with the bonds of Brazil or Panama.
What in your professional opinion would be the impact if in
2012 we take the first of S&P projections, it is the closest at
hand, and the U.S. Treasury bond loses its triple A credit
Mr. Orszag. I guess the way I would answer that is that we
are on a fiscal path in which the problems grow gradually worse
over time and they are going to continue getting worse if we do
not tackle some of the things that we were talking about
It is hard to parse out exactly where trigger points would
be so that there would be sort of discrete adjustments. What
you were describing may be one among many things that would put
that gradual deterioration on a more sudden path.
Mr. Cooper. I think it is a problem that clearly the next
President will have to confront if S&P is even in the ballpark
of being correct.
Mr. Orszag. Every budget analyst that I know suggests that
the United States is on an unsustainable fiscal path and that
the problem needs to be addressed. It would be better to
address it sooner rather than later.
Mr. Cooper. Exactly. I was just about to mention the
precious word unsustainable. Everyone agrees on that, but who
is doing anything about it? The reason the S&P projection is
not a prediction is they think some policy makers are going to
intervene. Well, things are keeping on pretty much business as
You mentioned in your testimony that the best way out of
the dilemma is to boost the savings rate and then you offer an
addition to the automatic 401ks that we passed last year,
perhaps some automatic IRA proposal, and then you say that
would hardly dent the problem that we face.
What can we do that would dramatically boost the national
Mr. Orszag. I think the single best thing under your
control or single-most effective thing largely under your
control is to move the federal fiscal balance from its current
level of one and a half percent GDP deficit and much larger
projected deficits perhaps even into surplus and to get it on a
more sustainable path.
Mr. Cooper. But although we hope to have a budget
improvement, I think most policy makers would tell you at least
privately we do not see a way out of these deficits for the
And no one is trying to reform the entitlement spending
that was discussed earlier that must be addressed if we are
going to curb growth in healthcare spending.
Mr. Orszag. And one of the reasons that I am putting so
much emphasis on CBO increasingly becoming the Congressional
Health Office is to provide options to you on what might help
bend that curve. So we are doing a lot of things, at least for
our part, to provide you with more options that you could
Mr. Cooper. Your CBO budget options book is excellent. You
could emphasize healthcare a little bit more and we would
appreciate that. We would also welcome more ideas on ways to
boost private savings because if you were to poll members of
Congress, you would find that our own personal savings behavior
is very regrettable. Just we mirror the public at large.
So I think suggestions along those lines would be very
helpful because here we all agree it is unsustainable, but no
one is doing much about it, either as policy makers or as
individuals. We say the words, but we must not mean them
because we are letting the day of reckoning come closer and
Is there an opportunity for CBO staff to work on ways to
boost, suggestions for us to boost private savings rates in
this country, something bolder than automatic IRAs?
Mr. Orszag. Sure, although I would note, and, again, this
is not a recommendation that I am making, but I would note that
the evidence in favor of the proposition that a lot of saving
behavior is driven by inertia and that that is a significant
factor in savings rates for many American families. I would not
downplay that too much.
Mr. Cooper. But today after 20 or 30 years of IRAs, what,
only ten percent of Americans have one with any substantial
Mr. Orszag. And that is in no small part in my opinion
because you have to take active steps to go and sign up, go to
a bank to get it. Even small impediments to taking action to
contributing have large effects.
The evidence from 401ks suggest that even, you know, having
to read through a document at work and sign up has a
significant deterrent effect. If you are in a plan unless you
opt out, your participation and contribution rates are a lot
The same logic could be applied to the IRA setting, but it
would require a variety of changes and I do not think it would
be a small matter in terms of the required statutory changes
Mr. Cooper. Thank you, Mr. Chairman. I see my time has
Chairman Spratt. Thank you, Mr. Cooper.
Ms. Kaptur. Thank you, Mr. Chairman.
Dr. Orszag, welcome. Do you have any recent number on what
we are projected to pay in interest to these foreign holders of
our debt this fiscal year? It is over 200 billion, is it not,
somewhere between 100 and 200 billion?
Mr. Orszag. That seems high in terms of interest on the
U.S. Treasury debt paid to foreigners, again going through the
math that we were walking through before.
Ms. Kaptur. I did not find it in your testimony.
Mr. Orszag. I do not believe I provided it in my testimony.
But total net interest payments will be a little bit above $200
billion. Foreign entities own about 40 percent of the debt. So
doing the math, that would be roughly $80 billion or so.
Ms. Kaptur. Okay. So we are approaching $100 billion. That
is not insignificant. That is larger than many of our
governmental departments. NASA's budget is $16 billion, for
example. So you are talking about big money here.
You are talking about substitutional effects in the
government of the United States where we could be spending
those dollars on, for instance, veterans. I think the veterans
budget is what, 60 to 70 billion a year now. I mean, you think
about what that displaces in terms of our economy and that has
been on an upward path.
I can tell you when I got to Congress, the amount of
foreign investment in U.S. securities was about eight percent
and I used to rail against it over in what was then called the
Banking Committee. Now we are over half and America has lost
their independence in my opinion.
And all of the actions that have occurred over the last 20
years, whether it is the destruction of our thrift
institutions, changing the name of the Banking Committee to the
Financial Services, charging people and giving them no interest
in their checking accounts, all the fees we are placing on
people, the lack of emphasis on savings, no postal saving stamp
program like Franklin Roosevelt.
As a grandmother, if you want to buy a--try to buy a
savings bond. You are too young to buy one. And your grandmom
wants to give it to the grandchild. Good luck. They want to
mail it in the mail. When ordinary people wanted help, the
government of the United States fights them every step of the
way. So it is really interesting to me we are part and parcel
of the problem, but we cannot see our way out of it.
Let me ask you about the Saudis. I see your chart here on
oil exporting countries and who owns what of this debt. Okay?
Does that include the special arrangements the Saudis have with
our government for the reinvestment of over a trillion dollars,
but it is done in dollar denominated assets? It does not appear
to me that that is in your chart. What can you tell us about
when that agreement was struck at Treasury and how that works
compared to the purchases by other countries of our bonds?
Mr. Orszag. I think I will have to reply in writing to you.
I do not have anything to say about that at this point.
Ms. Kaptur. Yeah. Treasury never wants to say anything
about that and it is pretty significant and it is different.
And I think your charts underestimate the impact of that inside
this economy and the close linkage between the reinvestment of
those assets inside this economy. I think the numbers are worse
than you presented in your charts.
I wanted to ask you about does the Treasury or anyone else
identify the top specific foreign purchasers of U.S. debt for
each fiscal year and, if not, why not?
Mr. Orszag. There is an identification by country of
holdings of different types of assets including public debt.
And we could provide those to you.
Ms. Kaptur. So we could track them back to----
Mr. Orszag. Yes. Now, there are various flaws in the data.
For example, those are typically based on surveys often of
custodians of assets. There can be banks in the UK holding the
asset on behalf of someone else. And so the country breakdowns
can often be a bit off relative to an underlying reality.
Ms. Kaptur. All right. I am going to ask some questions for
the record for you to get back to us on that.
Mr. Orszag. Okay.
Ms. Kaptur. What is the linkage you have seen between our
trade deficit and the increased foreign holdings of our debt?
Mr. Orszag. The trade and current account deficits
necessitate the mirror image of them is a net capital inflow
from abroad and part of that net capital inflow, actually in
recent years a very large share, has occurred in the form of
purchasing Treasury securities. So there is a direct connection
between our current account deficits and net capital inflows
from abroad. They are the mirror image of each other.
Ms. Kaptur. I know we have got other witnesses today, but I
am pretty concerned about these hedge funds and the investors
in those not being disclosed.
Would you support a federal law that would require
disclosure of anything over five percent in any of those hedge
funds that would be of a foreign nature, foreign purchases of
assets held by those hedge funds? Do you see any disadvantage
to doing that?
Mr. Orszag. Again, my role as CBO Director is not to
support or not any particular legislation. We would be happy to
provide an analysis of the pros and cons to you which I would
rather do again in writing since I know that our time is
Ms. Kaptur. Okay. Thank you very much for being here today
and I look forward to replies to the questions I have asked.
Chairman Spratt. Thank you, Ms. Kaptur.
Ms. Kaptur. Thank you, Mr. Chairman.
Chairman Spratt. Mr. Berry.
Mr. Berry. Thank you, Mr. Chairman.
Dr. Orszag, we appreciate your effort. You keep referring
to net interest. What is gross interest?
Mr. Orszag. It is significantly higher. It includes
payments to various different, for example, the Social Security
Trust Fund, which is part of the federal government.
Mr. Berry. How much is it?
Mr. Orszag. From memory, it is certainly north of $100
billion a year. It will take me a second to get.
Mr. Berry. That is fine.
Mr. Orszag. Okay. While you are asking your next question,
I will look it up.
Mr. Berry. Okay. When you present the net interest that we
paid in 2000 and then what we paid in 2006, there appears to be
very little impact on the interest that we are paying as it
relates to the amount of money we owe because we have borrowed
a couple or $3 trillion more than we owed at that time. Am I
correct about that?
Mr. Orszag. That is correct. And one of the reasons for
that is that the--well, there have been a variety of changes.
But, for example, looking at the interest rate on U.S.
government debt is one factor that is affecting because you
have the stock of debt and then the interest rate that is paid
on the debt and you are focusing on the fact that the stock of
debt has gone up as we have run these deficits, but the other
factor is the interest rate.
Mr. Berry. So does the amount of debt that we owe have any
impact on the interest rate?
Mr. Orszag. Yes, it does, but there are other factors that
affect interest rates also. And those other factors have
resulted--one of the phenomenon that has occurred over the past
several years is we have a very flat and actually for a period
of time we had an inverted yield curve which is unusual.
So a longer-term Treasury security like a ten-year bond
typically yields more than, you know, a three-month Treasury
bill. That yield curve has been very, very flat over the past
several years, unusually flat.
Mr. Berry. You have testified, and I have heard many others
say the same thing, that tax cuts do not pay for themselves. Do
farm bills pay for themselves? Do the American people get their
money's worth out of a farm bill?
Mr. Orszag. I think the question of the sort of costs and
benefits of agricultural programs is that is a different
question than the economic return to a tax cut. Basically I am
not going to touch that.
Mr. Berry. Thank you, sir.
Chairman Spratt. Mr. Scott.
I see our patient forebearing second panel next. You are on
deck. We are sorry to have kept you so long.
Mr. Scott, proceed.
Mr. Scott. Thank you.
Dr. Orszag, the gentleman from California had a situation
where we had to go to defend Taiwan and China could use the
fact that we are borrowing money from them as a negotiating
What would happen if China decided as part of the deal they
would not lend us money to defend Taiwan against them? What
would happen? Could we manage without borrowing money from
Mr. Orszag. The impact on our economy would depend in part
on the reaction of other investors, whether they would step in
rapidly or not. But a very sort of sudden and significant
withdrawal of flows of Chinese investment into U.S. Treasury
securities would likely have some at least short-term
disruptive effect. And how big that would be would depend in
part on what happened in the rest of the market and whether
other investors stepped in.
Mr. Scott. Interest rates are international.
Mr. Orszag. They are influenced by international capital
Mr. Scott. How much fluctuation, annual fluctuation is
there in international interest rates? I mean, are they pretty
stable from month to month, year to year, or can they go up a
point, two, three points a year?
Mr. Orszag. Fluctuations of two or three basis points in a
year are unusual, but not unprecedented.
Mr. Scott. We have a chart here that shows that in 2001, we
had about a trillion dollars in international debt; 2007, 2.2
trillion. How much did the overall debt, national debt increase
from 2001 to 2007?
Mr. Orszag. Roughly a trillion and a half dollars or so, I
Mr. Scott. Well, this is 1.2 trillion.
Mr. Orszag. I do not know what chart you are looking at,
Mr. Scott. This one.
Mr. Orszag. Oh, I am sorry. That is foreign-held debt. So I
was giving you the numbers for all publicly-held debt. Foreign-
held debt has increased by about three-quarters as much as the
Mr. Scott. Okay. Well, foreign-held debt went from one to
2.2. How much did the overall national debt go up?
Mr. Orszag. By a little bit above 1.5 trillion.
Mr. Scott. One point five. So out of the net 1.5 trillion
increase foreign-held net went up 1.2 which is 70 percent?
Mr. Orszag. That is roughly correct.
Mr. Scott. Of the net debt was financed from overseas
Mr. Orszag. That is correct.
Mr. Scott. You had an exchange where the bond rating might
be adversely affected. Can you say how close we are to a
tipping point where foreign countries might stop buying and, in
fact, might start selling debt and what that might do to our
Mr. Orszag. There is a risk of a sudden and severe
adjustment. That risk, I think, is small, but perhaps growing.
And I cannot identify a particular trigger point for you.
One of the inherent elements of a situation like this one
is that there are steps that one would presumably want to take
to avoid the risk of something happening even if you cannot
identify exactly when it could happen or even the exact
probability of it occurring.
Mr. Scott. What order of magnitude of interest rate shock
would we be looking at?
Mr. Orszag. Again, it depends on exactly what happened. And
someone once said that this kind of situation, things can go
wrong in such a wide variety of ways that it is just difficult
to parse out all of the various different scenarios. But there
have been estimates suggesting a hundred basis points or more
type of adjustment.
Mr. Scott. Now, if we had not messed up the budget starting
in 2001, we had projected that we would be able to pay off the
debt held by the public by approximately 2008. Is that true?
The projections in early 2001 would pay off the national debt?
Mr. Orszag. As you will remember at that time, there was
significant discussion about what would happen in the situation
in which all the publicly-held debt had been paid off.
Mr. Scott. And so all of this risk that we are discussing
now would not have been there if we were in the process of
paying off the debt held by the public?
Mr. Orszag. Or another way of putting it is in the kind of
scenario where you were running significant budget surpluses,
net national saving would be significantly higher.
Chairman Spratt. Dr. Orszag, as always, thank you for your
excellent presentation, your responsive answers. We look
forward to hearing you shortly, I think tomorrow or the next
Mr. Orszag. Thursday, yes.
Chairman Spratt [continuing]. Thursday. Thank you again for
your participation and for CBO's input.
Now our second panel, Dr. Robert D. Hormats, Dr. Mickey
Levy, Dr. Kenneth Rogoff, and Dr. Brad Setser.
If you have no objection as a panel, we will proceed in the
order I just mentioned unless you want to change the order, Dr.
Hormats, Mickey Levy, Kenneth Rogoff, and Brad Setser. Is that
agreeable with the panel?
Mr. Hormats, thank you for participating.
And thank you for your patience, all of you. Your prepared
statements will be made part of the record and to the extent
you wish, you can summarize them.
The floor is yours.
STATEMENTS OF ROBERT D. HORMATS, VICE CHAIRMAN, GOLDMAN SACHS
(INTERNATIONAL); MICKEY LEVY, CHIEF ECONOMIST, BANK OF AMERICA;
KENNETH ROGOFF; PROFESSOR OF ECONOMICS AND THOMAS DR. CABOT
PROFESSOR OF PUBLIC POLICY, HARVARD UNIVERSITY; BRAD SETSER,
SENIOR ECONOMIST, ROUBINI GLOBAL ECONOMICS
STATEMENT OF ROBERT D. HORMATS
Mr. Hormats. Thank you very much, Mr. Chairman and members
of the Committee. It is a pleasure to be here and I will just
try to make a few key points relative to the broader issues
that I have described in my written testimony.
One, you have discussed in previous prior testimony the
domestic savings versus investment imbalance. The domestic
issues are one part of the equation. The other is the question
of where the capital to fill the domestic saving shortage comes
from and the point has been made frequently that the biggest
increases have come from China and the oil producers.
There tends to be a lot of focus on the reserve
accumulations of central banks, but I just want to emphasize
that the critical issue for these countries is the enormous
amount of net savings as reflected in their current surpluses
so that we can be very reliant on foreign capital supplies from
countries that have very low reserves.
The reserve accumulation occurs when the central bank buys
up dollars or other currencies, but the reliance of the United
States on foreign capital would be there whether the reserves
have been accumulated or not because it really relates to the
net savings of these countries or, put another way, the net
In my testimony, I was asked particularly to look at some
of the scenarios for the unwinding of this huge dependence.
What could occur that would cause a major disruption or
interruption in the inflows of this capital? So I have briefly
laid out three separate scenarios.
One is what I call the benign scenario. Essentially the
benign scenario occurs and is occurring already with respect to
the oil producers. The oil producers now are as a result of
what was up until recently a decline in oil prices and as a
result of an increased amount of domestic demand and domestic
investment using a growing share of their surpluses so that
their trade surpluses which were over 500 billion in 2006 are
likely to be under 400 billion this year and under 300 billion
in 2008 which means they will have less investable savings,
less net export of savings to provide our markets.
And the same thing could occur in other countries. If you
see in China or any other major supplier of capital increase in
domestic demand and more of their money is used at home, there
would be less exportable savings. That is a relatively benign
scenario because it is demand led. It is based on the fact that
they have more demand for their capital. They invest more at
home. They grow more rapidly. They buy more American goods and
they use more of their goods at home.
That is a good scenario, but it does suggest to us that the
exportable savings of these countries does have limits and one
limit is that they may want to use more of their savings at
home, means there is less available to export to us and other
The next scenario is what I call the disruptive scenario.
If you look at the countries China, Saudi Arabia, Russia, big
owners of large amounts of reserves and large amounts of excess
capital, if they were to consciously and abruptly shift a large
portion away from the dollar market as a result of some
political conflict or for some other reason, a trade dispute,
that would have a very adverse impact on our economy because
others watching them would probably also sell dollar assets
because they do not want to be the last one through the door.
And that would push interest rates up rather significantly
in this country, maybe very significantly, in fact. The dollar
would decline. The net effect would be a marked slowdown in
U.S. growth, possibility a recession.
