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The Overstretch Myth
David H. Levey recently retired after 19 years as Managing Director of Moody's Sovereign Ratings Service. Stuart S. Brown is Professor of Economics and International Relations in the Moynihan Institute of Global Affairs at Syracuse University's Maxwell School of Citizenship and Public Affairs.See more by David H. LeveySee more by Stuart S. Brown
Would-be Cassandras have been predicting the imminent downfall of the American imperium ever since its inception. First came Sputnik and "the missile gap," followed by Vietnam, Soviet nuclear parity, and the 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 the 1990s momentarily put such fears to rest. But recently, a new threat to the sustainability of U.S. hegemony has emerged: excessive dependence on foreign capital and growing foreign debt. As former Treasury Secretary Lawrence Summers has said, "there is something odd about the world's greatest power being the 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, the current account deficit--the 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 continue adding to their already large dollar assets, in this scenario, would set off a panic, causing the dollar to tank, interest rates to skyrocket, and the U.S. economy to descend into crisis, dragging the rest of the world down with it.
Despite the persistence and pervasiveness of this doomsday prophecy, U.S. hegemony is in reality solidly grounded: it rests on an economy that is continually extending its lead in the innovation and application of new technology, ensuring its continued appeal for foreign central banks and private investors. The dollar's role as the global monetary standard is not threatened, and the risk to U.S. financial stability posed by large foreign liabilities has been exaggerated. To be sure, the economy will at some point have to adjust to a decline in the dollar and a rise in interest rates. But these trends will at worst slow the growth of U.S. consumers' standard of living, not undermine the United States' role as global pacesetter. If anything, the world's appetite for U.S. assets bolsters U.S. predominance rather than undermines it.