Q:Who buys Treasury bonds from the U.S.?Have you heard that the U.S. government came near to defaulting on its debts? It may sound strange to hear that the United States, a “rich country,” almost failed to repay its debts. In fact, it means that the U.S. government nearly reached the legal limit on its issuance of Treasury bonds. If a government cannot issue any more bonds and if outstanding government debts fall due, it will risk defaulting on them. Fortunately, the U.S. Congress approved an increase in the debt ceiling so that the government could issue more bonds and Washington avoided default. The maximum amount of debt that the U.S. government is allowed is now $9 trillion. That amount has increased $3 trillion during the Bush administration.
Who purchases the bonds issued by the U.S. government? Other countries' governments and financial service companies do. The main customers are Japan, China and Korea. They hold hundreds of billions of dollars of the U.S. debt. So how is the U.S. economy apparently doing well despite its astronomical debt?
The U.S. economy is said to be shouldering “twin deficits” ― a current account and a government deficit.
The current account deficit is the amount by which a country falls short when trading goods and services with other countries. If a country has a current account deficit, that means it imported more goods and services than it exported. If the country exports more than it imports, it will have a current account surplus. The United States' current account deficit reached $804.9 billion last year ― the biggest in the nation's history. That is nearly equal to Korea's gross national income last year, or the total that all Koreans made in 2005 ― 806 trillion won.
The United States also has a huge government deficit, which is related to government spending. The government deficit stood at $119.2 billion in February, breaking the former record of $114 billion a year ago. The government debt is expected to increase further this year due to the ongoing war in Iraq and restoration costs after hurricane damage. The U.S. Congressional Budget Office forecast that the government deficit would reach $371 billion this year, up by $52 billion from last year.
If you had huge debts, what would you do? Perhaps, your first response would be to reduce your spending. But the United States, rather than reducing expenditure, is taking on more debt to repay its outstanding debts. You might think it would be difficult for the United States, already sitting on a pile of debt, to borrow more money. It can do that relatively easily, however, because its currency is the U.S. dollar. Most international transactions, including trade in goods and services and capital transactions, are made in dollars. The dollar is the “key currency,” as it is a standard of global trade.
If the United States is short of dollars due to its twin deficits, it issues more bonds to get dollars from other countries and issues new dollars to repay the debt. That is possible because it is the country that issues the dollar.
But, if too many dollar bills are issued, what will happen? As the number of dollars increases, their value declines. If you have recently exchanged won for dollars, you will have seen this yourself. Early last year, you had to pay at least 1,050 won for $1. Now, you have only to pay 970 won for $1. The value of the dollar has declined 7 percent against the Korean won over the past year. It has also declined against the Euro and the Japanese yen.
The United States also cannot issue dollars without limit because more dollars would cause price hikes. Accordingly, the country is pressing other countries into raising the value of their currencies, in an attempt to reduce trade deficits with those countries. For example, the United States is pressing China to revalue its currency, the yuan, pointing out that 30 percent of the U.S. current account deficit comes from its trade with China. If the Chinese yuan appreciates, the price of U.S. products will become relatively lower. That, the United States hopes, would cause an expansion in U.S. exports to China and a reduction in imports from China, narrowing the U.S. trade deficit.
But it is doubtful whether the problems of U.S. deficits will be solved simply by revaluing other countries’ currencies. In fact, U.S. goods are not as popular nowadays as they used to be. Automobiles, which were a representative product of the United States, are losing ground in competition with carmakers from Japan, Korea and other countries.
Accordingly, unless the U.S. government tightens its belt and reduces its spending, the problem of the twin deficits will remain unsolved and the value of the U.S. dollar will keep falling. In that case, the function of the dollar as the key international currency will be undermined.
Meanwhile, Korean companies are complaining that the dollar's decline against the local currency is making it difficult for them to export. Does that mean the appreciation of the won is bad?
Let's assume that a local automaker produces a small passenger car for 18 million won and sells it at 20 million won. When the rate was 1,200 won per dollar, the company sold that car in the U.S. market for $16,700. Now that the dollar has declined to below 1,000 won, the company has to charge $20,000 to gain the same profit. But if the car price goes up, fewer U.S. consumers will buy it. If the company wants to maintain its sales, it will have to keep the same price and make less profit.
But a decline in the dollar could benefit Korea also. Those who have taken the Toefl test will know that. When the rate was 1,200 won per dollar, those who took the test for $140 had to pay 170,000 won. Now that the rate has declined to below 1,000 won per dollar, however, test takers can save 30,000 won. Similarly, local companies that have to purchase raw materials including crude oil to manufacture goods can now buy them at lower prices than before. Korea’s debts to other countries, which are denominated in dollars, will also be lower when denominated in won.
by Moon So-young