Now, at some point, other countries and other people might
come in to buy the cheaper dollar and the cheaper assets, but
it could take a long time for that to occur. It is like
catching a falling knife and it would be a very disruptive
The third scenario is what I call the highly disruptive
scenario and that is consider, for instance, a major terrorist
attack on the United States which struck America's
infrastructure, for instance, the Port of New York, the Port of
Long Beach, or a major dirty bomb that goes off in the center
of a major American city that rendered the city or part of it
uninhabitable for decades or a disruption in a major airport or
railway station or subway system through Anthrax which would
take it out of commission for a long time.
In such circumstances, foreign investors, particularly
private sector investors, initially would perceive a
significant risk of their U.S. investments and might pull money
out or simply not put any more money in. And the budget
implications of that would be enormous. The economy would
weaken, therefore revenues would decline. The government would
have to spend a lot more money on reconstruction, rebuilding,
And foreign central banks seeing this big increase in the
budget deficit would either perhaps decide they want to be more
cautious about concentrating large amounts of additional assets
into dollars or in some cases decide to withdraw some dollar
assets which, again, would push interest rates up dramatically
and have an adverse effect.
And even if the central banks did not panic and decided not
to do this, there would be perhaps so much cutting of private
sector money in the United States or withdrawals that it would
present a major issue to the central banks to have to work
together to stem that tide of a collapse of the dollar and an
increase in U.S. interest rates.
How much damage would be done would depend in part on the
fiscal situation of the United States. If we had a very large
budget deficit at the time and were heavily dependent on
foreign capital, we would be more vulnerable to this than if we
were in a strong fiscal situation and we were not as dependent
on foreign capital and we did not have as much debt.
So the underlying fiscal situation would have some effect
on how the markets perceived the impact of such a terrorist
attack on the American fiscal situation. And I think this is
worth looking at. The underlying fiscal strength of this
country would have some impact on how foreigners perceived the
degree of risk that would occur as a result of such an attack.
Let me conclude because I know there will be time for
questions. The book that you have in front of you and that I
have given a number of members and is on the table in back
makes one fundamental point that I think is well worth keeping
in mind. The title of the book is ``The Price of Liberty.'' It
comes from Hamilton.
And Hamilton made the point very clearly that there is a
very close link between the fiscal strength of the United
States and its national security. He was very much of the view
that if you want to have the opportunity to borrow at
reasonable rates during a crisis, a war or some other
emergency, the country has to be credit worthy so that
investors see it as a good place to invest their money.
If the underlying fiscal circumstances are weak as a result
of bloated budget deficits, for instance, that makes it harder
for the government to borrow in emergency situations. And if it
does borrow, it would presumably have to pay a lot more,
particularly if, as Mr. Cooper indicates, there is a risk that
there be a downgrading of American assets. That would make it
even more difficult for the United States to borrow in those
So the underlying circumstances of our country, I think,
would have a major impact on this. And his judgment is if you
want to have a resilient economy, an economy that can marshall
resources during a crisis, you cannot wait until the crisis
occurs to put the economic house in order. It has to be put in
order beforehand and that gives this country the resilience to
muster the resources it needs in an emergency and to borrow at
reasonable rates if such an emergency were to occur.
Thank you very much, Mr. Chairman.
[The prepared statement of Robert D. Hormats follows:]
Prepared Statement of Robert D. Hormats, Vice Chairman,
Goldman Sachs (International)
Mr. Chairman and Members of the House Budget Committee, it is a
great pleasure for me to appear before this committee to discuss an
issue of great economic, financial and national security importance to
our country--the growing dependence of the United States on foreign
I have been asked to discuss several aspects of this issue, with a
focus on the types of events that could lead to a sharp decline or
reversal of the large amounts of funds that have been flowing into this
country in recent years.
A few words of background might help to put this in context. First,
it is worth noting that the U.S. is, and will remain, heavily dependent
on foreign capital as long as out country's level of savings remains
substantially below its level of investment--as it has been for many
years. That imbalance is possible only if foreign investors--
individuals, institutions and governments--are willing to finance it
through the acquisition of U.S. assets (including stocks, bonds, real
estate) or provide direct loans to U.S. entities. The current account
balance reflects this savings/investment imbalance and thus tracks the
net inflow of investment funds from abroad into the U.S. In 2006 the
current account deficit was over $800 billion--roughly 6.5% of the
The US will continue to be heavily dependent on foreign capital if
this large domestic savings/investment imbalance continues. For
example, even if the much focused on increase in the U.S. trade and
current accounts imbalance with China were to be eliminated tomorrow,
the U.S. would still experience the same sized imbalance with the world
as a whole if our internal savings shortage remained the same--only it
would be shifted to different nations. The nation's aggregate current
account imbalance, and its dependence on foreign capital, would not be
reduced. If we wish to reduce our dependence on foreign capital--and
our vulnerability to its sharp interruption--we need to boost savings
at home. Without that, the much focused on goal of an adjustment in the
dollar/Chinese RMB exchange rate, or any other bilateral measure for
that matter, will have negligible effect.
A different set of issues relates to where the capital that fill
the U.S. savings shortfall comes from--and the answer is, increasingly,
from world's the emerging nations. In recent years there has been a
dramatic shift in the current account positions of the emerging
economies. This represents their export of surplus savings to the rest
of the world--and constitutes a new and unusual feature in the world
economy. Their growing current account surpluses collectively are the
major counterpart to the growing U.S. current account deficit.
It is the enormous amount of net savings in these countries--as
reflected by their current account surpluses--rather than their
reserves or central bank purchases of securities per se that enable
them to be large capital exporters. Although reserves and central bank
purchases have receive the lion's share of attention, the underlying
factor in their current account surpluses is this unusually high rate
of savings. And their surplus savings goes to countries that have the
largest savings deficits--at the top of the list being the U.S.
Although the world's largest savers have included a shifting cast
of nations during the last decade, the vast increase over the last
three years comes from two sources: China and the major oil producers.
While China gets most of the attention, and has the largest reserves
and savings surplus of any nation, collectively the largest increase in
savings over the last three years has been by the large oil producers
(such as Saudi Arabia, Russia, Iran, Nigeria and Kuwait), who are
recycling enormous sums of windfall oil revenues into the world's
Recent increases in oil prices caused the value of export revenues
of these nations to climb from $743 billion in 2004 to $1.245 billion
in 2006--an increase of $500 billion. About half of that added income
was spent on imported goods and services and half was recycled back
into global capital markets. Together these countries had a net trade
surplus of $533 billion in 2006; but that is expected to fall to below
$400 billion in 2007 due to lower oil revenues and increasing level of
imports. China's balance of payments surplus continues to rise at a
rapid rate and the country recorded a current account surplus of $250
billion in 2006.
It is important to recognize that all of the accumulated savings
and surpluses do not necessarily find their way into the foreign
exchange reserve holdings of central banks. That occurs when a central
bank buys dollars, or other foreign currency, with local currency. For
instance, Saudi Arabia might have a large trade surplus, but unless the
Saudi central bank buys those foreign currencies up from private
holders and corporations with its local currency, the riyal, they will
not be added to its reserves. If a country does intervene in the
currency markets, e.g. China buys up dollars with its currency, the
RMB, the dollars are added to its reserves. Much of the reserve
accumulation of recent years has occurred because foreign central banks
buy dollars that they earn on the trade account or that come in as the
result of foreign investment or speculation in their local currency to
avoid a sharp rise in their currencies vis-a-vis the dollar, and then
put dollars they buy into dollar denominated assets which they add to
All told, as of May, 2007 China's foreign exchange reserves
amounted to over $1.2 trillion; Japan, $887 billion; Russia, over $250
billion; and South Korea, $244 billion. Of China's reserves, over $400
billion is held in the form of U.S. Treasury securities and--based on
recent estimates--between $300 and $400 billion in the securities of
U.S. agencies, dollar denominated issues of the World Bank and
corporate bonds. All told, foreign official holdings of U.S. Treasuries
are approaching $1.2 trillion. But, it is again worth emphasizing that
America's dependence on foreign capital--and outstanding foreign
holdings of American assets--would be just as great if none of the
dollars in the hands of foreigners were added to central bank reserves,
but instead remained in private hands.
The enormous increase in the global accumulation of net savings and
their investment in the U.S. financial market are key factors
producing, inter alia, very low real interest rates in this country,
which in turn has helped to fuel the U.S. housing boom and other
aspects of growth. They also have been instrumental in narrowing credit
spreads between the highest rated creditors and lower rated creditors,
because lower interest rates encourage investors to push money into
higher yielding assets--usually of lower quality--and thus push down
interest rates on those securities as well.
the impact of a reduction in capital flows
The heavy reliance of the U.S. on capital flows from abroad raises
the question of the likely impact of a reduction or reversal of those
flows on the U.S. economy and financial markets. There are several
possible scenarios for this occurring.
A relatively benign scenario is already at play among the oil
producers--not as the result of a any conscious effort to cut off funds
from the U.S. or any other country but as the result of lower prices
for their exports (until recently) and their rapidly growing demand for
imports as they use their added wealth to build new public
infrastructure and factories and to boost domestic consumption. Their
trade surpluses are expected to fall from an annual level of $533
billion in 2006 to under $400 billion this year to under $300 billion
in 2008, which means they will have less available savings to invest
Similar developments are likely to occur in some of the other
surplus countries, for instance in the emerging markets of Asia, other
than China. China itself is likely to continue to record substantial
additional trade surpluses and thus generate substantial amounts of
excess and exportable savings for several years at least. But even that
could eventually change as domestic demand grows due to a broadening of
domestic consumption and purchasing power (as the Chinese government
seeks to increase living standards in central and western China and
especially in rural areas which feel left behind by the surge in urban
prosperity) and improved capital markets that enable the Chinese to use
more of their large savings at home rather than exporting such a large
portion abroad. These are rather benign and demand led scenarios--that
could evolve over time and enable adjustment to be quite smooth. But
they should also serve as a reminder that the U.S. cannot indefinitely
relay on abundant supplies of external capital.
In the case of a gradual decline in net available savings from,
say, China the impact on the U.S. rest of the world would be gradual--
increasing real interest rates and widening interest rate spreads
between the best credits and lower rated credits. However, as noted
above, this would be less of an interest rate story than a demand
story, as higher domestic demand in China would boost U.S. and other
nations' exports to that nation and would channel more goods produced
in China away from the world export market into meeting domestic
But what if the scenario were less benign? Suppose, for instance, a
high savings nation such as China or Saudi Arabia or Russia were to
consciously and abruptly shift a large portion of its funds away from
the U.S. dollar market and put them into assets denominated in other
currencies? That risk is often posed in discussions over U.S.
dependence on foreign capital. The likelihood of China, for instance,
doing this in current circumstances is very low because such a move
would be profoundly disruptive to its trade and therefore, to its
domestic economy. One of the reasons authorities in Beijing have
adopted a gradual approach to currency revaluation is that too rapid an
appreciation of the RMB vis-a-vis the dollar would weaken the
competitiveness of PRC exports in the U.S. and other dollar markets and
that would slow the growth of jobs in China, risking social unease in a
nation that has to find new jobs for some 30 to 40 million people
But were such a scenario to occur, there would be significant
implications for U.S. financial markets and the U.S. economy. Let's
suppose, hypothetically, there were a major dispute that caused a large
creditor nation to deliberately shift a substantial portion of its
foreign exchange accumulation to other currencies, such as the Euro. In
that circumstance, the dollar would drop sharply and interest rates in
the U.S. would spike, as a savings-short American economy would find
itself with insufficient funds. As the dollar fell and bonds weakened,
other investors, foreign and American alike, could sell off dollar
assets and buy those denominated in other currencies.
Such measures would cause a sharp drop in bond prices and thus
higher interest rates as the government and corporations scrambled to
obtain needed capital. That would produce a market slowdown in U.S.
growth--or possibly a recession. Of course, as the dollar dropped and
interest rates rose in the U.S. those countries that were the
recipients of this new money--the result of investors fleeing dollar
assets--might well come to see American assets as a desirable
investment and buy them, helping to reverse the deterioration. But this
would likely take a lot of time--and considerable damage could be done
in the interim.
Highly Disruptive Scenarios
Other scenarios would be even more worrisome. Consider, for
example, the implications of a terrorist attack on America's physical
infrastructure--such as a dirty bomb that renders a large section of an
American city uninhabitable for decades, or incapacitates a large
American port such as Long Beach or New York, or an anthrax attack in a
major airport, railway stadium or subway system that takes many months
to clean up. In such circumstances, foreign investors, particularly
foreign private sector investors, would perceive a significant risk to
their U.S. investments.
One response would be to sell their stocks, causing a plunge in the
U.S. market--already doubtless rocked by the attack. And the budget
deficit would widen significantly after such an attack--due to weaker
revenues resulting from the decline in and disruption of economic
activity after the attack and the need for tens or even hundreds of
billions of dollars of added government spending for reconstruction,
recovery and retaliation. Foreign central banks then might be reluctant
to add to their already large stock of U.S. government assets, pushing
up interest rates and thus further harming an already damaged economy.
And even if central banks did not panic into selling dollars, and
continued to buy dollar assets at their accustomed pace, private
holders of dollars might engage in panic bond selling or simply hedge
by selling dollars for foreign securities. As noted above, not all
foreign held dollar assets are in the hands of foreign central banks.
Enormous amounts are held by large financial institutions such as
insurance companies, pension funds, and corporate treasuries as well as
by individuals. And many American institutions and individuals might
engage in similar behavior as they see the dollar drop and bond and
stock prices fall. Whether a massive joint effort by central banks
could counter this sharp sell off is highly questionable. And it
doesn't need to be a terrorist attack to trigger such a calamity; a
devastating earthquake or a catastrophic hurricane could have similar
How much damage would be done, and for how long, would likely
depend on the soundness of America's fiscal policy and the nation's
overall financial soundness at the time. It is worth recalling that the
country had recorded four years of budget surplus before 9/11 and at
the time was paying down earlier accumulated debt; also it was far less
dependent on foreign savings than it is today (the current account
deficit was only 4% of GDP compared to 6.5% today).
By most projections, this imbalance will grow in the future.
Sharply rising Social Security, Medicare and Medicaid payments plus
climbing interest payments on the federal debt will produce bloated
deficits and rapidly rising debt levels. And given the nation's low
savings rate, these would entail even greater dependence on foreign
capital and still greater amounts of dollar holdings in foreign central
banks and institutional accounts if, in fact, foreigners continued to
be willing to supply funds abundantly during this period.
In such circumstances, a catastrophic terrorist attack would be far
more likely to cause large numbers of foreign investors to curb flows
of capital to the U.S. or sell off dollar-denominated assets, and to
cause Americans to do likewise, than were the nation in better
financial shape--with a budget surplus, a far lower level of domestic
debt, and less holdings of dollars abroad. Even if there were
significant central bank cooperation to mitigate the financial
implications of such an event, the task would be made more difficult if
this nation's underlying fiscal position had been eroded by a widening
of domestic and international imbalances.
Because we know that one of the stated objectives of terrorists is
to cause massive disruption in the U.S. economy, such financial
vulnerabilities could lead potential perpetrators to feel that they can
do a great deal of damage not simply by their initial act, but also
because of the secondary and tertiary economic disruptions that would
occur because of the subsequent turmoil in a more vulnerable financial
environment. In finances as in military affairs, vulnerability
frequently invites aggression.
ALEXANDER HAMILTON AND ``THE PRICE OF LIBERTY''
So a key point in determining the implications of such scenarios is
the soundness of American finances at the time. In the book that many
of you have before you, The Price of Liberty: Paying for America's
Wars, I trace the history of American wartime financing from the
Revolution, through the War of 1812, the Civil War, the two World Wars,
and the Cold War to the present.
Alexander Hamilton recognized from the very beginning that
America's financial strength was vital to its security. If the country
did not manage its finances well, he reasoned, it would not have the
resources needed to defend itself in time of war and it would lose
credibility in the eyes of creditors, making borrowing in time of war
or other national emergency all the more difficult. He was especially
zealous about maintaining the confidence of foreigners, whose funds had
been critical to the Continental Army's success in the Revolution.
Failing to retain their confidence, he surmised, would mean that they
would be reluctant to lend the nation money in a crisis, rendering its
economy vulnerable to disruption and perhaps depriving it of the
resources to defend itself.
Over two centuries have passed since Hamilton held office, but
these principles are just as relevant today. And indeed this nation is
more dependent on foreign capital during this war than during any in
The Iraq War is the first significant conflict during which the
U.S. has not raised taxes, cut non-security domestic spending and has
relied so heavily on foreign funds to finance its budget deficit.
During all other major wars, taxes were increased, non-security
programs were cut substantially, and borrowing was financed almost
entirely by Americans. While the current war represents only a small
portion of GDP--around one percent per annum compared to World War II,
over 35%; the Korean War, over 10%; and the Vietnam war, a bit less
than that--it soon will become the second most expensive war in
American history, second only to World War II. It represents such a
small portion of GDP because the underlying economy has grown so
dramatically during the last 60 years.
But that does not mean that future funding for national security
will be easy.
First, as after the Vietnam War, there will be demands for
a large ``peace dividend'' after the U.S. leaves or downsizes in Iraq;
Second, many national security needs--of the military, the
intelligence community and homeland defense--have been postponed as the
Iraq War has sucked up roughly $100 billion annually in budget
resources. Many of these will need funding in the future;
Third, the government will have a large bill to meet the
medical needs of wounded veterans for decades to come;
Forth, entitlement payments will grow dramatically in the
next decade, possibly squeezing down the discretionary portion of the
budget, of which defense constitutes the single largest component. If
that is to be avoided, taxes will have to rise and/or borrowing will
have to increase; and,
Finally, if the U.S. remains a savings short economy and
borrowing needs rise due to increased entitlement payments and growth
in other areas of the budget, dependence on foreign funds will
increase, adding to the county's vulnerability in the face of a
disruption of such funds.
All of this suggests that reliance on foreign capital will increase
and that as this nation attempts to meet its domestic social agenda and
its national security agenda we run the risk of greater vulnerability
to a disruption in the flow of foreign funds. Stepping up to the hard
realities of putting our entitlement programs on a more sustainable
footing, developing a multiyear strategy to fight the War on Terror and
meet other security needs, while ensuring the fiscal resilience to
address unexpected demands on our nation, will be a major challenge for
this and future Congresses and for the next president.
