A debtor’s capacity to project military power

…hinges on the support of its creditors

Lending money to governments to fight wars has a very long history, giving creditors a degree of influence over debtor monarchs or governments. But at least four factors make the situation in the early twenty-first century different. First, the global economy—and not least global financial markets—are connected in an intricate sense. Second, the creditors are not only sovereign but in several instances also from countries where the state-owned companies are entrenched economic players in their own right. Third, the individual and combined size of the sovereign wealth holdings is unprecedented. And finally, the geopolitical relationships between the principal debtors and creditors is competitive and adversarial, if not antagonistic.

In this light, the Council on Foreign Relations has published a special report by Brad Setser on the sovereign wealth and sovereign power. It argues “that the United States’ current reliance on other governments for financing represents an underappreciated strategic vulnerability.”

The willingness of foreign central banks—which remain a far more important source of financing for the United States than sovereign wealth funds (SWFs)—to build up dollar reserves has long provided a stable, but limited, source of external financing. But the United States increasingly relies on financing from central banks that already hold far more reserves than are needed to assure their own financial stability. It is true that foreign central banks have an interest in keeping the dollar strong. But the United States might have more to lose from a disruption of this relationship: financial flows create mutual interdependence, but the interdependence is asymmetric. The longer the United States relies on central banks and sovereign funds to support large external deficits, the greater the risk that the United States’ need for external credit will constrain its policy options. [CFR]

While much of the recent analysis on sovereign wealth has been from an economic standpoint, Dr Setser’s report provides directions for a realist appreciation of the issue. To the extent that they give rise to a balance of terror, it is possible to see excess foreign reserves holdings of central banks and large sovereign wealth funds as strategic weapons. How these ‘weapons’ work, how they might be employed and how they might be deterred or defeated are all questions that should concern geopolitical strategists.

6 thoughts on “A debtor’s capacity to project military power”

  1. They say that if you owe the bank $1,000 you cannot repay, you are in trouble; but if you owe the bank $1 billion and you cannot repay, the bank is in trouble.

    Think of the rest of the world’s central banks who hold dollar reserves as the bank and the US as the creditor who is in danger of defaulting. It puts the US in a very interesting position — it can take a lot of folks down if it starts to drown. The rest have a very good incentive to keep the US afloat.

    Bottom line: the world is full of suckers.

  2. Atanu,

    That’s an aspect of the balance of terror…it’s perhaps like a weapon with two triggers; one in the hands of the person holding the gun, the other in the hands of the person at who it is pointed.

  3. And its always poor Papistan that gets blamed for negotiating with a gun to its own head. Seems, the scene fits the US just as well on a gobal scale.

    One reason foreign central banks hold so many $ is that there’s oil that can be bought in dollars off the 2 major oild bourses in the world – in NY and London respectively. Ever since Bretton Woods, $$ now can’t be redeemed for gold. Black Gold has since replaced gold. One wonders if poor saddam wouldn’t have been targetted but for his attempt to bypass oil-for-food sanctions by selling oil in euros instead. Now, one hears Iran has regsitered a Euro-dealing oil exchange. The hammer will fall on Iran for this reason alone. JMTs etc.

  4. Sud – “One wonders if poor saddam wouldn’t have been targetted but for his attempt to bypass oil-for-food sanctions by selling oil in euros instead.”

    If such were the case, the Democrats who are just as concerned about US economic hegemony as the Republicans, would not have been so vehemently opposed to the Iraq war.

  5. Consider a bank that invests in a mortgage bond for $100,000 from a home-buyer. Normally, I would expect that the bank would have done its homework, and evaluated the alternate investment opportunities carefully, before deciding to buy the bond. Yes, the bank would be very interested in, and probably would like to influence, how the home owner manages their finances, but to place them in financial distress, or worse, shoot them dead? I don’t think so.

    Yes, the home owner would lose their home, but The bank would suffer serious investment losses, too, when the home owner’s financial well being take a nose dive, as the current mortgage crisis in the U.S. shows. Note also that sovereign debt is often, if not always, unsecured.

    Well, worst come to worst, “Who has more nuclear weapons and ballistic missiles, eh?”, as a colleague of mine in the finance department was wont to say, when the Japanese held piles of American paper in the eighties!

  6. Trilok:
    “If such were the case, the Democrats who are just as concerned about US economic hegemony as the Republicans, would not have been so vehemently opposed to the Iraq war.”

    Does it really matter what the opposition says when it is, err, in opposition? (Hint: The nuke deal and the BJP)

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