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.