Chairman Spratt. Dr. Levy.
STATEMENT OF MICKEY LEVY
Mr. Levy. Yes, Mr. Chairman. Thank you very much for the
opportunity to speak today.
The debate about the high U.S. current trade account
deficits have been going on for quite a while, many decades.
The long-standing concerns about the current account imbalances
and that they would cause severe damage to the U.S. economy
have not unfolded. They are overstated. And I think one of the
reasons why they are overstated is so many people in the United
States think parochially and they do not think about what is
going on in the world.
In fact, foreign capital inflows have fueled economic
growth. If you look over the last couple decades or through
history, rising trade and current account deficits occur when
the U.S. economy is strong, when there is stronger job
creation, when there is stronger investment.
Now, I would say that these will not unhinge the economy as
long as international trade and capital is allowed to flow
freely, the U.S. dollar is allowed to fluctuate, and the policy
makers, both the monetary and the fiscal policy makers, pursue
low inflation, pro-growth economic policies.
Now, the debate about fiscal policy should not be
influenced by the current account deficit. If you look at the
U.S. or if you look at other countries like Japan and Germany
that have budget deficits higher than the U.S. but large
current account surpluses, the twin deficit framework does not
work. They do not hold water. They do not move in tandem.
What fiscal policy makers have to do is address what they
are capable of doing and that is address the long-run unfunded
liabilities, particularly the entitlement programs.
Efforts to adjust fiscal policy to reduce the current
account deficit without considering how the changes in fiscal
policy, that is the tax spending structures underlying the
deficit changes or the allocative impacts of those on the
economy could lead to undesirable side effects not just in the
U.S. but internationally.
Now, if the world, if every country had about the same rate
of economic growth, same rate of savings, same rate of
investment, imbalances would be minor. But the reason why we
have imbalances around the world is countries are growing at
different rates, different rates of saving, different rates of
The U.S. for about 15 years straight grew dramatically
faster than all of Europe and Japan, from 1990 until 2004.
Capital flowed in to the strong United States. At the same time
as Europe, particularly Germany and Japan languished, they had
excess saving relative to weak investment opportunities. They
had excess saving and they had to do something with that
Now, more recently China, India, other countries have
accumulated large amounts of assets. They are excess savers.
Now the OPEC nations and Russia are also excess savers. The
excess savers that invest in the United States do not do so to
bail out the United States. They do so because it is in their
economic best interest to do so.
And I would like to touch on that a touch more. They
voluntarily invest in U.S. assets. And I must note in my
position, I am able to sit down with the heads of portfolios of
all the leading central banks around the world and a lot of the
private investors as Bob does also. And what I find is they are
absolutely economically rational in over-weighting ownership of
dollar denominate assets. They have no intention of changing.
They are attracted by the U.S.'s rule of law, historic
stability, high interest rates, et cetera, et cetera.
So once again, it is not just that the U.S. benefits
because if we did not have capital inflows, our investment
would be constrained to saving and we would not have the same
pace of economic growth or job creation or investment or
economic future. But foreigners who invest in the U.S. benefit
just as much.
The decades long worries that foreign investors are
abruptly going to pull out of U.S. assets, they are just
absolutely misplaced. The reason why they are misplaced is they
do not think about it from the other side of the balance sheet.
What do excess saving nations do with their excess saving?
Now, if you take the central banks that have accumulated a
tremendous amount of assets and have to invest internationally,
they respond to the same variables that we do in the U.S. What
drives interest rates are U.S. economic growth, inflation, and
the Federal Reserve's inflation fighting credibility, fiscal
policy and fiscal credibility, and they make their investment
decisions the same as U.S. investors.
And I just ask the following question. Do you think we
would be any less vulnerable if our U.S. debt were held by
leveraged hedge funds or pension funds for all U.S. managers?
Think of the following. Over the last six, seven years as
the U.S. publicly-held debt has increased and a large portion
of it has been bought by foreign sovereign institutions, real
interest rates have been low. Our cost of financing the deficit
has been very, very low. They have actually gotten the short
end of the stick because not only have they gotten higher
interest rates than they would in other industrialized nations,
but they have also incurred a weaker dollar.
I would also note that the financial variables that are
crucial to a sound U.S. economy like interest rates, corporate
bond yields, the stock market, foreign exchange, these are
driven by economic and inflation fundamentals.
Once again, foreign investors, be them private investors or
foreign central banks, they are affected by the same day-to-day
fluctuations. They respond to the same economic data. And what
would lead them to shift would be a significant change in
policy that led them to believe there would be a decline in
their expected rate of return on dollar denominated assets.
Now, earlier Congressman Edwards and others said, well,
what if China sells all their U.S. Government debt. Well, it is
not going to happen, but let us speculate, just hypothesize it
did. They would be hurt more than anybody else, including the
U.S. Maybe Japan would be hurt more because the dollar would
fall and the mark to market on their asset books would get
Now, the initial response may be a rise in interest rates.
Okay? Other investors around the world, including hedge funds
in Chicago and Los Angeles and London, would jump on the higher
interest rates and buy. And while there would be higher
volatility in the short run, rates would not be that much
And some of the discussion about just static analysis, what
would happen, do you think, not to use names, but do you think
Goldman Sachs or Bank of America portfolio managers would sit
on the sidelines if rates went through the ceiling while the
economy is growing moderately and the Fed is doing a great job
keeping inflation under control? Absolutely not.
So, yes, you would have higher volatility, but I would
emphasize the point that the United States benefits by net
foreign capital inflows. It always has through history. It will
continue to do so. Foreigners that have excessive saving
benefit by being able to invest in the United States.
And let me make one other point here. There is also a lot
of concerns that the recent decline in the dollar could push up
inflation. Not so. The Federal Reserve is the gatekeeper on
inflation. As long as it follows low inflation, monetary policy
with credibility, the lowered dollar will not push up
inflation. It will change relative prices.
And all you have to do is look at the pricing behavior of
European, say, auto exporters to the U.S. as the dollar has
fallen about 25 percent. They have not increased prices
materially and the reason is the Fed has been doing a very good
So let me just wrap up here. We have imbalances around the
world. The imbalances reflect imbalances in economic growth. It
just so happens that the U.S. rate of economic growth has
slowed while Germany and Japan have maintained their momentum.
So rates of growth among industrialized nations are narrowing
and the trade deficits actually started to come down as has the
current account deficit.
If you look at it from both sides of the balance sheet, it
is not that big a problem, but let me just conclude by saying
we live in an internationalized world. It is imbalanced. And
the trade deficit which, by the way, the trade and current
account deficit soared during the Clinton years. That is good
because it was associated with economic strength and job
creation and investment. Okay. That is actually good. So it was
But I would just conclude by saying the fiscal policy
makers should address the long-run problem. And let me give you
the best example of how you should think about how fiscal
policy should not be considered in the context of the current
The best fiscal policy you can come up with now is a
meaningful reform of the long-run entitlements. Okay? If it is
properly structured to grandfather in changes in the benefit
structure, it will not have any benefit. It will not do
anything to the current account or trade deficit in the near
term, but it will still be the best thing for the nation in the
And let me just conclude by saying I think it would
increase Congress' credibility to come up with a long-run
[The prepared statement of Mickey Levy follows:]
Prepared Statement of Mickey D. Levy, Chief Economist,
Bank of America
The debate about the high U.S. trade and current account
imbalances--and worries about their dire consequences--has been going
on for decades. Long-standing concerns that these imbalances will
severely damage U.S. economic and financial performance have not
unfolded and are overstated. The foreign capital inflows have fueled
U.S. economic growth, and contributed to job creation and business
investment, homeownership and higher standards of living. The large
U.S. current account deficit and foreign accumulation of U.S. debt will
not unhinge the U.S. economy, as long as international trade and
capital are allowed to flow freely, the U.S. dollar is allowed to
fluctuate and the U.S. policymakers continue to pursue low inflation
pro-growth economic policies.
The debate about fiscal policy should not be influenced by
the debate about the U.S. current account deficit. Sustained healthy
economic performance requires coming to grips with the long-run Federal
budget imbalance, which requires reforming the entitlement programs by
making their benefit structures economically rational and fair.
Delaying necessary reform only increases the eventual cost of
adjustment. Fiscal reform must focus on improving U.S. government
finances and making them conducive to maximum sustainable economic
growth. Efforts to adjust fiscal policy to reduce the current account
deficit without regard to how changes in the structure of the
underlying tax and spending programs would affect economic performance
are unwise and could generate unintended and undesirable economic and
financial side effects.
History shows that budget imbalances and current account
imbalances do not move in tandem in the U.S. or overseas. The so-called
``twin deficit'' framework is not a rational basis for conducting
fiscal policy or for thinking about global imbalances. Currently, the
U.S. budget deficit is 1.3 percent of GDP while its current account
deficit is 5.6 percent; both Japan and Germany have large current
account surpluses (3.9 percent and 5.1 percent, respectively) despite
running budget deficits (Japan's is 5.8 percent of GDP).
The U.S. trade and current account imbalances and the
large current account surpluses overseas and the large net
accumulations of foreign holdings of U.S. debt have been a natural
consequence of global differences in rates of economic growth,
investment and saving. From the early 1990s through 2005, the U.S.
economy expanded significantly more rapidly than other industrialized
nations, raising demand for capital and imports. The U.S. has
insufficient national saving relative to investment. Until recently,
foreign industrialized nations have grown more slowly, both in terms of
GDP and investment, dampening their demand for imports and capital.
China, other Asian nations and more recently, OPEC nations as well as
Russia, benefiting from higher oil prices, have excess saving relative
to investment. The capital inflows into the U.S. from excess saving
nations--largely through their accumulation of U.S. debt--provide the
U.S. capital necessary to continue healthy economic expansion.
Foreign assets owned by the U.S. have risen, but U.S.
assets owned by foreigners have risen more rapidly, so the U.S. net
foreign debt is $2.5 trillion. U.S. ownership of foreign assets is
heavily in equity and direct investment, which provides relatively high
returns, while foreign investment in U.S. assets is largely in U.S.
debt securities, which provide relatively low yields. Consequently, the
U.S. net international income position is near balance.
Foreign investors, including Asian central banks, which
have accumulated over $2 trillion of foreign currency reserves,
voluntarily invest their surpluses heavily in U.S. assets. Their
investment decisions are economically rational: they are attracted by
the U.S.'s rule of law and historic stability; healthy economic
performance and relatively high real interest rates; low inflation and
credible central bank; and liquid markets. Excess saving nations
benefit just as much from their investments in U.S. dollar denominated
assets as the U.S. benefits from the net foreign capital inflows. U.S.
and global economic growth and standards of living are improved by
capital that flows internationally from excess savers to high expected
rate of return activities.
Decades-long worries that foreign investors will abruptly
sell their U.S. assets are misplaced. Such concerns tend to ignore the
objectives and needs of excess savings nations, and what drives their
investment decisions and behavior. Foreign investors, including central
banks, seek high risk-adjusted rates of return. Foreign nations that
have accumulated U.S debt will not shift out of dollars quickly in a
way that would jar financial markets unless there is a dramatic shift
in economic fundamentals, or shifts in U.S. policies perceived to be
damaging to U.S. economic or financial performance. A jarring shift out
of U.S. dollars likely would damage foreign owners of U.S. assets as
much as it would damage the U.S.
Financial variables that are crucial to sound U.S.
economic performance, including interest rates, corporate bond yields,
the stock market and foreign exchange rates, are driven primarily by
fundamental U.S. and global trends in economy and profits, inflation,
and central bank and fiscal policy. Investment decisions by foreign
holders of U.S. assets may temporarily affect financial markets, just
as decisions by U.S. investors do, but they do not influence Fed
behavior or inflation or how the U.S. economy performs.
Foreign investors are subject to many of the same
economic, inflation and financial market fluctuations as U.S.
investors. Their investment behavior is at least as stable as that of
U.S. investors, and their ownership of U.S. assets does not raise the
risk or vulnerability of U.S. economic and financial market performance
any more than if those assets instead were owned by U.S. pension funds,
money managers or hedge funds.
Concerns that the recent decline in the U.S. dollar will
push up U.S. inflation and damage financial markets and the economy are
misplaced as long as the Federal Reserve pursues a credible low
inflation monetary policy. Under a low inflation monetary policy
regime, even if the U.S. dollar continues to fall, relative prices
would change, and real interest rates may rise modestly, but inflation
would not be pushed up. It is inappropriate and misleading to assert
that current U.S. dollar weakness will have a similar impact as the
1970s when the Fed was pursuing an inflationary monetary policy.
The U.S. trade and current account deficits have begun to
recede from their peaks, and I expect they will decline materially,
particularly as shares of GDP. The U.S. demand for capital and imports
has slowed in response to the recent soft-patch in U.S. domestic
demand, while its exports are growing rapidly, driven by strong global
growth and the weak U.S. dollar. The economic momentum in Japan and
Europe (particularly Germany), which reflects in part structural
improvements, is narrowing economic growth differentials among
industrialized nations and increasing expected rates of return on Euro-
and yen-denominated assets. Accordingly, the growth of foreign demand
for U.S. assets has slowed, while the U.S.'s financing gap between
national saving and investment has begun to recede.
The government's net costs of servicing debt owned by
foreigners have been low, and concerns are misplaced. My largest
concerns are not the magnitude of the global imbalances or the foreign
accumulation of U.S. government debt, rather the potential for
wrongheaded policies that would interrupt international trade or
capital flows, or domestic policies that would damage U.S. growth
prospects and reduce expected rates of return on U.S. dollar-
NOTES ON THE WIDE U.S. AND GLOBAL IMBALANCES
If the U.S. and other major nations had similar rates of economic
growth, investment and saving, global imbalances would be minor. But
they do not. The rising U.S. current account imbalances are largely the
story of the relatively stronger U.S. growth from 1990-2005 and global
demand for U.S. assets. This has happened before; the U.S. has
experienced long periods of relative economic strength simultaneous
with large net capital inflows and wide current account imbalances (the
best example is the U.S. industrial revolution). In recent decades,
periods of rising current account deficits have been associated with
strong growth in GDP, investment and jobs, and rising homeownership.
This should not come as a surprise: foreign capital flows into the U.S.
when it is strong, investment and employment are rising and expected
rates of return are high. The only periods recently when the U.S. trade
and current account deficits declined occurred when GDP slumped and
From the early 1990s, when the U.S. current account was in balance,
through 2005, the U.S. economy grew persistently faster both in terms
of nominal and real GDP growth and investment than all other
industrialized nations (see Chart 1). The growth differentials were
sizable and cumulative. Consequently, U.S. imports of goods and
services rose significantly faster than foreign demand for U.S.
exports, and demand for U.S. assets rose, so the U.S. current account
deficit rose commensurately (see Charts 2 and 3). Until recently, the
economies of Germany and Japan languished, and so did their imports.
Reflecting this, they ran high trade and current account surpluses.
That is, they had excess saving relative to investment, and were
unattractive to foreign investment flows.
Noteworthy, Japan has run high current account surpluses, despite
huge government budget deficits. Its budget deficit is nearly four
times higher than the U.S.'s and its government debt is approximately
170 percent of GDP, more than four times higher than the U.S.'s 37
percent. This is not surprising: for over a decade, Japan's economy and
investment languished, and it attracted little foreign capital inflows;
its saving far exceed investment and it was a sizeable exporter of
capital. Devotees of the so-called ``twin deficit'' paradigm should
heed the message provided by this international comparison.
The composition of U.S. imports illustrates the strength of U.S.
businesses as well as consumer spending growth: presently, 40 percent
of U.S. goods imports (and 33 percent of total U.S. imports of goods
and services) are industrial supplies and capital goods used for
business production and expansion (see Chart 4). Those shares rose
during the 1990s. It is inappropriate and misleading to place all of
the blame on the U.S. consumer for rising imports and trade and current
The rising current account deficit in the 1990s illustrates both
the widening gap between U.S. investment and saving, and the strong
foreign demand for U.S. dollar-denominated assets. They both occurred
simultaneously: as global demand for U.S. assets rose--modestly through
the mid-1990s and then jumping during the 1997 Asian crisis--capital
availability and rising asset prices fueled U.S. domestic demand.
Consumption and business investment rose rapidly--and U.S. saving fell
further behind surging investment. The U.S. current account deficit,
which rose to approximately 1.5 percent of GDP by mid-1997, jumped
dramatically to 4.5 percent by year-end 2000 (see Chart 3). Yet the
U.S. dollar appreciated even as the current account deficit rose
because foreign capital readily flowed into the U.S. seeking high risk-
adjusted rates of return.
The rate of net national saving was flat during the 1990s, as high
business saving and a shift from the government's cash flow deficit to
surplus was offset by the declining rate of personal saving. Despite
the lower rate of personal saving, the real net worth of households was
rising with the appreciation of real estate and the stock market.
Households felt richer and more confident and so they spent a larger
portion of their take-home pay. The rate of personal saving, which only
measures the portion of disposable personal income that is spent, does
not capture appreciation of real estate or stocks or bonds, and as such
is a very limited--and misleading--measure of saving.
New Dimensions in Global Imbalances. The trends in global trade and
current account imbalances so far this decade reflect new dimensions in
global economic performance and international trade and capital flows.
First, the U.S. recession in 2001 and associated slump in investment
and domestic demand that carried into 2002 reduced the demand for
imports, which temporarily lowered trade and current account deficits.
Import growth subsequently resumed, contributing to a surge in the
trade deficit through 2005. While the trade imbalance has continued to
rise in nominal terms, in real terms it has begun to drift down, and as
a percent of GDP, it peaked at 5.7 percent in 2005Q1 and has receded to
5.3 percent in 2007Q1. This reflects in part slower import growth since
early 2006 that has been associated with weaker consumer and business
spending growth in response to the Fed's interest rate hikes and the
adjustment in housing.
