The Overstretch Myth: Can the Indispensable Nation Be a Debtor Nation?

Abstract

Would-be Cassandras have been predicting imminent downfall of American imperium ever since its inception. First came Sputnik and the missile gap, fol lowed by Vietnam, Soviet nuclear parity, and Japanese economic challenge a cascade of decline encapsulated by Yale historian Paul Kennedy's 1987 overstretch thesis. The resurgence of U.S. economic and political power in 199os momentarily put such fears to rest. But recently, a new threat to sustainability of U.S. hegem ony has emerged: excessive dependence on foreign capital and growing foreign debt. As former Treasury Secretary Lawrence Summers has said, there is something odd about world's greatest power being world's greatest debtor. The U.S. economy, according to doubters, rests on an unsustainable accumulation of foreign debt. Fueled by government profligacy and low private savings rates, current account deficit difference between what U.S. residents spend abroad and what they earn abroad in a year-now stands at almost six percent of GDP; total net foreign liabilities are approaching a quarter of GDP. Sudden unwillingness by investors abroad to con tinue adding to their already large dollar assets, in this scenario, would set off a panic, causing dollar to tank, interest rates to skyrocket, and U.S. economy to descend into crisis, dragging rest of world down with it. Despite persistence and pervasive ness of this doomsday prophecy, U.S. hegemony is in reality solidly grounded: it rests on an economy that is continually extending its lead in innovation and application of new technology, ensuring its continued appeal for foreign central banks and private investors. The dollar's role as global monetary standard is not threatened, and risk to U.S. financial stability posed by large foreign liabilities has been exaggerated. To be sure, economy will at some point have to adjust to a decline in dollar and a rise in