This document discusses the threat of financial warfare posed by the rising US debt and foreign holdings of US treasury securities. It summarizes that the 2008 financial crisis greatly increased the US debt, which is now over $12 trillion and held significantly by China. If China or other foreign creditors decided to suddenly sell these holdings, it could destabilize the US economy through higher interest rates and inflation. The document argues this growing debt vulnerability undermines US national security and global influence.

1. “The Effects of the Financial Crisis on U.S. Debt and the Threat of Financial Warfare”
Midn 1/C Keith Hollis
United States Naval Academy
March 18th
, 2010

2. In early 2009, the symptoms of a financial crisis came like a warning shot that
sent doubts and fears down the spines of nearly everyone who could see the writing on
the wall. That is, global investment bank Bear Stearns came crashing down, and
eventually was sold on the cheap to J.P. Morgan to temporarily prop up the crumbling
financial system. Even earlier than this however the news was smattered with bits about
increasing foreclosure rates and sub prime mortgage lending. Some knew what was
happening, others simply chose to ignore the warnings.
By the time Lehman Brothers and Washington Mutual, two of the largest banks in
history to collapse, came toppling down, preventative action was far too late. What was
left in the laps of taxpayers and the United States government was a grave dilemma. This
dilemma spanned ethical, moral, and fiscal spectrums, but it was an issue that needed to
be taken with vigor to keep America from collapsing all together. With ethical and moral
dilemmas aside, America’s fiscal situation was already dire prior to the financial crisis.
In 2006, the United States debt was about 8.5 trillion dollars, or about 70 percent of US
gross domestic product.1
What has ensued since then has been a frantic, and expensive,
response to set up a makeshift support system for our country and world’s financial
system.
First, it is helpful to establish the difference between debt and deficits. A deficit
is equivalent to the amount of money you add to your credit card bill every month. For
1
Claire Suddath, “A Brief History of the U.S. Deficit,” Time, August 25, 2009,
http://www.time.com/time/nation/article/0,8599,1918390,00.html (Accessed February 9, 2009).

3. example, in a month if you pay off $500 in credit, but spend $600, you have a $100 dollar
deficit for that month. Debt however is the total balance on your credit card, the amount
you owe total. It is the sum of all deficits.
At the most recent count, the United States federal debt was valued at 12.5 trillion
dollars.2
This amount of money is equivalent to over $41,000 dollars for every man,
woman and child in the entire country. 3
Although there are myriad contributors to this
debt, the financial crisis only exacerbated the situation by placing further obligations
from the government to foreign holders of our debt. These foreign holders include, in
order of largest to smallest, China, Japan, and foreign oil exporters. The recent explosion
in the United States national debt has caused some concern and doubt in our ability to
actually repay all these accrued debts.
The financial crisis was not just felt within the United States however. The
International Monetary Fund values the total cost of the crisis at about 11.9 trillion
dollars, including the nearly one trillion dollars contributed by the United States
government in stimulus plan, short term lending, and TARP (troubled assets relief
program) designed to support our country on the brink of a financial catastrophe.4
The
countries comprising the G20 will face the biggest budget deficit since World War II, at
10.2 percent of GDP.5
The largest deficit however, will be that of the United States at
13.5 percent of GDP, all simply due to the financial crisis.6
It is important to note however that it is not unnatural to spend during recessions
and run up debt. In fact, this can help stimulate economic growth and curb
2
http://www.brillig.com/debt_clock
3
Ibid.
4
Kevin Jess, “IMF: Total Cost of Financial Crisis at $11.9 Trillion,” Digital Journal,
http://www.digitaljournal.com/article/277282 (Accessed February 9, 2009).
5
Ibid.
6
Ibid.