Second, global economic growth has strengthened and international
trade has been growing rapidly. U.S. exports have risen over 8 percent
annualized, and the U.S. remains the world's largest exporter of goods
and services. The U.S. maintains a healthy ``competitive edge'' in a
wide array of industries, and is well positioned, both in terms of what
it exports and to where it exports, for export growth to remain strong
(see Charts 5 and 6). Importantly, the economic momentum in Japan and
Germany reflects structural improvements that will sustain healthier
growth. These trends abroad are contributing to narrower economic
growth differentials among industrialized nations, and increasing the
attractiveness of investing in Europe and Japan. In turn, they will
serve to narrow global imbalances.
Third, Asian nations have been large net savers and have
accumulated foreign currency reserves at an historic pace (see Tables 1
and 2). Combined they have become the world's largest exporters of
capital, which is a twist on history insofar as some of them, most
notably China, are relatively poor nations in terms of GDP per capita
but also growing rapidly. The largest portions of their surpluses have
been invested in U.S. debt securities.
Fourth, China has emerged as a dominant global factor in both
international trade and finance. As a major manufacturing hub that
imports supplies and materials, and produces and exports finished
products, it runs trade deficits with most other Asian nations, and
huge trade surpluses with the U.S. (presently, approximately $220
billion) and Europe. Benefiting from its surging trade surpluses, high
foreign direct investment and extraordinarily high rate of saving,
China has accumulated approximately $1.2 trillion in currency reserves.
Fifth, benefiting from the dramatic rise in oil prices since 2004,
OPEC nations and Russia have become large excess savers. In the last
several years, the cumulative rise in surpluses by these nations has
been dramatic (see Table 3). The fact that global oil transactions are
conducted in U.S. dollars is a key factor explaining the large share of
these surpluses that have been accumulated in U.S. dollar-denominated
Stronger growth in Europe and Japan, and more moderate growth in
U.S. domestic demand, and associated narrowing in real interest rates
(as the European Central Bank and Bank of Japan have continued hiking
rates, narrowing the gap with the Federal funds rate) and expected
rates of return on investment will generate a narrowing of the U.S.
trade and current account deficits.
NOTES ON THE FOREIGN ACCUMULATION OF U.S. ASSETS
U.S. economic and financial performance has benefited from the
nation's ability to run high current account deficits. The economy is
no more vulnerable as a result of the foreign accumulation of U.S. debt
than if that debt were owned by U.S. pensions, money managers or hedge
funds. Reliance on net foreign capital inflows allows the U.S. to
leverage its resources and economic strengths. If U.S. investment were
constrained to national saving, there would be insufficient investment,
and economic growth, job creation and standards of living would be
lower. Similar to U.S. corporations that borrow to leverage their
resources and expansion, the key to the sustainability of the current
account deficits is what the net capital inflows are used for and what
is the rate of return on the capital relative to the costs of financing
it. Historically, the benefits have far exceeded the net costs.
The majority of U.S. assets owned by foreign investors are debt
securities, primarily U.S. government and agency debt (see Charts 7 and
8). This is particularly true of U.S assets held by foreign central
banks. While foreign holdings have increased substantially as a share
of outstanding U.S. government debt, foreign purchases of U.S. equity
and direct investment are minor relative to the dramatic rise in
household and corporate net worth (see Chart 9). According to the
Federal Reserve's Flow of Funds Accounts of the United States and the
Bureau of Economic Analysis, foreign ownership of U.S. equity assets
and direct investments total $4 trillion, compared to U.S. household
net worth of $56.2 trillion.
Rather than be concerned about the increased foreign ownership of
U.S. government debt, Congress should be thrilled with the highly
favorable outcome: the government's real costs of servicing the debt
have been very low, and the capital inflows have facilitated stronger
U.S. economic growth. So far this decade, when foreigners have
accumulated U.S. government debt rapidly, yields on U.S. government
bond have been below their longer-run average in nominal and real
terms. The real government bond yields have been far below real GDP
growth, while profits and real household net worth have grown
significantly faster than output and the unemployment rate has receded.
Clearly, the net returns on the foreign purchases of U.S. government
debt have been highly favorable.
Foreign purchasers of U.S. government bonds generally have not
fared as well. Foreign holders of U.S. government debt receive a yield
on their bonds with virtually no credit risk but they do have interest
rate and currency risk. In reality, they do not own claims on future
U.S. economic performance. Although yields on U.S. government bonds
have been significantly higher than yields in other industrialized
nations, net real returns to foreign purchasers of U.S. government debt
have been reduced by the decline in the U.S. dollar. In contrast,
foreign purchasers of U.S. private assets--bonds, equity or direct
investments--own claims on returns from U.S. production, and have
enjoyed higher rates of return. A reallocation of foreign owned U.S.
assets away from government debt and into equities and direct
investments would generate higher returns but would involve higher
U.S. purchases of foreign assets, in contrast, have provided
substantially higher yields, based on the significantly heavier
weighting in equity and direct investments, sharply appreciating global
asset values, and the decline in the U.S. dollar.
Concerns about heightened economic vulnerability arising from
foreign accumulation of U.S. government debt hinge in part on an
assumption that foreign investors have significantly different
objectives than U.S. investors. In reality, their objectives are
similar: they seek high expected rates of return on a risk-adjusted
basis. They base their investment decisions on the same fundamentals as
U.S. investors: indicators of economic performance, inflation,
expectations about Federal Reserve behavior, and the soundness of
fiscal policy. They have little sway over how those variables behave.
In practice, particularly in the case of foreign central banks, foreign
holders of U.S. debt tend to be less leveraged and more ``buy and
hold'' type of investors than their U.S. counterparts.
I am hard-pressed to see any heightened vulnerability arising from
foreign ownership of U.S. debt. Expectations of a sharp decline in the
U.S. dollar would temper the foreign demand for U.S. assets. However,
U.S. bond yields exceed those in other major industrialized nations
(except the UK), and U.S. markets are attractive for other reasons.
Over time, if overseas industrialized nations maintain their healthy
economic expansions, and as financial markets in emerging nations
mature and become more liquid, foreign investors may gradually reduce
their shares of assets allocated into U.S. dollars. That is not a cause
for alarm. As long as U.S. economic performance remains sound, the Fed
maintains its inflation-fighting credibility and other polices are
conducive to healthy growth, foreign demand for U.S. government debt
will remain healthy.
NOTES ON U.S. FISCAL POLICY
The primary problems with Federal government finances are not
short-term cash flow issues. The Federal budget deficit is estimated to
be approximately 1.3 percent of GDP in Fiscal Year 2007. Tax receipts
have risen above 18.5 percent of GDP, modestly above their long-run
average, and spending growth has slowed. The Congressional Budget
Office projects that under current law, the budget returns to
surpluses. Presently, despite the enormous jump in defense and national
security spending, the U.S. budget deficit is among the lowest of all
industrialized nations, and U.S. government debt as a percent of GDP is
far below other nations (see Charts 10 and 11). With the U.S. deficit
declining as a share of GDP and well below government interest rates,
the debt/GDP ratio is projected to decline in the near term.
However, the longer term outlook for government finances is
distinctly negative. Top fiscal policy priorities are entitlement
reform, which is necessary to close the long-run gap posed by the
unfunded liabilities of the government's retirement and health care
programs, and tax reform. Based on current law benefit and tax
structures and reasonable economic and demographic assumptions, the
long-run projected unfunded liabilities of the social security and
Medicare systems are so enormous--the present value of the gap between
projected long-run benefits and taxes is estimated to be approximately
6 percent of GDP--that reform requires modifying benefit structures to
make them economically rational. Tax hikes to close the gaps would be
so large they would damage economic performance.
Fiscal policy decisions about the entitlement programs must be made
based on sound economics, and not arithmetic modifications to long-run
projections that ignore the allocative impacts of the tax and spending
changes. Changes to social security must be phased in so that older
workers have time to adjust their retirement plans, and they must be
fair. American citizens expect eventual reform because they sense that
the current benefit structure cannot be sustained. Congress's
credibility will rise when it successfully tackles the issue. Reforms
of Medicare and Medicaid are even more imperative and will be more
difficult to achieve. Successful reform necessarily will involve the
introduction of incentives that influence the supply of and demand for
Tax policy must deal with the unintended, increasing burden imposed
by the Alternative Minimum Tax, the extraordinarily burdensome
complexity of the personal and corporate tax systems and the phasing
out of key provisions of the 2001, 2002 and 2003 tax legislations.
The details of both entitlement and tax reform are far beyond the
scope of these hearings. But the starting point for success requires
that fiscal reform must be aimed at improving the government's domestic
finances consistent with sustained healthy economic performance, and
not for the explicit purpose of trying to reduce the current account
deficit. The U.S. current account is affected by numerous factors
beyond the scope of fiscal policy--including differing rates of
economic growth, investment and saving around the world, demographics,
and inflation--which explains why there is no reliable linkage between
budget imbalances and current account imbalances. I encourage Congress
to pursue sound fiscal policies that will strengthen long-term U.S.
economic performance, and to reassess the premises of many concerns
about the U.S. current account deficit and the holders of government
Chairman Spratt. Thank you, Dr. Levy.
STATEMENT OF KENNETH ROGOFF
Mr. Rogoff. Thank you, Mr. Chairman, and thank you to the
Committee for inviting me to testify here.
I want to just start by framing the issue a little bit
differently. There has been a lot of discussion about how much
U.S. debt is held by foreigners. But, of course, as many of you
have pointed out, we have a giant, very liquid, very healthy
And I think the real number to think about is not the 2.2
trillion but the $14 trillion that foreigners hold overall in
U.S. assets, in equity, direct foreign assets, and other
liabilities. That is the real number that matters.
Of course, on the other side of the balance sheet, we hold
about 11 trillion in assets, abroad less. We are net debtors.
However, because we are much better financial managers, we are
much more innovative, it is a very strong sector of our
economy, we actually earn about as much money on our 11
trillion on average as they earn on their 14 trillion.
And that is part of the reason the problem has not spun out
of control faster, that we have gotten a good rate of return.
In fact, in recent years, and then this is more of a
coincidence, due to circumstances like the dollar going down,
foreign stock markets rising particularly faster, U.S. net debt
has actually grown quite a bit more slowly than you would think
from looking at the trade balance. The trade balance is about
700, 750 billion, but the net debt has been going up at only
half that rate. That probably will not continue.
And certainly I think the point to underscore is that, you
know, this is part of a much larger picture which is
fundamentally a very healthy one for the United States, that
financial globalization is something we benefit from a lot.
Now, I do think there is an awfully strong case to improve
our tax system and both Dr. Hormats and Dr. Levy have mentioned
the entitlement system. And I could not agree more.
I would add to that the tax system has gotten more complex
and probably less equitable in recent years. And I wish we
would see a big tax simplification, something like the flat
tax, a consumption tax, which I think would do a lot to help
savings. And I think a combination of those things is really
needed and would address a lot of the underlying concerns.
Now, in my testimony, I took to heart the title you gave us
which is, is our economy vulnerable, so I went through some
doomsday scenarios, largely sarcastically, I suppose, or
dismissing them because I do not think the really worst ones
are that big a concern.
I mentioned the China one which has already been discussed
here and everyone has made the point they shoot themselves in
the foot. It is not really an issue.
There is a rise of what are called sovereign wealth funds
where, you know, China has $1.2 trillion in assets. They are
getting a little tired of holding Treasury bills which do not
pay much. And they are starting, all of the big foreign
official holders, are moving more into higher return assets.
And, of course, the most spectacular recent investment was
China buying part of the Blackstone IPO.
I think there is a potential here to have some financial
debacles simply because although the previous speaker assures
us, you know, that they behave very rationally, I think maybe
the ones that are smart enough to be talking to him may be
behaving rationally, but there is a lot of nontransparency, bad
And I have no doubt that given the explosion of financial
markets, we will see some, you know, financial tales that will
surpass anything we have seen before. But I do not think it
will bring down international financial markets. It will more
likely bring down the country and possibly the government that
is the instigator.
And I might add in the meantime our very successful
financial sector will probably make even more money off of
these guys while they are investing in these sovereign wealth
funds. Governments have a terrific record of losing money when
they go against the private sector. And I am convinced that
And then finally, just, you know, forgive me, but I asked
the question because I took your title very literally, should
we think of any really crazy things we should worry about and I
remember Goldfinger where he, of course, tries to corner the
gold market. And we have the Hunt brothers in the 1980s.
And I think actually the deeper financial markets that we
have probably make us more robust to these things than we used
to. It is not easy to corner the commodity markets anymore.
However, although some of these doomsday scenarios, I
think, are unlikely and not such a great concern, although more
transparency, better regulation, I mean, the usual things is a
good idea. And I think this is a growing issue when you are
dealing with some of the sovereign wealth entities.
I do think our foreign borrowing is a vulnerability if we
are forced to tighten our belts quickly. And I will just start
with Dr. Hormats' third scenario because that is the kind of
one that worries me where we have something really catastrophic
happen here. And then all of a sudden, the fact that we are
borrowing $800 billion and suddenly we do not seem that
attractive, that is a real problem.
Now, when foreigners just try to simply get their money
out, it will drive equity prices down. It will affect bond
prices. But, frankly, our economy is pretty resilient to that.
We are very widely spread. I mean, there will be losses, but we
are resilient to that.
We are not so resilient to all of a sudden not being able
to borrow this fresh new money, this $800 billion that we get
every year. I would regard this borrowing as a vulnerability,
and I strain. I cannot think of a really good analogy.
But I mean, since we are talking about soft landing and
hard landing, you know, if you are parachuting down from a very
high level and, you know, you are aimed at a nice soft patch of
land, fine, you will land softly. But if a gust of wind comes
along, you can be in trouble.
It is a ten-year landing here, fifteen-year landing from
this soft landing scenario that Dr. Orszag talked about at the
beginning and we are vulnerable.
And I think that as Dr. Orszag emphasized, starting to
think about policies which would increase our national saving
sooner rather than later and working in coordination with
international agencies like the International Monetary Fund to
try to promote policies in other countries that would help
improve the scenario is something that is important to think
Now, and, again, to echo Dr. Hormats, you know, I mean,
when something happens, it is too late and this is a
vulnerability. And the fact that we live in this great world
does not mean it will not happen.
Argentina is doing great now. I promise you they will have
another default, but they are not worried about it right now.
[The prepared statement of Kenneth Rogoff follows:]
Prepared Statement of Kenneth Rogoff, Thomas D. Cabot Professor of
Public Policy and Professor of Economics, Harvard University,\1\ and
Visiting Fellow, Brookings Institution
With the United States running a current account deficit at 6
percent of national income, foreign nationals have been accumulating
U.S. assets at a spectacular rate. Taking into account recent stock
market gains, foreigners now hold well over $14 trillion of U.S.
assets, more than a 100% of U.S. gross domestic product. Foreigners,
mainly foreign central banks and government investment funds, hold more
than $2.5 trillion in U.S. Treasury securities alone. Incredibly, the
United States absorbs roughly 70 percent of all net saving produced by
the world's current account surplus countries, including China, Japan,
Germany and the oil exporting countries. Borrowing on this scale by any
large country, much less the world's pre-eminent economy is
unprecedented in modern world history.
\1\ Kenneth Rogoff, Department of Economics, Littuaer Center 232,
Harvard University, Cambridge MA 02138-3001; Phone: 617-495-4022, Fax:
617-495-7733; [email protected], http://www.economics.harvard.edu/
Many observers are asking whether U.S. indebtedness to foreigners
might pose any subtle hidden threats to the U.S. economy or, even to
U.S. national security. With China alone holding $1.2 trillion in
reserve assets and foreigners collectively holding more than twice that
in U.S. Treasury securities, is there any risk that the United States
might be subject to economic blackmail? What about the rapid
proliferation of so-called sovereign wealth management funds, most
famously China's $3 billion investment in the private equity group
Blackstone? Sovereign wealth funds now control nearly $2 trillion in
assets, more than stand-alone hedge funds. Is there a risk that foreign
governments will use their financial relationships to compromise U.S.
security? Is there any danger of exotic ``Goldfinger''-like scenarios
where foreign governments might use their massive leverage to
precipitate a wholesale financial collapse in the United States?
The short answer is these more extreme risks are unlikely to
materialize, but the United States continued dependence on foreign
borrowing is a significant vulnerability in the event of shock, such as
a collapse in US housing prices, or an extreme national security
breach, that might slow the inflow of new funds into the United States.
In this testimony, I will first discuss why the more extreme scenarios
are relatively implausible, then go on to discuss where the real
WHEN A DEBTOR IS BIG ENOUGH, IT'S THE BANKS' PROBLEM: THE UNITED STATES
As foreign wealth continues to explode in a number of transparency-
challenged countries, we are likely to see some spectacular financial
debacles. Governments have a long tradition of losing massive amounts
of money in financial markets. This tradition is not likely to end
anytime soon, which is good new for global private investors, some of
whom continue to reap huge profits at governments' expense. However,
any attempt by a well-heeled foreign government to use its financial
leverage to upset the US economy will almost certainly backfire. The US
economy will not wilt, and the foreign instigator will either lose a
bundle of money immediately, or get caught and be forced to forfeit the
gains. The key to U.S. resilience is our country's credibility in debt
markets; the U.S. governments' credibility in international debt
markets is so great that it is virtually impossible for any such crisis
to precipitate a default. Absent, this risk, it is very unlikely for a
foreign-instigated financial crisis to spin beyond the control of the
Federal Reserve and other regulators.
