The Effects Of External Debt On Sustaining U.S. Financial Hegemony

United States established its financial hegemony in the period of Bretton WoodsSystem, but the financial hegemony didn’t disappear with the collapse of BrettonWoods System. In contrast, during Post-Brettton Woods System, United States hasbeen still the dominator of international monetary system by modifying the order ofinternational finance, in which U.S. Treasury has been the standard of internationalmonetary system instead of gold. The U.S. financial hegemony has been strengthenedand the number of external debt has been increasing as well in the new style ofinternational capital cycle system. It seems unbelievable that United States has beenso deep in external debt as a financial hegemony country. It is also hard to understandthe symbiotic relationship of financial hegemony and external debt. Then, how doesU.S. sustain the financial hegemony with external debt? Does external debt havepositive effects on strengthening the financial hegemony? If so, which part does U.S.government take in in the process of external debt sustaining or strengtheningfinancial hegemony? What about private sector or Federal Reserve System? Howlong could this kind of U.S. financial hegemony stand? This paper would try to findout answers to these questions by using logic and history analysis research methodson the basis of international political theory.This paper begins with exploring the mechanism of external debt related tofinancial hegemony by theoretical analysis. According to the cost-benefit analysis inHegemonic Stability Theory, though it is important to have comparative advantagesof economy, the key to hold financial hegemony is increasing the benefits fromfinancial hegemony as much as possible and controlling the cost of sustaininghegemony at the same time. There are three preconditions for sustaining financialhegemony by external debt. If it could make its external debt denominated bydomestic currency, the financial hegemony country can control the cost of debt byinflation or exchange rate adjustment. If it could induce or even dominate the flow ofinternational capital, there may be more choice of creditor for the financial hegemony country. If it could handle and overcome the crisis, the financial hegemony countrycan not only improve its status in the international finance system, but also impute therisk of debt to other creditors.Subsequently, this paper study on how three sectors, namely the U.S. government,the private sector and the Federal Reserve, help the United States meet the threepreconditions and ensure financial hegemony to be strengthened by external debt.The U.S. government mainly depends on financial diplomacy to exert its effort inthe process of external debt sustaining financial hegemony. Treasury bondsdenominated by domestic currency play as an interest’s instrument for exchange inUS financial diplomacy. The purchase of US Treasury bonds can be used as means orobjective according to the need of financial diplomacy in some international situation.After the collapse of the Bretton Woods System，US persuaded industry countries toagree that US Treasury bonds could be used as a substitute for gold. US succeeded infinancial diplomacy and Treasury bonds have naturally been the dollar carrier as soonas the closure of dollar-gold exchange window. To strengthen the newborn dollar-debtcycle system, US forced Middle East to price oil in dollars by its military strength. Itmeans that the trade surpluses of the oil exporting countries would eventually flowinto United States by investing financial assets which are denominated by dollars.Subsequently, US has been actively promoting global financial liberalization andeconomic integration process to bring emerging countries into the dollar-debt cyclesystem. Moreover, U.S. has established the benefits association with emergingcountries by importing and lending. Most emerging countries opened their capital andfinancial account and allow international capital to invest in domestic financialmarket. In that case, increasing incomes accumulated by economic growth are morelikely to flow to U.S.The U.S. private sector exerts its effort in the process of external debt sustainingfinancial hegemony by creating and maintaining financial comparative advantage.The financial comparative advantage of the U.S. is thanks to the depth, efficiency andstability of financial market. In this paper, the author makes the financial comparativeadvantage of the U.S. quantified by building an index. It is easier to comparefinancial strength among these countries. Then, the author breaks the private sector into the banking sector, non-bank financial sector and multinational companies, andstudy how their external debts effect on sustaining financial hegemony, respectively.U.S. commercial banks are mainly the debtor in international financial markets. Thehigher liquidity and lower risk of them make the U.S. commercial banks moreattractive to international capital. Shadow banking is representative in U.S. non-bankfinancial sector. Thanks to financial innovations, it can be more effective andflexibility in credit, term and liquidity transformation. Thus, the net position of theU.S. private portfolio is negative most time. The negative net position of U.S. privateinvestment is much narrowed by the increasing profits of U.S. foreign directinvestment. The profits of foreign direct investment by Multinational corporations arethe main resource of U.S.net international investment income. Thus, the growth of netexternal debt in private sector is always mildness due to market forces.Fed exerts its effort in the process of external debt sustaining financialhegemony by maintaining dollar hegemony. Dollar hegemony is a quiet importantpart of U.S. financial hegemony. Because the most external debt is denominated bydollar, the fluctuation of dollar exchange rate could affect the U.S. external debt.During the First World War and post-First World War reconstruction, the Fed hadplayed a positive role in the international finance expansion to enhance the status ofdollar in international monetary system. During the Bretton Woods System, the Fedhad been practicing with a low interest rate monetary policy to maintain anexpectation that dollar would appreciate more than other currencies in the most time.The expectation of dollar appreciation was helpful to keep dollar in overseas for alonger time. After the collapse of the Bretton Woods system, Fed has to keep thesufficient liquidity and lock the risk of financial market by acting as the last lender orlast dealer to ensure dollar overseas return. Fed has also cooperated with Treasury inexchange rate adjustment in virtue of dollar hegemony to rebalance the internationalpayments and lower the external debt, which may enhance the sustainability ofexternal liabilities to maintain U.S. financial hegemony.This paper also discusses that the duration of U.S. financial hegemony withincreasing external debt and the trend of the number of external debt. In author’sopinion, U.S. financial hegemony is still full of powerful and the effect of external debt on sustaining U.S. financial hegemony would not change in medium term, aslong as the components (ie, dollar hegemony, the dominance in finance, order theinternational financial, handle financial crisis) of U.S. financial hegemony still workwell. Therefore, it might be biased to judge the sustainability of the U.S. financialhegemony only based on analyzing the size and the trend of U.S. external debt. Dueto the mechanism of U.S. financial hegemony, the trend of U.S. external debt is morelikely to depend on global economic trends. Though U.S. might adjust the size ofexternal debt by the valuation effect and exchange rate, it is difficult for U.S. todominate the trend of external debt alone.The conclusions of this paper are as follow:First, the U.S. financial hegemony is line with the academic definition both onthe level of financial institutions and the level of sovereign state. The threepreconditions for financial hegemony being sustained by external debt are allsatisfied.Second, in the process of external debt sustaining U.S. financial hegemony, U.S.private sector attracts international capital inflows with financial advantage by virtueof market forces; U.S. government induces foreign exchange reserves and tradesurplus into U.S. financial markets by the national credit and financial diplomacy. Fedmaintains dollar hegemony by cooperating with the international monetary policy ofTreasury.Third, the investment on Treasury bonds is the main resource of net external debtgrowth. Therefore, the growth of U.S. external debt is due to the U.S. financialhegemony and suggests the high national credit of the United States. In other words,U.S. financial hegemony has weakly related to the duration of external debt. It ismore likely to depend on dollar hegemony, financial comparative advantage, thepower of ordering international finance, and the ability of handling financial crisis.Additionally, the hegemony on international military and politics is also in favor offinancial hegemony.