4. unemployment rates. That being said, deficits are also not good. They can enslave
people, and even countries to other countries. They also greatly impact the efficiency and
ability for countries to deal with the unexpected, such as disasters or emergencies.
At the end of World War II, America owed debt to Americans. However, now
this debt is owed to foreign investors, who could choose to pull the plug and exact
“financial warfare” on the United States. Imagine a situation where investors continually
put their money into America, but one day decide that all this borrowing could lead to
inflation, so they decide to leave the dollar, forcing the Federal Reserve to massively
increase interest rates and ultimately throw America into a recession. This decision, at
some point, will no longer be within our control, rather it will lay in the hands of those
who fulfill our financial obligations.
Additionally, there are other ways that a foreign country could influence the
United States decisions. One such example of the enslaving properties of debt came in
the first recorded incident of “financial warfare.” The Suez Crisis in 1959 was an attack
on Egypt by various countries, including Great Britain and France that resulted from the
Egyptians decision to nationalize the Suez Canal. The United States, for several reasons,
could not support this attack and had to use unconventional tactics to end this invasion.
It’s medium: finances.
During World War II Britain ran up deficits and financed these through the
United States purchase of US Government Sterling Bonds. In response to the British
invasion of Egypt, the Treasury Department of the United States mobilized itself to be
able to sell these holdings, and this threat severely devalued the British pound by

5. massively increasing the supply of Sterling on the market.7
With this devaluation, it was
only a matter of time before Britain’s economy would lay limp and dysfunctional. It
would render them helpless and unable to provide the basic goods citizens need to sustain
life within a week.
For these reasons, Britain and France withdrew from their invasion, and the
United States and exercised control over the former superpower through financial means.
Eerily, the United States is putting itself in almost the exact position described above.
We are running up a huge debt in reaction to both war and the financial crisis, and this
debt is being financed by countries from all around the world. If the United States does
not act quickly to curb, control, and reduce these deficits, it will soon lose its ability to
pursue economic and foreign interests throughout the world, and essentially compromise
our national interests.
Furthermore, financial warfare is looking to be more and more of a viable option
in the arsenal of foreign countries. The most probable and able culprit would be China,
however there are many negative implications for a country wanting to exact this type of
method to exercise power. This could come through China causing calculated currency
undervaluation by running current account surpluses comparable to its past years of ten
percent plus. With many countries seeking a strategy of “exporting their way out of the
current crisis,” many obstacles will be put in front of the US in reducing their debt to
foreign countries, with China being a prime example.8
7
Noah Schachtman, “U.S. Could Use Crisis to Wage ‘Financial Warfare’,” Wired, March 16, 2009,
http://www.wired.com/dangerroom/2009/03/finance-threat/ (Accessed March 01, 2010).
8
Fred C. Bergsten., “The Dollar and the Deficits.” Foreign Affairs, November/December 2009, 35.

6. Likewise, the Chinese could dump massive amounts of dollars in order to cause
economic uncertainty in the United States. Although a massive amount of selling or
under financing would probably hurt the Chinese just as much as Americans, if done in
small increments it could be an effective strategy to cause political, social, and economic
uncertainty in the United States. As it stands, the Chinese hold about one trillion dollars
in the debt of the United States, mostly in securities and treasury notes.
An advisor to the director of national intelligence, James Rickards, specializes in
financial warfare and believes that China could conceivably set out to overtake the
United States in this way, which has obvious security implications. "You can envision
scenarios where they launch a financial attack, you know — a Pearl Harbor on the dollar,
if you will," he said. "And those are the things that I think national security professionals
rightly think about. But it doesn't even have to be that. It could just be China acting in its
own best interests, in a way that causes interest rates to go up, the dollar to go down."9
Rickards also warns about skepticism Americans may have about the ability of
the Chinese to actually execute this. "Don't think the Chinese aren't sophisticated about
this," he said. "There are plenty of economists in China who went to MIT and Harvard
and the University of Chicago who know more about this than anyone. Those are the
kinds of little plays within the bigger picture that I think people are not paying attention
to, and they're potentially threatening."10
Even with the massive leverage that China holds, some believe that the crisis will
play into the U.S. favor in terms of financial warfare. Their reasoning: the financial
crisis, as bad as it may have seemed in the United States, has much more detrimental
9
Tom Gielten, “Downturn Raises Risk of Global Financial Warfare.” National Public Radio,
http://www.npr.org/templates/story/story.php?storyId=100832254 (Accessed March 01, 2010).
10
Ibid.