For example, were China to suddenly reallocate a large share of its
predominantly dollar portfolio into Euros, the ensuing dollar decline
would inflict a massive capital loss on the Central Bank of China. A 20
percent drop in the dollar against the Yuan would cost the Chinese
Central Bank well over a hundred billion dollars. Fundamentally, when a
debtor owes the bank a large enough amount, the debt becomes the bank's
problem. China, whose reserves amount to 50 percent of its GDP, faces
risks far to great to ever seriously consider this option. Of course,
over time, one can expect China to significantly diversify out of
dollar assets, but the time frame will be one that markets can easily
RISK POSED BY SOVEREIGN WEALTH FUNDS
One should entirely dismiss the risks posed by the recent trend
towards riskier investment strategies by sovereign investors, notably
the so-called ``sovereign wealth funds.'' With deep pockets and the
potential to draw on vast credit lines, sovereign wealth funds can
potentially take larger and more leveraged risk positions than even the
most aggressive private hedge funds. Given many of these funds weak
governance and lack of transparency, global regulators are rightly
concerned that one of these funds may precipitate a significant
financial crisis. An ill-considered massive bet by a sovereign wealth
fund, or perhaps the actions of a rogue trader within a sovereign
wealth fund, could cause a massive price fluctuation in a financially-
sensitive part of the global economy. Here again, however, the big
loser would be the government that owned the sovereign wealth fund, and
would ultimately have to foot the bill for a catastrophic loss. True,
there could be substantial collateral damage as in international
financial crisis, but again, given the solid fundamentals of the U.S.
financial system, prompt response by regulators and the Federal Reserve
should be able to contain the problem.
Yes, one can imagine more far-fetched and devious schemes to upend
the global financial system. In the James Bond movie ``Goldfinger,''
the villain aims to bid up the value of his own gold holdings by
irradiating the gold in Fort Knox, thereby cornering the market. In the
real world, the Hunt brothers were accused of cornering the futures
market in silver in the early 1980s. Given today's spectacular
explosion in global financial assets, it is easy to imagine financial
fraud and crime surpassing all previous benchmarks. Yet, in the scheme
of things, deeper financial markets probably make things safer not
riskier. It is far harder to corner a commodities market today than it
was twenty five years ago. Rather than resisting financial
globalization, the right approach is to continue to promote better
corporate governance at home, and greater transparency on the part of
financial entities, including sovereign wealth funds. In pursuing these
goals, the United States should continue to work closely with
multilateral agencies such as the International Monetary Fund or the
Bank for International Settlements.
the united states is a big winner from financial globalization
In contemplating any policy actions, it is important to recognize
that the United States is a massive winner from financial
globalization. Although it is true that the United States is a large
net debtor (with roughly $3 trillion in net debt), the cost to the
United States has been relatively modest because, on average, Americans
have earned a significantly higher return--about 1.5 percent higher--on
their holdings of $10 trillion in foreign assets than foreigners have
earned on their holdings of $13 trillion in U.S. assets. This
differential has met that U.S. net debt accumulation has been
significantly less rapidly than our $800 billion trade balance deficit
might suggest, typically half as much. U.S. financial firms are the
envy of the world, they arguably constitute the United States' most
successful export industry. Any attempt to block foreign entities from
engaging in the United States could lead to retribution that backfires
and hurts U.S. interests.
ALTHOUGH A SIMPLER, FAIRER TAX SYSTEM IS NEEDED
Of course, this does not mean that US should give privileged tax
treatment to hedge funds and private equity any more than it should
give better treatment to other export or import-competing industries.
But a patchwork fix could prove highly counterproductive. Faced with
the rapidly changing winds of globalization, the United States needs--
now more than ever--a much cleaner and simpler tax system. A flat tax
with a large exemption at low incomes would likely prove far fairer and
more efficient in practice than the current labyrinth of taxes.
THE MASSIVE UNITED STATES CURRENT ACCOUNT DEFICIT STILL POSES REAL
VULNERABILITIES THAT SHOULD BE ADDRESSED
I have argued that growing international indebtedness does not
seriously expose the United States to any of the more extreme doomsday
scenarios. This is not to say that we should greet the US current
account deficit with equanimity. It is a significant vulnerability that
could significantly amplify the effects of growth crisis precipitated
either by economic factors (say, a historic collapse in housing
prices), or geopolitical factors (a terrorist attack of unprecedented
dimensions on U.S. soil.) If the United States were forced to cut back
the flow of its new borrowing by say, a half--to $400 billion per year,
the trade-weighted dollar could easily fall 20-25 percent, and interest
rates could rise by close to one percent across the board.\2\ On
impact, it is quite possible that financial markets would overshoot.
\2\ For calibrations on how a closing up of the US current account
might affect the trade weighted US exchange rate, see Obstfeld and
Rogoff (2005, Brookings Papers on Economic Activity, and 2007, National
Bureau of Economic Research.)
Thus, in a crisis, the United States' position as a big net
borrower could prove an Achilles' heel that considerably amplifies the
magnitude and duration of a crisis. Although this risk has not
materialized even after years of very high US deficits, it remains a
concern. Policies to raise US public and private savings would be a
helpful step towards ameliorating these risks. So, too, would be more
flexible exchange rates in Asia and a greater reliance on domestic
demand for growth in Europe. Coordinated policies have been advanced by
the International Monetary Fund for many years now, though with
relatively little traction, especially in China but also in the United
States. While it is true that US current account is showing signs of
stabilizing this year, the ``soft landing'' scenario will take at least
a decade to fully materialize, leaving the U.S. vulnerable to a ``hard
landing'' scenario in the interim.
In sum, the United States, with its superior legal system and
transparency, is a big winner in financial globalization. Integration
of global financial markets has helped lead to lower interest rates and
a more stable US economy. Foreign investment in the United States has
to be viewed in the context of the larger picture, which takes into
account the enormous success of U.S. investors abroad. Doomsday
scenarios, while theoretically possible, seem remote. However, although
these extreme risks are remote, the United States massive dependence on
foreign borrowing remains an important vulnerability. Any global
macroeconomic or geopolitical shock that leads to a sharp contraction
of the US current account deficit is likely to produce a massive dollar
drop, and possibly a sharp interest rate rise, that would considerably
amplify the adverse effects of the shock on the U.S. economy. It would
be far better to take steps to gradually close up the United States
massive borrowing gap than to wait for such a crisis.
Chairman Spratt. Argentina was one of the wealthiest
countries in the world in 1925 and in two generations, their
whole economic fortune was reversed. And that is why we are
sitting here asking if the fundamental decisions we are making
now that might have such a profound effect on our future.
STATEMENT OF BRAD SETSER
Mr. Setser. I want to thank the members of the Committee
and the Chairman of the Committee for inviting me to testify.
It is a particular honor to participate on such a distinguished
I think it is fair to say if Dr. Rogoff thinks foreign
holdings of U.S. debt are something of a vulnerability, I tend
to think they are somewhat larger of a vulnerability than he
does, so I think that you will find that my testimony is a
little bit less optimistic than Rogoff's, though I was perhaps
not quite as pessimistic as Dr. Hormats and certainly far more
worried than Dr. Levy about the consequences of not only large
but rapidly growing foreign holdings of U.S. debt.
I am going to focus on overall foreign holdings of U.S.
debt stripping out equities but including holdings of assets of
U.S. liabilities other than treasuries. So you have foreign
holdings of corporate bonds, foreign holdings of housing debt.
In total at the end of 2006, foreigners held about $10
trillion in U.S. debt. About five trillion of that is long
term. And of that long term at the end of 2006, the best I can
tell, about 800 billion was held by the various entities of the
Chinese government and around 700 billion by the Japanese
By the end of 2007, given ongoing global financial
integration and given the need to take on additional debt to
finance the current account deficit, our gross debt will rise
to about twelve trillion. Six trillion of that will be long
term and Chinese holdings will likely rise to between 1.1 and
I mention China specifically because China's very large and
rapidly growing current account surplus which likely will reach
$350 billion this year combined with ongoing capital inflows
into China means that Chinese reserves are on track to increase
by between 450 and $500 billion this year.
To put that into perspective, it means that China's
government has the capacity to buy a Unico or similarly sized
company every month and still have enough money left over to
buy the entire net issuance of U.S. treasuries.
Because of this, China necessarily is financing a
relatively large share of investment here in the United States
and China is the largest single buyer of U.S. treasuries,
largest single buyer of U.S. agencies, the largest potential
source of demand for many other securities. And as a result,
people will watch Chinese government moves very closely, and it
is the largest actor in the world's foreign exchange markets.
Now, I want to focus specifically on three points in more
detail. The first is a point that Dr. Rogoff alluded to which
is that despite the ongoing deficit the United States has run
over the last several years, the United States' net
indebtedness or actually its net international investment
position, that is the broadest measure of the U.S.'s external
position, one that includes equity investments, has not
deteriorated by much.
Now, that is a little bit deceptive because the net debt
position just looking at changes in debt has deteriorated quite
significantly. It has deteriorated by about $4 trillion since
2000 which is about equal to the sum of the ongoing current
But that has been offset by a very strong rise in the
dollar value of U.S. equity investments abroad. I do not think
actually that has so much to do with U.S. financial skill. It
probably has more to do with the fact that the U.S. had a lot
of investment in Europe and the euro dollar moved by about 40
percent over that period, generating a large gain in the dollar
value of U.S. assets.
Even in local currency terms, though, foreign equities have
outperformed the U.S. equity market and I think many investors,
including some of the central banks around this world, have
recognized that they would have been better off instead of
lending the U.S. money, they had insisted that to finance the
deficit the U.S. hand over some other equity assets.
Now, I do think that over time, the relatively generous
terms on which the world has been willing to lend to the U.S.
will likely evolve and that over time, the U.S. income balance
will change and the U.S. will start making significant interest
payments to the rest of the world.
The second point I want to emphasize is the large role that
foreign central banks and sovereign wealth funds have played in
financing our current account deficit. Back in 2000, the U.S.
was attracting about 50 to 100 billion in net inflows from
official actors. Between 2002 and 2004, that rose to about 400
billion. It fell a little bit in 2005, then rose to around 450
billion in 2006. And in the first quarter of this year,
according to the data from the BA, it was around $600 billion
or about 70 to 75 percent of the current account deficit.
Now, that probably in all honesty is an understatement
because some of the difficulties in tracking purchases made
through London. But in broad terms, as the U.S. slowed relative
to the rest of the world, foreign central banks increased the
amount of their financing, offsetting a fall in private flows.
Had that not happened, the recession that we have experienced
would likely have been worse.
That is my third point, which is that to date, official
flows have generally been a source of stability, not a source
of instability because in general, the official central banks
have offset falls in private flows.
Here, I would frame the risk a little bit differently than
some have. Now that the market has become accustomed to the
expectation that the official sector will increase its
financing when private demand for U.S. asset falls, all the
official sector has to do to precipitate difficulties is not
live up to that expectation.
So if the official sector the next time private demand for
U.S. assets falls did not increase its purchases from an
already high level, in my view, there would be an impact on
U.S. financial markets.
But I think looking ahead, we should be wary of several
different kinds of risk. I think the first risk well spelled
out by Dr. Hormats is the risk that foreign investors overall
and particularly foreign central banks may shift from
financing, you know, providing too much financing to the U.S.
to providing too much little.
Now, earlier it was mentioned that foreign central banks
would be shooting themselves in the foot if they sold. I would
actually argue it is the contrary, that they are shooting
themselves in the foot whenever they buy.
China right now is investing 15 percent of its GDP in
building up its reserves buying U.S. dollars which are likely
to depreciate over time. If the dollar depreciates by 33
percent, they are going to lose five percent on GDP on an
aggregate and one-third of each marginal dollar that they buy.
They would be better off shooting themselves in the foot now
because they are going to have to shoot a much bigger bullet in
their foot in the future.
So there is some risk that they may reevaluate the policy.
And I do not think this policy reflects the financial
attractiveness of the United States. I think it is much more a
reflection of the necessities created by their decisions to peg
to the dollar.
The second risk is ironically the opposite. It is that
central banks will continue to provide the U.S. with too much
financing, blocking necessary adjustment, and allowing the
underlying disequilibrium to build. That implies larger debts
over time and eventually more interest payments to the rest of
And I think the third risk, and this would conclude, is
that our foreign creditors will change the terms on which they
are willing to finance the United States. Dr. Orszag mentioned
that foreign central banks may conclude that they are saturated
I think most foreign central banks have already concluded
that they are saturated with their U.S. Treasury holdings and
they are looking to find investments that offer higher yields
in large part because they realize that they are stuck in the
Now, as that happens, there will be tensions associated
with the shifting portfolios and I think it is unrealistic to
expect that foreigners will be willing to finance the U.S. on
as generous of terms, terms which have implied very large
losses in their own local currency terms and in very large
losses relative to what they would have obtained had they
invested in, say, euros. It is unlikely that those generous
terms will continue. So even if ongoing flows remain, the cost
of those flows to the U.S. economy will likely rise.
My policy recommendations are the same as those that have
been put forth before, although I would also add that given
that the U.S.'s petroleum deficit is about $300 billion, steps
to reduce our energy consumption could also contribute to an
[The prepared statement of Brad Setser follows:]
Prepared Statement of Brad Setser, Senior Economist, Roubini Global
Economics and Research Associate, Global Economic Governance Programme,
University College, Oxford
``FOREIGN HOLDINGS OF US DEBT: IS OUR ECONOMY VULNERABLE?''
I want to thank the members of the committee for inviting me to
testify. It is a particular honor to participate in such a
At the end of 2006, foreigners held an estimated $10 trillion in US
debt--roughly $5 trillion in long-term debt securities and $5 in short-
term securities and cross-border bank claims. Roughly $800 billion of
the $5 trillion in long-term claims were held by China's government
(counting some securities held by China's state commercial banks) more
than the perhaps $700 billion in long-term US debt securities held by
Japan's government.1 By the end of 2007, total foreign holdings of US
debt will rise to around $12 trillion, total foreign holdings of long-
term debt securities will be close to $6 trillion, and long-term debt
held by China's government likely will rise to around $1.1 trillion.
I mention China specifically because the strong recent rise in
China's current account surplus, along with ongoing private capital
inflows into China, has made China's government the largest single
source of (net) financing for the US current account deficit. China's
foreign exchange reserves--counting the reserves likely to be shifted
to a new investment agency--are set to rise by between $450 and $500
billion in 2007, with between $300 and $350 billion of that increase
flowing into US assets (Chart 1). China's foreign assets are growing so
rapidly that it could buy a company the size of Unocal every month--and
still have enough money left over to buy all the Treasury bonds that
the US needs to sell to finance its budget deficit. Right now, China's
government is the largest single buyer of US Treasury and US ``Agency''
bonds, the largest potential source of demand for many other dollar-
denominated financial assets and--given that it must sell a fraction of
the dollars it accumulates intervening in the foreign exchange market
to keep the dollar share of its reserves from rising--also the largest
actor in the foreign exchange market.
Financial integration implies rising foreign holdings of US assets
and rising US holdings of foreign assets. But so long as the US is
running a large external deficit, foreign holdings of US assets will
need to rise faster than US holdings of foreign assets. The large US
current account deficit--roughly $800b in 2006--has been financed
primarily by placing debt, and specifically long-term debt securities,
with foreign investors. US direct investment abroad, along with US
purchases of foreign equities, recently have exceeded foreign direct
investment in the US and foreign purchases of US equities.
My testimony will emphasize three points:
To date, the United States' large trade deficit has not
resulted to a significant deterioration in the United States' net
international investment position (US liabilities to the world net of
US holdings of foreign assets) or to a deficit in the income balance
(the gap between the interest and dividends the United States receives
on its investments abroad and the interest and dividends the United
States pays to foreigners). Going forward, that is likely to change.
The United States should not expect foreigners--including foreign
governments--to finance the United States on as generous terms as the
US has enjoyed over the past few years.
Foreign central banks and government-owned investment
funds have played an important role financing the US current account
deficit over the past several years. As the US economy has slowed
relative to the rest of the world in late 2006, reducing the
attractiveness of US financial assets to private investors abroad, the
share of the US external deficit financed by foreign central banks
Official financial flows have generally been stabilizing
rather than destabilizing; foreign central banks have bought dollar-
denominated assets, financing the US deficit, when private investors
haven't wanted to. Bringing the US deficit down in a gradual, orderly
way will require ongoing central bank financing. However, the United
States ongoing dependence on inflows from foreign central banks still
poses substantial risks. The US should worry both about the possibility
that foreign central banks will provide the US with too little
financing, forcing rapid and disruptive adjustment, and the possibility
that foreign central banks will provide the US with so much financing
that a necessary adjustment is deferred.
One theme will run throughout my testimony: the United States has a
strong interest in a process of gradual adjustment that reduces the
United States' need to borrow from the rest of the world to finance
domestic investment. The absence of any adjustment is undesirable: it
implies that foreigners will continue to finance a very large share of
all US domestic investment and a large buildup of the United States'
foreign debt. Too rapid adjustment is also undesirable. A sharp fall in
foreign financing of the US would lead the dollar to fall, stimulating
US exports, but it would also push up US interest rates, leading other
parts of the economy to slow. Gradual adjustment--say 1% of GDP a
year--would facilitate the shift of resource from sectors of the
economy that have benefited from the low interest rates associated with
large (net) inflow of foreign savings to the US toward sectors that
would benefit from a weaker dollar. Gradual adjustment also provides
foreign governments time to take steps to stimulate domestic demand and
wean their economies off export-led growth.
THE ONGOING INCREASE IN FOREIGN HOLDINGS OF US DEBT IS UNLIKELY TO
CONTINUE ON SUCH GENEROUS TERMS
The United States' current account deficit topped $800b--roughly 6%
of US GDP--in 2006. Its 2007 deficit is likely to be comparable in
size. As the US economy emerges from its recent growth slump, the US
current account deficit is likely to resume its increase in the absence
of a fall in oil prices or large additional falls in the dollar.
Right now, the current account surpluses that offset the US deficit
are overwhelmingly found in East Asia and the world's oil-exporting
economies. Should oil prices stabilize, rising domestic spending and
investment in the oil-exporting economies should reduce their current
account surplus. However, East Asia's surplus looks set to continue its
rise. China's current account surplus was $250b (a bit under 10% of
China's GDP) in 2006. Its 2007 surplus is expected to rise to $350-
400b--an unprecedented sum. Japan's current account surplus is also
rising, in part because of rising interest income from Japan's large
holdings of foreign debt. So long as East Asia's surplus continues to
rise, global adjustment will be difficult. Surpluses in one region have
to be offset by deficits elsewhere.
