Two nations, Germany and Japan, effectively control the world’s credit, providing more than half the world’s “surplus” savings. If they ever decided to stop lending to their prime debtors, Britain and the United States, the world economy would quickly change. This fact should send shivers down the spines of anyone who knows history.

The U.S. government is relying more and more heavily on the kindness of foreigners and former enemies to finance its deficits.

Since 2000, the percentage of U.S. public debt owed to foreigners has doubled. As of July, foreigners held just over $2 trillion, or 44 percent, of federal public debt outstanding. Japan alone now holds more than $680 billion; China, $242 billion; United Kingdom, $160 billion; and Caribbean Banking Centers, $103 billion (U.S. Department of the Treasury).

As of August 15, the total national debt of the United States was $7.9 trillion. In other words, every man, woman and child in the United States owes more than $26,500 in federal debt. And that is just the federal debt, which does not include the $53 trillion hidden debt that USA Today says the “federal, state and local governments need immediately—stashed away, earning interest, beyond the $3 trillion in taxes collected last year—to repay debts and honor future benefits promised under Medicare, Social Security and government pensions” (Oct. 3, 2004). Added to personal debt, the article estimates the hidden debt weighing on each household’s obligation as taxpayers to be about $473,000!

All this debt makes the United States vulnerable to foreign political and economic leverage. When you are a debtor, others are able to exert pressure on you. In essence, debt makes you more vulnerable to coercion.

This kind of pressure was demonstrated in 1997 when former Japanese Prime Minister Ryutaro Hashimoto wondered publicly about what would happen to the American economy if Japan diversified and began to sell some of its then $300 billion in U.S. treasury securities (remember, Japan now owns more than $680 billion). Following Hashimoto’s remarks, the Dow Jones Industrial Average suffered its largest single-day loss since the crash of 1987. Aids to Hashimoto quickly responded by saying the remarks were not intended as a threat.

But what if, at some point, America’s debtors did want to influence U.S. policy? In a potential conflict between China and Taiwan, would China stand idly by, holding $242 billion, if the United States was to interfere to protect democratic Taiwan? On the other hand, would Taiwan simply hold its $72 billion if China attacked it and America did not come to its aid?

How about if China and Taiwan were to peacefully reunite? Together they would control $314 billion of U.S. debt. Since China also effectively controls Hong Kong, you can add in an additional $48 billion of U.S. debt, for a grand total of $362 billion.

That is no small amount of potential economic or political influence!

Unfortunately, the U.S. government did not learn from Prime Minister Hashimoto’s remarks and the subsequent reaction of the dollar and the stock markets. Eight years on since the Hashimoto incident, the United States’ indebtedness to foreign nations has continued to expand to the extent that even little South Korea can exert enormous pressure on America’s markets. On February 22, the Bank of Korea, America’s seventh largest lender, holding $53.1 billion, announced that it planned to diversify reserves out of U.S. dollars (Bloomberg.com, February 22). That same day the dollar fell sharply, bonds dropped, and the Dow plunged over 174 points.

Unhappily for America, it seems like more and more nations are starting to diversify their reserves out of U.S. assets. One way a country reduces its exposure to reserves of another nation is by selling that nation’s bonds; in other words, selling that nation’s currency. When a country sells dollars, it increases the dollar supply relative to demand, causing the value of the dollar to drop.

When the Royal Bank of Scotland released a survey in January showing that central banks were increasing euro holdings, the dollar dropped a half percent against the euro. In the survey, 70 percent of 56 central banks said that they increased exposure to the euro currency. Fifty-two percent also said they reduced their exposure to the dollar. According to billionaire investor George Soros, central banks of oil-exporting countries in the Middle East, along with Russia, are diversifying out of the dollar and spurring the dollar’s decline (ibid.).

Falling demand for U.S. treasuries could have a significant effect on the U.S. economy.

If foreigners even slow their purchases of U.S. treasuries, the economic effect could be dramatic. The U.S. must take in roughly $2 billion a day in foreign investment to finance its current account deficit (Washington Times,April 16). If foreigners become more reluctant to invest in U.S. treasuries, the dollar will fall.

This would have a two-pronged effect on the U.S. economy.

First, a falling dollar would increase the cost of imports, giving rise to inflation. Any goods manufactured in foreign countries, whose currencies are increasing in value versus the dollar, would become more expensive. This might make it especially tough on companies like Wal-Mart, which sell mostly foreign-produced goods.

Second, if the dollar falls too much, the Federal Reserve would be forced to raise short-term interest rates in an attempt to support it. A rising short-term interest rate could start to close the gap between the short-term and long-term bond yields, causing the yield curve to flatten or invert. In the past, an inverted yield curve (i.e. short-term interest rates being higher than long-term rates) has preceded every recession since the middle 1960s except for one (Economist,June 7).

A recession, with its associated economic slowdown and subsequent job losses, could threaten the housing bubble. For many two-income families, all it would take is for one wage earner to lose his or her job before the family home would become unaffordable. An increase in houses on the market accompanied by decreased demand would cause prices to plummet. This scenario is even more disturbing when one considers that much of the recent U.S. economic expansion has been fueled by increasing house prices and subsequent mortgage refinancing.

The American economy is losing its resiliency. The country is selling its independence to foreigners—and with no personal savings, Americans will have much less to fall back on in the event of a world investment shift.

America is falling from its seat of power and will be replaced on the world scene—just as Britain was toppled and every other empire that has dominated the world. That is the main lesson America is forgetting: The nation is proving to be no different than any other nation that has risen to power and then fallen.

America’s ballooning debt will contribute to the greatest fall in history. At some point, the huge increases in American debt will help to convince foreigners that America is not a safe place to invest in. If America is ever considered economically unsafe for foreign money, that money will rapidly disappear. And once the foreign money is gone, it will leave Americans with a mountain of debt that cannot be easily repaid.

Prepare to greatly reduce your standard of living now.

In reference to America’s trade deficit and debt, Morgan Stanley’s chief economist, Stephen Roach, made headlines with comments delivered at a private gathering in Boston. According to the Boston Herald, Roach suggested the United States has less than a 10 percent chance of avoiding economic Armageddon. “Roach sees a 30 percent chance of a slump soon and a 60 percent chance that ‘we’ll muddle through for awhile and delay the eventual Armageddon’” (Nov. 23, 2004).

To Roach, it’s not a matter of if—but when.