A current account deficit indicates that a country saves less than
it invests; a surplus indicates a surplus of savings over investment.
The US consequently must finance its savings shortfall either by
placing debt with investors in the rest of the world, attracting large
(net) inflows into its equity market or attracting large net inflows of
foreign direct investment. New foreign equity investments in the US--
whether direct investment or the purchase of foreign stocks--have been
more than offset by new US equity investments abroad. Inflows into the
US banking system have generally been offset by outflows from the US
banking system. By contrast, foreign purchases of US debt securities
have exceeded US purchases of foreign debt, providing the large net
inflows needed to cover the United States current account deficit.
As a result, the US net debt position--the gap between what the US
has borrowed from the world and what the US has lent to the world--has
deteriorated dramatically over the past six years. Since the end of
2000, total foreign holdings of US debt have increased from $4.3
trillion to close to $10.0 trillion while US lending to the rest of the
world has increased from $2.9 trillion to an estimated $4.6 trillion.
Net US external debt consequently has increased from $1.5 trillion at
the end of 2000 to about $5.4 trillion at the end of 2006--the $4
trillion increase is in line with the cumulative $3.6 trillion US
current account deficit over this time frame.
However, the overall US net international investment position--the
difference between all US assets abroad and all US liabilities to the
world--hasn't deteriorated at the same pace. The dollar value of US
equity investment abroad has increased far more rapidly that the dollar
value of foreign equity investment in the US. The dollar value of US
equity investment abroad increased from $4.5 trillion in 2000 to $9.1
trillion in 2006, while the dollar value of foreign equity investment
in the US increased from $4.3 trillion to an estimated $5.9 trillion.
The United States' net equity position consequently shifted from rough
balance to a $3 trillion surplus (Chart 2).
The improvement in the US net equity position largely reflects
capital gains on existing US equity investment, not large (net) US
purchase of foreign equities.2 Since the end of 2000:
Foreign equity markets generally outperformed the US
equity market in local currency terms.
The dollar's slide against European currencies and the
Canadian dollar has substantially increased dollar value of existing
investment in Europe and Canada.
Indeed, the capital gains on US equity investment abroad since 2002
have been large enough to entirely offset the increase in debt
associated with the current account deficit, so the US net
international investment position hasn't deteriorated.
The income balance--the gap between the interest and dividends that
the US pays to the rest of the world and the interest and dividends
that the US receives from the rest of the world--also has not
deteriorated as rapidly as many had feared. The revised data from
Bureau of Economic Analysis (BEA) indicates that the US actually
received more interest and dividend income from the rest of the world
than it paid out in 2006 (Chart 3).
Here too the overall balance can be disaggregated into the interest
payments on debt and the dividends payments on equity. As one would
expect, payments on US external debt have increased substantially.
Interest payments on US external debt likely totaled $430b in 2006, up
from a low of $170b in 2003 and $250b in 2000 (Chart 4).3 This trend
continued in the first quarter of 2007: the q1 data suggests the 2007
US interest bill will be substantially higher than $500b. However,
interest income on US lending abroad--which seems to be primarily
short-term--also has increased. Right now, the implied interest rate on
US lending is close to 6%, while the implied interest rate on US
borrowing is close to 4.5% (Chart 5). In my judgment, this large gap is
unlikely to persist. As the average interest rate on the United States
(large) stock of external debt rises, the US income balance should
begin to deteriorate.
The US income balance has also been helped by a large ongoing gap
between the reported dividend income of US direct investment abroad and
foreign direct investment in the US, a gap that stems more from low
reported returns on foreign direct investment in the US than high
reported returns on US direct investment abroad (Chart 6).
The ability of the United States to run large deficits without much
deterioration in its net international investment position or a
significant deterioration in its income deficit reflects the
willingness of the United States' external creditors to add to their
holdings of US debt when--at least in retrospect--they would have
received far larger financial returns had they invested in foreign
equities. Foreigners would have fared better if they had forced the US
to sell its existing external assets rather just buying US debt.
THE ROLE OF FOREIGN CENTRAL BANKS
No one doubts that foreign central banks--including the People's
Bank of China--have been very large buyers of US debt securities. The
BEA data show that official purchases of US assets rose from under
$100b a year in 2000 and 2001 to nearly $400b in 2004. Official inflows
then fell to $275b in 2005--a year when rising US short-term rates and
the Homeland Investment Act helped support the dollar--before rising to
$440b in 2006 and an annualized $600b in the first quarter of 2006.
Large as these inflows are--the $440b in central bank purchases of
US assets in 2006 far exceeded the $155b in marketable Treasuries
issued to finance the US fiscal deficit in 2006, and the large
cumulative increase in central bank holdings of Treasuries since 2000
has limited the increase in marketable treasuries held privately (Chart
7)--the BEA data likely understate the role central banks and sovereign
wealth funds have played in financing the US external deficit. The BEA
data do not capture the dollars that central banks have on deposit in
banks outside the US. Those dollars are then lent out, and indirectly
help to increase private demand for dollar-denominated debt, including
US dollar denominated debt.4 Most importantly, recent BEA data do not
capture large central bank purchases of US assets made through private
custodians in London and other financial centers. The BEA's data is
revised annually to reflect the information provided by United States
Treasury's annual survey of foreign portfolio investment in the US,
which tends to do a better, though still imperfect, 5 job of capturing
the ultimate ownership of US debt securities. However, the most recent
data points tend to substantially understate central bank purchases of
A number of technical difficulties complicate efforts to determine
the exact impact of central bank demand for US debt on US yields.
Custodial bias makes real-time estimates of the size of official
inflows hard. The shift in central bank demand from Treasuries to
Agencies after 2005 further complicates analysis. But many studies find
a substantial impact--100 to 150bp at the peak of central bank demand
for US assets in 2004 (Warnock and Warnock, 2005, Moec and Frey, 2005).
When the analysis of the recently revised data--which shows far higher
central bank purchases in 2006 than the BEA had previously indicated--
is completed, I would expect to find that central banks exerted a
similar impact in 2006.
Central bank demand for US debt, generally speaking, has allowed
the US to finance a larger deficit at lower cost than otherwise would
have been the case. Assessing the long-term impact of these policies on
the overall US economy is difficult, since strong demand for debt
securities and low interest rates help some sectors even as other
sectors are hurt by other countries efforts to keep their currencies
Central bank demand for US debt has helped lower the interest
burden of the US government. It has encouraged heavy household
borrowing, both to support consumption growth in excess of income
growth and--between 2003 and 2006--a surge in residential investment.
More recently, low interest rates have supported strong demand for
corporate debt, whether from firms looking to buy back their equity
(and thus push up their stock price) or private equity firms, which
borrow heavily to buy the listed stock of publicly traded companies.6
Conversely, those sectors of the US economy that compete with imports,
particularly imports from emerging economies, and that export goods and
services have been hurt by the policies that gave rise to these large
In aggregate, I believe the negative long-term impacts of the
policies that have given rise to large official inflows to the US
outweigh the positive. While many in the US clearly have gained from
low interest rates, it is hard to argue that the US has been borrowing
from abroad to invest in ways that will generate the future export
revenue needed to repay the United States' growing external debt.
Suburban housing is not an obvious source of export revenue--and firms
that borrow to buy back their equity rather than to finance new
investment are not obviously increasing the United States' future
export capacity either. Many abroad have also gained from their
government's efforts to prop up the dollar--not the least China's
export sector. But these policies will also generate losers, notably
taxpayers in emerging economies who will at some point incur large
losses on their government's dollar holdings.
Nonetheless, it is important to recognize that central banks have
generally acted to stabilize rather than to destabilize the foreign
exchange and bond markets. Since early 2004, the IMF's data on central
bank reserves indicate that central banks effectively have bought
dollars--and dollar-denominated bonds--when private market participants
have been unwilling to do so, helping to stabilize US and global
financial markets. As a result, a fall off in (net) private demand for
US assets has not let to a large drop in overall foreign demand for US
assets, allowing the US to finance its large deficit at a relatively
low costs. Volatility in private demand for US assets has translated
into volatility in central bank dollar reserve growth, not volatility
in financial markets or in aggregate financial flows to the US.
This has been particularly apparent over the last three quarters.
As the US economy slowed and growth abroad picked-up, net private
capital inflows to the US fell. US demand for foreign assets rose, and
demand for US assets from private investors abroad fell. The BEA's
data, for example, show for q1 that central banks provided about $150b
in direct financing to the US in the first quarter--a net inflow equal
to about 75% of the US current account deficit.
The $150b in official inflows in q1 is if anything an under-
estimation of likely central bank financing of the US in the first
quarter. The high-frequency data released by the US (The monthly
Treasury International capital data and the quarterly BEA balance of
payments data) tend to overstate private purchases and understate
official purchases. Lower frequency data--notably the United States
annual survey of foreign portfolio investment--tends to do a better job
of picking-up central bank purchases of US assets. The last survey--
which covered the period between June 2005 and June 2006--showed $345
in official purchases of long-term US debt, $125b more than in the
unrevised data. The last survey, for example, revised the United States
estimate of Chinese purchases of US debt up by $90b. (See Chart 8;
Chinese holdings of US Treasuries jump every June, when the survey data
is released). There is no reason to think that this pattern will
I consequently prefer high-frequency estimates of the increase in
central bank dollar holdings that are derived from reported increase in
foreign central bank reserves, along with an estimate of the share of
those reserves that are held in dollars. This methodology has its
limits. It will, for example, over-estimate central bank purchases of
dollars if central banks are reducing the dollar's share of their
reserves. Nonetheless, this methodology accurately predicted the large
upward revisions in central bank holdings in the last survey (see
Charts 9 and 10).
With total global reserve growth topping $250b in q1, this
methodology implies that central bank demand for dollar assets now tops
$200b a quarter. Preliminary data for q2 suggests global reserve growth
will top $300b by a substantial margin, which implies a truly
extraordinary $250b in central bank demand for dollar assets in q2. The
very strong recent growth in the New York Fed's custodial holdings--
which have been running at an annualized pace of close to $500b this
year--provide strong indirect evidence of a strong rise in US
dependence on inflows from foreign central banks (Chart 11).
RISKS: TOO LITTLE OFFICIAL FINANCING, TOO MUCH OFFICIAL FINANCING AND
MORE DEMANDING TERMS FROM THE OFFICIAL SECTOR
Ongoing US dependence on central bank demand for US assets carries
with it three risks:
Central banks stop adding to the dollar holdings.
Central banks resist all market pressure for adjustment,
allowing the underlying disequilibrium--and total foreign claims on the
US, to build.
Foreign governments change the terms of their financing of
Professor Rogoff, a fellow member of this panel, has argued that
the large credit line extended by emerging economy central banks to the
US constitutes a kind of reverse foreign aid. Both relatively poor
emerging economies and wealthy oil exporting economies that are
intervening heavily to keep their exchange rates from appreciating are
effectively ``over-paying'' for US dollar-denominated assets. Should
they stop intervening, their exchange rates will rise--reducing the
value of their existing dollar holdings in local currency terms.
The resulting losses potentially are quite significant. Chinese
intervention in the foreign exchange market is currently close to 15%
of its GDP. If the RMB is undervalued by 33% against a basket of euros
and dollars that corresponds with China's foreign currency reserves,
the annual cost of this policy is roughly 5% of China's GDP.8 It is
possible--though unlikely--that China might conclude that its interests
would be better served running a 5% of GDP fiscal deficit to finance a
social security system and better health care rather than incurring an
expected loss of 5% of its GDP lending to the US and Europe. Of course,
the effective subsidy that China extends to American borrowers also
benefits China's export sector--there are strong interests inside China
that seek to maintain the current policy. However, those who depend on
the kindness of strangers shouldn't take their continued kindness for
Emerging economies do not need to sell their existing reserves to
shake the system--all they need to do is stop adding to their dollar
reserves/ dollar assets of their investment funds. Indeed, if emerging
markets just held their purchases of US assets constant at a time when
private demand for US assets fell, they could have a substantial impact
on US financial markets. The markets now expect that emerging economy
central banks will be the dollar's buyer of last resort.
China is the largest single source of financing for the US external
deficit. China probably accounted for about 1/3 of all long-term debt
purchased by foreigners in 2006, and more like 1/2 of all foreign
purchases of Treasuries and Agencies. The strong increase in the pace
of Chinese reserve growth implies that China will likely account for a
higher share of total purchases in 2007. Changes in how China allocates
its immense and rapidly growing portfolio consequently could have a
large impact on US markets. A reduction in Chinese purchases of all US
debt would have the largest impact, but even shifts in the kinds of
assets that China buys now could have a substantial impact. For all the
attention that China's $3b investment in Blackstone generated, it
likely represents less than one week's worth of Chinese purchases of
China is not the only actor with the potential to shock the US
financial system. The Institute for International Finance recently
reported that the oil-exporting economies of the Gulf have more
accumulated foreign assets than China. They also hold nearly as large a
share of their assets in dollars, even though only 10% of their imports
come from the US. Should the Gulf states change the dollar's share of
their portfolio suddenly, they too could potentially put substantial
pressure on the dollar.
This risk isn't new. Back in 2003, Former Treasury Secretary
Lawrence Summers warned that the United States dependence on credit
from countries selling goods to the US was generating ``a balance of
financial terror'': the US was dependent on China for large-scale
financing, while China depended on the US to provide sufficient demand
for its products. More recently, Summers noted that one lesson of the
cold war is that a system based on a balance of terror can be stable
for quite some time.
However, the system's current apparent stability is in some ways
deceiving, as the costs emerging economies are being asked to bear to
sustain the United States existing current account deficit are rising.
Emerging market reserve growth has doubled since early 2006, rising
from around $600b to around $1.2 trillion, as private investors shifted
funds from the US to the emerging world. To be sure, large scale
reserve growth generates benefits for exporters in emerging economies.
But rapid reserve growth also limits the domestic monetary policy
autonomy of many emerging economies, as well as generating financial
losses--now generally hidden--that taxpayers in emerging economies will
eventually have to absorb. The constellation of interests that supports
the status quo may not last forever. At some point, the perceived costs
of buying dollars when the dollar is under pressure may exceed the
perceived benefits that emerging market economies gain from resisting
market pressures for appreciation.
One risk is that emerging economies suddenly stop adding to their
dollar holdings, forcing the US to adjust to fall off in foreign
financing too rapidly. Another risk, ironically, is that emerging
economies will continue to add to their reserves at a pace that allows
the US to continue to defer a necessary adjustment.
Substantial swings in the private sector's willingness to finance
US external deficits--and a large gap between the size of the US
deficit and net private inflows in 2003, 2004, 2006 and so far in
2007--have not translated into large swings in the US external accounts
or sharp swings in US economic activity. However, strong central bank
demand for US debt--a byproduct of their decision to resist market
pressure for their currencies to appreciate--risks thwarting all
adjustment, not just thwarting disruptive adjustment.
If the US trade deficit remains constant as a share of GDP, the
deterioration in the US income balance associated with a rising stock
of external claims on the US implies a growing current account deficit
over time. The Congressional Budget Office's recent analysis of the US
external deficit accurately noted that a sharp adjustment process would
bring the US deficit down quickly, limiting the overall increase in US
net external indebtedness. By contrast, a period without any
adjustment--or a further rise in the US external deficit--that is
followed by a period of gradual adjustment implies that the overall US
external debt stock would rise even further than would be the case if
the US deficit started to fall now.
This risk is not entirely theoretical. The recent slowdown in US
growth--combined with an acceleration in global growth--created close
to ideal conditions for the US external deficit to fall. Strong global
growth supported US exports. The slowdown in US growth slowed the
increase in US imports. Indeed, the US deficit with those regions of
the world--Europe and North America--that have allowed their currencies
to appreciate has fallen substantially. However, the US deficit with
East Asia continues to rise (Chart 12). At a result, the fall in the
United States overall deficit has been modest. Most of the improvement
in the current account deficit from its recent peak in the third
quarter of 2006 stems from lower oil prices.
A final risk that is worth noting: the rest of the world may change
the terms associated with its financing.
Countries like China have resisted taking policy steps--like faster
RMB appreciation or a major initiative to stimulate domestic
consumption--that would lower their current account surplus and reduce
the scale of their purchase of US assets. However, such countries are
clearly seeking to invest in US assets that offer the prospect for
greater returns than US Treasuries.
Such an evolution is natural. China holds far more liquid Treasury
and Agency securities than it needs to address even a most draconian
shock. Moreover, China's heavy concentration in US fixed income
securities (Chart 13)9 is itself a risk. A rise in Chinese holdings of
US equities is a natural by-product of China's large surplus, the
United States large deficit and a balanced Chinese portfolio of US
assets. China's willingness to hold such a high share of its national
wealth in low-yielding debt is far more unusual than its interest in
exploring alternatives that offer higher potential returns.
The current pace of accumulation of Chinese foreign assets suggests
that China's total foreign assets will rise from about $1.5 trillion at
the end of 2006 (with about 1.2 trillion of that reserves and reserves-
like assets) to more than $3 trillion by 2010. A world where China
creates a $1.5 trillion dollar investment fund, rather than adds $1.5
trillion to its reserves, over the next few years isn't impossible to
envision. Even if China adds roughly equal sums to its reserves and
investment fund over the next few years (Chart 14), its investment fund
could reach be the largest in the world by 2010. Creating an investment
fund won't eliminate the constraints on China's overall portfolio that
stem from China's continued adherence to its dollar peg. However,
shifts in the kind of assets that China is purchasing could still
influence US markets. A Chinese move away from long-term fixed-income
debt could increase US interest rates by as much as 50 basis points.
Other central banks now adding to the reserves rapidly (Russia) and
other central banks with large existing stocks of reserves (Korea and
Japan) have either announced that they are creating a new investment
fund (Russia, Korea) or are rumored to be considering an investment
fund (Japan). All seem to be struck by the high returns Singapore has
obtained from its investment funds. So long as oil prices remain high,
the assets of existing investment funds in Norway will continue to grow
as well. All these funds already hold substantial quantities of US
equities, both directly and through their investment in private equity
and hedge funds.
Trying to shut the investment funds of foreign governments out of
US markets is neither feasible nor desirable. So long as the United
States is running large external deficits, US government is unlikely to
be in a position where it will be able to dictate what kind of U.S.
assets its creditors are allowed to buy. Moreover, any move to shut
government investment funds out of the US market would invite foreign
governments to try to limit US investment in their markets.
Nonetheless, the growing presence of government investment funds in
US equity markets raises a host of questions--questions about US
capital market regulation as well as questions about the transparency
of large investment funds. Edwin Truman of the Peterson Institute has
argued that the increased role of central banks and sovereign wealth
funds in global capital markets implies that both should adhere to a
higher level of transparency. He specifically has called for more
disclosure of their investment strategies as well as the currency
composition of their portfolios. I second Dr. Truman's suggestion,
along with a recent suggestion from the Treasury's Acting Under
Secretary, Clay Lowery, that the IMF encourage investment funds to
develop a code of best practices.
So long as the US is running a large external deficit, foreign
holdings of US assets will need to rise faster than US holdings of
foreign assets. In many ways, the past few years have been atypical.
The United States' external deficit has been financed entirely by the
net sale of debt securities rather than by the net sale of equities, in
no small part because of unprecedented growth in central bank reserve
assets. The low interest rate on US external debt--relative to both the
returns the US has achieved on its equity investment and the interest
rate on US external lending--has allowed the US to continue to earn
more on its foreign investment than it pays on its foreign debts.
These patterns are unlikely to persist. So long as emerging
economies are unwilling to allow their currencies to appreciate and run
large current account surpluses--especially with private capital
flowing in net into emerging economies--many governments around the
world will be accumulating external asset rapidly. Over time, though,
more of those assets will be handed over investment funds and fewer
will be held as central bank reserves. The US will likely both have to
sell more equity to the rest of the world and pay a somewhat higher
interest rate on its external debt than it has recently.
Foreign investors--and right now that means foreign governments--
now finance, directly and indirectly, a larger share of domestic US
investment than makes sense over time. While rapid central bank reserve
growth and large official financing of the US deficit can help the US
postpone the necessary adjustment, the longer the adjustment is
deferred, the greater the long-term risks.
The process of adjustment is more likely to be smooth if it is
supported both by policy changes here in the US and abroad. The US
government should adopt policies that would allow the US to finance
more investment out of domestic US savings, just as many emerging
economies should put more of their savings to work at home. Further
reduction in the fiscal deficit and a new push to reduce our energy
import bill--the United States ``petroleum'' deficit is now close to
$300b--are the most obvious policies for the United States. Governments
in emerging markets need to do more than complain about US profligacy,
particularly when their purchases of US debt have masked the
consequences of the United States' low level of savings and large
resulting external deficit. East Asian economies with high savings
rates--notably China--have substantial scope to take policy steps to
support domestic consumption. Most governments that now manage their
exchange rate against the dollar--whether in the Gulf, Latin America or
East Asia--would benefit from additional exchange rate flexibility.
Both the United States large deficit and equally large surpluses in
many emerging economies built up gradually over time. Bringing the US
deficit and emerging economy surpluses down without tremendous costs
will also take time. If the US and the world are to adjust gradually,
they need to get started.
\1\ The US has not formally released data on the total stock of
foreign claims on the US for the end of 2006. I have drawn on the data
from the 2005 net international investment position, the 2006 capital
account data from the Bureau of Economic Analysis, the 2006 Treasury
survey of foreign portfolio investment in the US and China's reserves
data to compile these estimates. The actual data should be released at
the end of June.
\2\ Since the end of 2000, cumulative US direct investment abroad
has exceeded foreign direct investment in the US by about $200b.
Portfolio equity inflows and outflows are roughly equal.
\3\ These estimates are derived from the balance of payments data
released by the Bureau of Economic Analysis. The exact number for 2006
though depends on dividend payments on foreign portfolio investment in
the US--a data point that the BEA has yet to release. I assumed that
2006 dividend payments matched 2005 dividend payments. Since these
payments are small, this is not a large source of error.
\4\ Foreign central banks purchases of euro and pound denominated
securities also help to generate indirect demand for US debt, as such
purchases push down European yields and make US assets relatively more
attractive to private investors in the US and Europe.
\5\ The survey data seems to understate the Middle East's likely
holdings of US assets, perhaps because neither the high-frequency data
BEA data (which is derived from the Treasury's TIC data) nor the annual
survey picks up foreign central bank funds--and sovereign wealth
funds--that are managed by private portfolio managers.
\6\ Central banks are not large direct participants in this market
but by lowering yields in Treasury and Agency bonds (and buying these
bonds from pension funds and other investors) they encouraged other
investors to reach for yield. Significant central bank deposits in the
international banking system have also supported the leveraged loan
\7\ In the first quarter of 2007, the increase in the New York
Federal Reserve Bank's custodial holdings of US treasury and US Agency
bonds exceeded the estimated increase in central bank holdings of US
treasury and US Agency bonds in the BEA's balance of payments data by
about $20b. Central banks who buy US securities in London sometimes
hand those securities over to the New York fed; the transfer of
custodianship though is not considered a sale.
\8\ This calculation ignores the ``carry'' the Chinese government
gets from borrowing at low interest rates in China to buy US dollar
debt. It is clear, though, that these interest gains--which themselves
stem from China's artificially low interest rates--are not large enough
to offset the capital losses from a substantial RMB appreciation.
China's reserves are now roughly 45% of its GDP. China's central bank
will eventually face a loss equal to 15% of China's GDP.
\9\ The best data on China's holdings of US assets comes from the
annual US survey of foreign portfolio investment. As of June, 2006,
China held slightly a bit under $700b in US debt: $375b of US Treasury
bills and notes, $260b of ``agency'' bonds, and $60b of corporate debt.
In addition, China held slightly over $20b of US equities--and a bit
over $15b in plain old bank deposits. Treasuries and Agencies accounted
for 90% of all Chinese holdings of US securities, debt securities
accounted for 99.5% of China's US portfolio (Chart 5) and US securities
accounted for around 70% of China's total reserves (included reserves
shifted to the state banks. The US data does not distinguish between US
assets held by China's private sector (including its state commercial
banks) and US assets held by China's State Administration of Foreign
Exchange. However, given the size of China's reserves, it is reasonably
to assume that the State Administration of Foreign Exchange accounts
for most of China's recorded holdings of US securities.
CHARTS AND GRAPHS
Chairman Spratt. Thank you all for the range of your
opinions and for some very provocative proposals.
Let me ask you again about what happens if we have some
rapid adjustment, some rough, rocky road that leads to those
holders of dollar denominated assets to dump their assets and
to the phenomenon that Lester Thoroshe described of having most
of the holders decide they did not want to be the last man out
on a declining asset.
Could a scenario like this happen if foreign investors
looked at the charts that we were looking at earlier and
decided that given the projection of the cost of Medicare and
Medicaid and Social Security, two multiples as a percentage of
our GDP, that it would be inevitable that we might try to
inflate our way out of our debt or that we would be asking
secondly foreigners to underwrite not just our economy but
Not investment in assets like the British did with the
building railroads out west in the second half of the 1800s but
for Medicare, for Medicaid, for Social Security, for transfer
payments upon which there would be no significant return. Could
you imagine a scenario in which foreigners are looking at
something like that?
Mickey Levy keeps shaking his head, but is that a scenario
to be concerned about?
Mr. Levy. Can I take a crack at that? We are all concerned
about the unfunded liabilities of the entitlement programs and
there is no question but that they need to eventually be
If you look through history over time, you will find that
interest rates tend not to be that correlated with budget
deficits or expected budget deficits, that interest rates tend
to be driven by the rate of economic growth, inflation, and the
Federal Reserve's inflation fighting credibility.
So if you talk about scenarios of shocking the system, you
have to ask, well, if you shock the system, what is going to
happen to economic growth and inflation. As long as the economy
is growing moderately and inflation is under control and the
Fed is conducting its job with credibility, do not look for a
sharp rise in interest rates because if one even huge investor
sells, whether it is a foreign investor or domestic investor,
other investors will look at the fundamentals and be buyers.
So it is a complex issue and I just do not think you could
say if you shock the system, then what if.
Chairman Spratt. Others? Dr. Rogoff?
Mr. Rogoff. Yeah. Well, I mean, one piece of your comment I
actually think people are not concerned enough about which is
that over the--there is this view that inflation will never be
a problem again because we solved it. I think we live in a very
benign world. Growth has been very fast. The central banks of
the world have a relatively easy job in the political economy
of bringing down inflation because things are pretty good.
We do not have inflation anywhere. The Congo does not have
inflation. They have had, you know, trillions of percent
inflation since 1970, same with Brazil. But it is possible that
some of the social stresses that we face, not soon, but in 15,
20 years, could put pressures on the system that we do not, you
know, fully admit today. But I do not think they would fall
uniquely on the United States. So, you know, yes, it is an
awkward position, but where would investors go? Are they going
to go into Japan which is aging sooner, to Europe which is
aging sooner, to China which has a big problem? So there is not
Chairman Spratt. But all of those countries have
substantially higher savings rates.
Mr. Rogoff. Yeah. Partly because their aging problem is
upon them. I mean, that is one of the reasons it is argued that
they do have higher savings rates. So I think that we could see
a generalized decline in asset prices some day when people get
worried about this and that could cause a lot of problems.
And I do think our vulnerability of needing to keep
borrowing fresh money is a concern. But this is a global
phenomenon. I do not think it is uniquely our problem.
Mr. Setser. Yes. I would just add that, you know, there are
many different scenarios that worry me. I probably worry too
much. But I would argue that the time scale in which the trade
deficit needs to correct is more likely to come sooner rather
than later while the time scale associated with the entitlement
problem is later rather than sooner.
And by that, I mean the trade deficit right now is around
six percent of U.S. GDP and it seems to me that that is going
to need to adjust downward within the next ten years where the
entitlement problem starts to bite perhaps at the end of that
Mr. Hormats. I think it is a sort of a slow motion train
wreck and it is also true that other countries have similar
problems. In fact, a lot of countries in some cases have even
greater amounts of unfunded liabilities relative to their GDP.
But, you know, we are the biggest country in the world in
terms of the economy and I think we cannot be responsible for
what other countries have done. We can be responsible for what
we are not doing.
And I think, Mr. Chairman, you have raised a point of long-
term vulnerability. We now have to suck up a huge portion of
the world savings. You are quite right. The savings rate in
most other countries is considerably higher than here and a lot
of it is important in the United States because we have such a
large savings gap between our investment and our savings rate.
And I do think that the more dependent we are on this
foreign capital, if some disruption should occur, and I
associate myself with those who believe that China or any other
country is not willingly going to pull the rug out from under
the dollar or the capital markets in the United States because
they have an interest in American assets and they have an
interest in selling here and they do not want the dollar to
collapse, but if there were to be some untoward, some
unexpected event like, for instance, an act of terrorism, the
more reliant we are on foreign capital to fill what will be a
greater requirement if the budget deficit rises as a result of
entitlements, then we do become more vulnerable if, and even if
it is a small if, but if there is a disruption in the inflow of
that capital for whatever reason.
So those big numbers down the road, it is not right away,
but as you point out, it is somewhere down the road. Those do
imply a vulnerability to an interruption that is greater than
would be the case today.
And the other point I would add is it is not just
foreigners who might pull their money out in the event of a
major crisis. It is Americans. In an open global capital
market, they may conclude, you know, that if something goes
wrong here, they have other options to put their money
So we tend to focus a lot on the buildup of liabilities and
vulnerability to foreigners, but in an open global market, even
if we had no liabilities to foreigners, even if we were in
balance with a large number of Americans being able to move
their capital abroad, if we do not run our fiscal policy
properly, they have the option of moving also. So in a global
world, they can go both ways.
Chairman Spratt. Mr. Ryan.
Mr. Ryan. Thank you, Mr. Chairman. This is very interesting
I think it seems to me we are getting one solid conclusion
out of this hearing and the various testimonies and that is
people have difference of opinions on the magnitude of this
risk with respect to how foreigners might act. And I do not
think you see this. Neither of you said this is the number one
But it seems like the one thing that we know for certain
that is an undisputable fact is demographics and the state of
the promises that our government has made with respect to our
entitlement programs and the trajectory that we are on with
those entitlement programs.
So since we are the fiscal policy makers, I will just ask
each of you and we will just go from, you know, the way you
started, should the number one thing we focus on here as fiscal
policy makers be to contain the growth of entitlement spending?
Should we not be mostly concerned with the growth rate of
entitlements, their call on debt, and the credit of the United
Is this not ultimately a monetary in addition to a fiscal
policy problem and if we had to pick one problem that we need
to focus on where we can make the best difference, would it not
be containing and constraining the growth of entitlements?
Mr. Hormats. Yes. I think that in the medium and long term,
they are unsustainable. If you look at the Trustee's report of
Medicare and Social Security both, those numbers, and we saw
the chart before, those numbers are not sustainable.
And it is not going to happen today or tomorrow, but I
think we have all indicated if you do not start acting in the
near term, it will be much more difficult to deal with in the
longer term. The pain of adjustment will be considerably
greater and the degree of vulnerability will be considerably
greater as well.
So this is something that needs to be addressed and we need
a very candid discussion with the American people as to why it
should be addressed and why you simply cannot duck the issue.
These are going to be tough.
In some cases, there will be groups that do not like this
potential solution or that one, but it does strike me that in
the medium and long term, if we do not deal with that issue, we
are going to have a much more difficult set of fiscal issues to
And to get to your point on monetary policy, Ben Bernanke
when he testified a couple months ago said that even though the
budget deficit was improving, this may well be the calm before
Mr. Ryan. Right. Right.
Mr. Hormats. This was the storm he was talking about, just
this. And he was also implying at that point, the Fed may not
be able to do that much about it, you know.
Mr. Ryan. They can only monetize so much. They just
Mr. Hormats. Yes. And he was in effect saying that, you
know. That is right.
Mr. Levy. Let me just add two points to the need for
entitlement reform. Firstly, it has to be grandfathered in.
Well, let me start out with another point.
The gap between under current law projected long-run
benefits and projected long-run taxes called FICA contributions
is so large, you cannot close the gap by raising taxes in an
arithmetic way. You have to address the benefit structure.
The other thing I would say is to be fair, and you want to
be fair about this, you have to grandfather it in so that it
does not affect workers, say, over 55, so they have the time to
adjust their work/leisure decisions.
The third thing I would say is the American citizens at
this point fully recognize that the current benefit structures
are unsustainable and I think Congress would build credibility
by addressing them rather than passing it on to the next
This has been going on forever. I mean, we have known since
1972 the long-run projections on Social Security and Medicare
have not made sense. And it has just been delayed and delayed.
And I just think Congress would--it is a tough issue, but I
think you would build huge credibility for yourself by honestly
saying, hey, we have got a long-run problem. We need to
rationalize economically our long-run benefit and tax structure
and we will phase it in in the fairest way possible.
Mr. Ryan. Let me interject and I will just keep it within
the context of this question. It would be nice to know, and
maybe it is not a question one can answer, is if we proceeded
with a sincere, workable, real entitlement reform plan, if
Congress actually did this and the President signed it, would
we get reward from the financial markets and would that reward
from the financial markets, this lead other countries to say,
gosh, there is a premium to be had for stepping up to the plate
and solving these problems and so Sarcosi's hand would be, you
know, aided and Merkel and Germany and Japan would see, you
know? Would we be able to show leadership and would we get a
fiscal and a capital market dividend by doing that? Do you
think that that is quantifiable in any way possible and do you
think it would occur? And anybody who wants to speak, please
Mr. Levy. I would say unambiguously, yes. And what you need
to do is go back to 1993 when President Clinton came into
office. He put through a package that increased taxes, but also
reduced spending on a wide range of issues. And the spending
cuts did not add up to that much, but they sent a message. And
within a year, bond yields came down significantly. And I just
think it was a great way to build credibility.
Mr. Hormats. I agree with that. And I would also add that
if this does not happen, the closer we get to the point where
Mr. Levy. Where the lines cross.
Mr. Hormats [continuing]. Really get out of kilter, the
market is going to start anticipating one of two things unless
there is a change. One is higher taxes which is bad for growth
if they get way out of line or higher borrowing which pushes up
interest rates considerably.
And the market has not reacted yet, in part because some
people think growth will resolve the problem. I do not believe
it will and most people do not. And the other is they think the
President and the Congress in their wisdom at some point will
get to it.
Well, if we get to 2009 with a new Administration and a new
Congress and we do not see the beginnings of this, they are
going to start projecting out. And I agree with Dr. Levy. I
think you would get really good marks and it would also
embolden other countries.
Some countries have actually done a lot better, Britain,
Canada, Chili, Singapore, Sweden. A number of other countries
have begun to address these much more boldly than we have.
Mr. Rogoff. I want to frame the question a little
differently. I certainly agree we have to do something about
entitlements. But it is mostly medical care. And when you think
about what the problem is, it is not an accounting problem.
What is the problem? The problem is that we are having a
lot of technological innovation. People are getting longer life
expectancies, better quality of life. And as we Americans get
richer and we are going to continue to get much richer over the
next century, we want to spend more of our money on that.
There are several prominent economists, David Cutler, my
colleague at Harvard, Robert Hall at Stanford, who have
estimated that the current 16 percent or whatever it is the
health sector takes up is going to be 30 percent by the year
2030 and a lot of that will just be quality improvements.
And the dilemma we face is that when healthcare was three
percent of GDP, we will just say everybody should have it. I
mean, what is there to discuss. When it is 30 percent of GDP,
it is Marxism. I mean, how do you handle this? It is not an
easy problem. I have written about this myself.
Mr. Ryan. Especially in defined benefits sense of the word,
Mr. Rogoff. Well, it is going to be hard to have a stable
equilibrium when, you know, people see what is going on and
some people are living longer and healthier lives. It is a real
political challenge of the future. I have written about this
I want to come back, though, to the current account a
little bit. And I agree with Brad. I mean, that is a problem
that is sooner not later. That is a problem that may just have
a soft landing in ten years, but it might not. That is going to
hit us a lot faster than the budget deficit. There are a number
of reasons that it is more difficult to handle, one of which
is, you know, by gosh, we just do not export that much and it
is not that easy to adjust overnight if we have to.
And if you look at the numbers, that is a much more
immediate vulnerability and I think is a serious issue. And we
tend to be lulled to sleep about it a little bit because it has
been a great economy. But if we enter a period where it is not,
suddenly we could wish we had taken some steps sooner.
Mr. Setser. Rather than take up more of the Committee's
time, I will just second Dr. Rogoff's remarks.
Chairman Spratt. Mr. Cooper.
Mr. Cooper. Thank you, Mr. Chairman, and thanks to this
very distinguished panel. We appreciate your wisdom.
I would like to thank Dr. Hormats in particular. This is a
great book. It should be required reading on the other side of
the aisle as well as our side of the aisle. As he points out,
we are going through the first war in American history that is
deliberately unpaid for.
There are so many issues that are important to touch on. I
think the average listener would hear things like the ten to
fifteen-year window of vulnerability that Dr. Rogoff described,
a window during which we hope we can work toward a soft
landing, but it will not happen automatically, it will take
real effort on our part, and a window in which we are
vulnerable to a myriad of circumstances that could happen
around the world.
We have also heard that basically one country can control
the value of our currency and it depends on their perception of
risk reward. One expert panelist says they are doing the
rational thing by investing such a huge percentage of their
savings in treasuries. Another panelist says, well, they
actually would have gotten a lot better return if they had done
a lot of other things.
It worries me because the one thing that all the panelists
can agree on is the need for entitlement reform, but that is
precisely what is not happening nor is likely to happen for the
foreseeable future here in Washington.
We have one of Dr. Hormats' former Goldman Sachs colleagues
now running the Treasury Department and it seems to me that he
finds it easier to discuss serious issues with the Chinese than
with the U.S. Congress. If that is not a warning sign on the
slowness of entitlement reform, I do not know what it is.
I mentioned earlier in asking Dr. Orszag some questions the
Standard & Poors projection that within about five years, the
U.S. Treasury bond would lose its triple A rating. I would like
to ask each of the panelists whether you are in relative
agreement or disagreement with that projection. Start with Dr.
Hormats and go down the line.
Mr. Hormats. I have not had a chance to read it
unfortunately. Although now that you mention it, I certainly
I do think there is that risk that as these numbers grow
for the reasons you have mentioned, the attractiveness of U.S.
assets, they become less desirable. They become less attractive
assets. Whether they will be downgraded to that point, I do not
know, but I do think they are certainly less attractive.
I would have to look at why they have come up with these
various downward gradations to be able to answer. But certainly
they are less attractive, sure, absolutely they are.
Mr. Cooper. In your testimony, you went further than that.
You said in finance and in military affairs, vulnerability
Mr. Hormats. Yes.
Mr. Cooper. So our financial weakness actually motivates
terrorists and others to do harm to us.
Mr. Hormats. Yes. And it is certainly true. You are quite
right. There are clearly terrorists who would if they could get
weapons of mass destruction and deploy them, they would that. I
mean, fortunately we would be able to stop it and maybe they
have not gotten ahold of them anyway. Let us hope they have
But the fact is one of the goals of the terrorists, and we
know this from intelligence reports, is to disrupt the American
economy. Now, whether we have a budget surplus or budget
deficit, they are still going to try to do that. We had a
surplus last time and they blew up the World Trade Centers with
airplanes and the Pentagon.
But I would also say that to the extent they think they can
really disrupt this economy, whatever they do, there will be a
multiplier effect if our fiscal situation is weak and we are
not in a very strong fiscal situation to be resilient and to be
able to come back quickly.
If they think they can disrupt the American economy, it
just adds one more incentive to them to do this. And they will
try to do it anyway, but they will have a greater incentive or,
not a greater, an additional incentive if they think they can
really wreak havoc on our fiscal situation.
And Osama Bin Laden has said that his goal is to bankrupt
the United States. He said that in October 2004 and a lot of
intelligence people believe that is their goal. So we should
not play into this by giving them a weak fiscal situation that
would make whatever attack they decide to do even worse.
Mr. Cooper. Dr. Setser, the S&P, agreement or disagreement?
Mr. Setser. I have not looked closely at the S&P report, so
I do not want to comment on its details. S&P is evaluating the
risk that the U.S. government will default on its obligations,
i.e., not pay.
In all honesty, I do not think that is the most important
risk foreign investors in buying U.S. Treasury bonds face. I
think the most important risk they face are much more tied to
currency risk, which is not something that Standard & Poors
And my personal view is that the risk associated with the
currency stemming from the factor that Dr. Rogoff mentioned,
the fact that the U.S. export is about 11 percent of its GDP
and is running roughly six percent of GDP trade and transfers
deficit, that that math is in a lot of ways much worse than
even the long-term fiscal math, although a lot depends.
Obviously if you go far enough out and have a high-end
projection on healthcare, the fiscal math can look very bad.
But in the short run, I think the currency math associated with
a large trade deficit relative to the U.S. exports face that I
think is the most important risk.
Mr. Cooper. I see my time has expired. Is there a moment
for Dr. Levy or Dr. Rogoff?
Chairman Spratt. Yes.
Mr. Cooper. The two others had not had a chance to answer.
That is okay. Quickly.
Mr. Levy. I just think their report and what they say is so
misleading that it does not even deserve merit. And if they
could come out with a report like that and not in the same
report identify South Korea, Japan, every European nation whose
unfunded liability's projections are much larger than ours, the
U.S. has among all large industrialized nations the lowest
budget deficit as a percent of GDP and the lowest debt to GDP
ratio. I do not know what S&P is thinking about.
Mr. Cooper. Dr. Rogoff.
Mr. Rogoff. Well, it does sound as far fetched as the
Goldfinger exercise. I mean, I just do not see that short of
time frame the U.S. credit declining, you know, for the reasons
Dr. Levy said. I will second what Dr. Setser said about you
look at the math on the trade balance, it is a lot scarier.
Mr. Cooper. Thank you.
Chairman Spratt. Ms. Kaptur.
Ms. Kaptur. Thank you, Mr. Chairman.
Dr. Hormats, prior to 9/11, give me a sense here, how
important was the Cantor Fitzgerald Brokerage in transacting
U.S. Treasury bond sales? Extraordinarily important?
Mr. Hormats. It was a major player.
Ms. Kaptur. They were the major player; were they not?
Mr. Hormats. Yes.
Ms. Kaptur. Thank you very much.
Could you also tell me in the early 1980s, did you have
anything to do with structuring the special agreement made with
Saudi Arabia to convert their investments in our market into
dollar denominated investments?
Mr. Hormats. Did I? No, I did not.
Ms. Kaptur. You did not. All right. Thank you.
Could you tell me what the profits of Goldman Sachs were
last year, please?
Mr. Hormats. I do not recall, but I will submit it to you
in a follow-up and I will give you our annual report with all
Ms. Kaptur. Thank you.
And also, they were substantial. They were quite a bit over
the prior year; were they not?
Mr. Hormats. Which year was this, last year?
Ms. Kaptur. Last year.
Mr. Hormats. They were, I would say, reasonably good, yes.
Ms. Kaptur. Yes. What about Bank of America, Dr. Levy? What
were your profits last year?
Mr. Levy. Do not know. I would be pleased to submit them
for the record.
Ms. Kaptur. Thank you very much.
And I would just comment on your statement that the trade
deficit has not gone up. The trade deficit in the first quarter
of this year is higher than it was in the last quarter of last
I would like to ask what will the role of your two banks be
with China's new Wealth Sovereignty Fund? Both your companies,
I am told, hold at least a five percent share in Chinese owned
banks. You may deny or accept or modify that fact. And the
Chinese government announced in March of this year it was
creating a new fund to buy foreign technology equities and
I would like to know will your firms be involved in
advising on these purchases, making those investments in your
corporate name, or will the Chinese be passive investors in
The Financial Times reported that Goldman Sachs made a 100
percent $4 billion profit off your Chinese bank investments in
just five months. Doctor, I do not know if that is true or not.
I hope you can confirm it for the record.
And for the sake of disclosure, Mr. Chairman, I have to ask
Your presence here today in advising us, obviously you have
a lot of respect in the international financial community, but
one might say is there some kind of sweetheart deal by the
government of China for your companies, Goldman, Bank of
America, to use your enormous influence before the government
of the United States because of the investments that you are
So my first question is, what will be your role with regard
to China's new Wealth Sovereignty Fund?
Mr. Hormats. I do not know and I was not prepared to answer
that, but I will certainly go back and try to get you an
Ms. Kaptur. You are in charge of the international
Mr. Hormats. Well, I am not in charge of that. I simply do
not know the answer. I am not in charge of all parts of the
international, but I will certainly get you an answer.
Ms. Kaptur. So you do not know whether your firm will be
advising or participating----
Mr. Hormats. I do not know. Do not forget there is a point
to be made about this fund. The fund is very much in an
inchoate stage. It has not been fully put together yet and,
therefore, I do not know what the fund is exactly going to look
The Chinese have said they are going to do this as you
correctly point out, and there was an article in the FT, but
the details of it have not yet been released. And I have no
idea whether we are going to play a role or not play a role.
But I am more than happy to get you whatever information I
can get and if I am able to get any, I will be more than happy
to provide it.
Ms. Kaptur. The Financial Times story that you made a
hundred percent $4 billion profit off your Chinese bank
investments in just five months, can you confirm or deny that?
Mr. Hormats. I will get back to you on that.
Ms. Kaptur. That is very interesting.
Mr. Hormats. But in terms of the testimony here, I come on
my own to try to provide the best judgment I possibly can and
this is my judgment. It has nothing to do with any relationship
we may have with any other country. I am trying to provide a
factual and judgmental assessment of what I think is in the
interest of the United States.
Ms. Kaptur. Well, I would say, Mr. Chairman, you know, when
witnesses come before us and there are international financial
questions before us, disclosure is important. And to the extent
we can obtain that for the people of the United States who are
paying the freight here, I think it is very important for us to
Mr. Hormats. I agree. The more transparency, the better.
Ms. Kaptur. Absolutely.
Mr. Hormats. That is a good part of our American system.
Ms. Kaptur. Absolutely.
Dr. Hormats, do you know what percent of Goldman Sachs is
owned by interests from other countries? I was told the
Japanese had a 20 percent share in your company. Is that true?
Mr. Hormats. I do not know. Well, a long time ago, but I do
not know what the portion--you mean what percentage of our
stock is owned by foreigners? I have no idea, but I----
Ms. Kaptur. Of the actual equity in your firm.
Mr. Hormats. I know what you mean exactly. I mean, I do not
know that we know it. But if it is knowable, I am sure it is
public information. If it is public information, I am more than
happy to provide it.
Ms. Kaptur. Then I would be very grateful if you could
provide it to the record.
I will ask the same question of Mr. Levy. Bank of America?
Mr. Levy. Bank of America has a ten percent passive
minority investment in CCB Bank in China. That is the extent I
know about it.
Ms. Kaptur. Thank you. To the extent you can----
Mr. Levy. I am only an economist.
Ms. Kaptur. To the extent you can provide clarification for
the record, it would be greatly appreciated.
Mr. Chairman, in ending, let me just say that these
gentlemen live in the macro world and it is a very important
one. I am actually a Jeffersonian Democrat, not a Hamiltonian.
I do not have a Hamiltonian mindset.
I am troubled as an American citizen that our savings are
negative, that the dollar is in decline in value, that local
banks that used to belong to people in our community have now
become derivative institutions and part of the problem of the
American savings rate going down.
I am troubled that wages and income levels are stuck for
the majority of people I represent, that the State of Ohio has
the number one housing foreclosure rate in this country. I see
that the extremely wealthy are doing extremely well. The rest
are struggling and we have more poverty.
This is not an America that I want to give to my children
and grandchildren. So I appreciate your listening to me. You
live in very special circumstances and work in very special
circumstances. Not all Americans share in that. And I
appreciate your listening today.
Thank you, Mr. Chairman.
Chairman Spratt. Yeah. Let me thank each one of you for
coming, for taking your own----
Mr. Scott. Mr. Chairman.
Chairman Spratt. Oh, I beg your pardon. I beg your pardon.
Mr. Scott came back in the room.
Mr. Scott. Thank you, Mr. Chairman.
Chairman Spratt. I yield to the gentleman from Virginia.
Mr. Scott. Thank you.
I want to follow-up with the question with Mr. Levy. I
think your answer to Ms. Kaptur's question was who the bank
owns. I think the question she was interested in is who owns
the bank in terms of your stockholders.
Mr. Levy. I do not know. It has been a decades long
Mr. Scott. Is there any problem with foreigners buying
equity positions in United States corporations?
Mr. Levy. Not as far as I am concerned. As long as it does
not jeopardize, you know, national security, the answer is no.
Mr. Scott. Does anybody think there is a problem with
American companies being bought up by foreign interests?
Mr. Rogoff. I mean, fundamentally no as long as we maintain
transparency and good corporate governance. I mean, frankly,
when you are borrowing $800 billion a year, they want to buy
something. So, you know, it is not surprising that they're
Mr. Scott. Is there any problem with the fact that we
cannot finance our national debt without foreign help? The
increase in the net national debt was about 1.5 trillion the
last couple of years. Increase in net foreign holdings is about
Mr. Setser. I will try to answer that question. I mean, I
think it depends on where you stand. It depends a little bit on
where you sit. The fact that we have been able to finance our
debt by placing a large share of that debt with foreign central
banks has kept U.S. interest rates low.
Low U.S. interest rates have benefited those who hold
housing, particularly in coastal communities, since the housing
prices have gone up much more in some parts of this country
than in others. It has helped many who borrow. It helped
private equity funds who borrow debt to buy equity.
But the counterpart to all this is that the countries that
are intervening in the foreign exchange market to build up this
foreign exchange which they lend to the U.S. are holding their
currencies down and holding the dollar up and that is hurting,
unambiguously hurting parts of this country. It is hurting
Ohio. It is hurting Michigan.
I mean, it is hurting those parts of the country that
specialize in trade and manufactured goods production and those
parts of the country have not seen the same upward appreciation
in housing prices.
So I think the overall impact is a little hard to assess
because it has such a disparate effect on different parts of
the country and I think we should recognize that.
Mr. Scott. Well, based on where we are borrowing the money
from, does this borrowing pattern translate in any way into oil
Mr. Setser. I would say that high oil prices are one of the
reasons why and the recycling of those petro dollars have
contributed to very high savings rates and have helped hold
U.S. interest rates.
You know, without these large demand for U.S. securities,
primarily debt securities, from countries intervening in the
exchange rate and countries building up petro dollars, U.S.
interest rates would have been higher.
Mr. Scott. Does that translate into higher oil prices?
Mr. Setser. I think it works the other way is what I was
trying to suggest.
Mr. Scott. Okay. So borrowing money from Saudi Arabia is a
good thing for oil prices?
Mr. Setser. I would put it the other way, that high oil
prices mean the Saudis have lots of money which they will
invest somewhere. And recently the Saudis, I think in
particular, have been building up their central banks' assets
very rapidly. And while they are very secretive, it is
reasonable to assume that some of that is going into the U.S.
Mr. Scott. If one country, China, for example, decides to
stop buying U.S. dollars, is there a possibility of a herd
effect which could magnify the problem?
Mr. Hormats. I think as I mentioned, it is unlikely the
Chinese would do that because they have an interest in holding
dollar assets. As you know, one of the questions has been
whether they will allow their currency to appreciate sharply
against the dollar. And so far, they have allowed it to
appreciate, but only very gradually. They do not want to see a
precipitous decline in the dollar, in part because they already
have a lot of dollar denominated assets and in part because
they want to have their goods remain competitive in dollar
markets, the U.S. and other dollar or dollar-related markets.
So the probability of their pulling the rug out from under
our currency or our capital markets is very, very low. If there
were some circumstance where any country that held a lot of
reserves were to do this, and it would have to be very
extenuating circumstances, much more than any sort of normal
act, then other countries might, as I mentioned in my
testimony, decide that they wanted to sell before the dollar
fell too much.
But I think the odds of that scenario are pretty unlikely
unless some really traumatic event were to occur. And if it
happened, it would be very, very tragic, very traumatic for our
system. But the odds of it occurring, I think, are relatively
But as I say, they are not zero and the more dependent we
are on foreign capital, there is always some risk that some
untoward event, some unexpected event could occur. And it need
not be China. It could be any other central bank too.
Mr. Scott. Mr. Chairman, I guess I just need to study up on
international financing because the idea that we seem to be
better off borrowing from foreign countries rather than saving
and balancing our budget and being in a capital plus situation
did not seem to--I just----
Mr. Hormats. Well, I think we are better off if we can roll
out our own savings. It would be better if we had a higher
savings rate. I do not think any of us would argue about that.
But the fact is since we do not, unfortunately we have to get
it from somewhere and we get it from those countries that do
have high savings rates. But you are quite right. It is not the
best of circumstances. I think if we could find a better way
that we did not have to rely that much, it would be better.
Mr. Levy. Would you rather have extraordinarily weak
economic growth, no job creation, dismal investment
opportunities, so then you would have excess saving and a
current account surplus?
Mr. Scott. I think the last time we had a budget surplus
when the stock market was doubling about every five years, we
were creating more jobs than in recent history. And I thought,
you know, and I do not know, I am not an expert on this, but I
thought that was a good thing.
Mr. Levy. I was referring to the current account, the
current account issue.
Mr. Scott. I was referring to jobs and the stock market.
Chairman Spratt. To our panel, let me extend the thanks of
the whole Committee for your participation, for your written
testimony, for your oral presentation, for your answers. We
very much appreciate it. We have learned a great deal about
this matter from you and we are indebted to you for having come
and being so patient and forebearing and participation. Thank
you very much.
[Whereupon, at 5:04 p.m., the Committee was adjourned.]