7. effects to other nations across the world. With these economies on thin ice, it would be
very easy for the United States to use even more “arm twisting” tactics in order to
persuade friends and enemies alike to conform to the United States’ desires. As
discussed earlier, this was preformed once already by the United States, and it is
conceivable that in a time of globalization that it could happen again.
Yale management professor Paul Bracken believes that most likely the United
States could accomplish financial warfare by targeting the “foreign bank accounts of the
top 500 people" in an enemy state.11
"That financially decapitates a country’s elite," says
Bracken.12
Most recently this idea came up when Russia invaded Georgia. David
Rivkin, former Justice Department official, pushed for retaliation to the Russian invasion
using this very method. He suggested attacking the assets of “ex-KGB siloviks and
wealthy Kremlin-friendly tycoons" that "bankrolled [Russian overlord Vladimir] Putin’s
rise."13
Although never implemented, the tactic could play into the United States strength
in the future, which could most definitely enhance the nation’s security.
There are several other implications of the economic downturn that have proven
critical to the national security of the United States. One such aspect of the United States
economy that is jeopardizing the state of the union is somewhat counterintuitive. During
the Cold War, the United States restricted the exportation of many advanced
technologies, and even though the cold war has passed, these restrictions remain. What
Mitchel B. Wallerstein calls this ideology is “fortress America,” or the outdated mindset
that the “United States is the primary source of most militarily useful scientific ideas and
products and that is can continue to deny technology to potential adversaries without
11
Schachtman.
12
Ibid.
13
Schachtman.

8. seriously damaging the global competitiveness of U.S. companies…or jeopardizing
national security.” 14
The losses from these export controls are estimated to be as high as 9 billion
dollars a year. “In trade negotiations, the United States should seek to reduce foreign
barriers to its exports, especially in its highly competitive service sector” suggests Fred
Bergsten of International Affairs15
. The export controls that the U.S. have now are
simply outdated, most relics of the Cold War era in which technology and sensitive
information was being hoarded. With a split government, most Conservative forces are
highly resistant to such ideas, it is understandably so because of the message it would
send in a time of war. “Until such changes are implemented, the countries security and
economic competitiveness remain threatened.”16
So what exactly is it about strict export controls that threaten national security?
According to Wallerstein, there are four specific ways. Firstly, Wallerstein suggests that
the technology used by our military is already dual use, so new firms try to avoid the
economic costs, both financial and legally, by investing in technologies that have
seemingly no application to military advancement. Because of this effect, the military
and the United States is being deprived of cutting edge technologies that could be put to
use on the battlefield. In particular, firms are “unwilling to tolerate the risk and expense
associated with long export-licensing delays.”17
Secondly, foreign countries may possess great technologies than the US already,
but are unwilling to interact with the department of defense because of the fear of
14
Mitchel B. Wallerstein, “Losing Controls.” Foreign Affairs, November/December 2009, 13.
15
Bergsten.
16
Ibid.
17
Wallerstein.

9. becoming involved with export controls. Almost congruous to this, is the fact that export
controls make it difficult for the U.S. military use foreign allies for maintenance and
repairs of equipment. As it stands currently, export licenses would be required for each
individual repair, which makes the entire process entirely inefficient and not worthwhile.
Although subtle, these two things would directly combat our war fighting effort and
undermine national security.
Finally, Wallerstein suggests that foreign competition may be getting crowded out
and therefore knowledge that gets passed back and forth in normal interactions between
foreign operators is not being acquired. This knowledge usually gives insight into
foreign military capabilities and can be useful in estimating a countries technical
intelligence.18
However, the underlying theme in nearly all of these issues is the rising debt that
the United States owes to foreign creditors. David Walker, former comptroller of the
United States, says “I will argue the most serious threat to the United States is not
someone hiding in a cave in Afghanistan or Pakistan, but our own fiscal
irresponsibility.”19
The deteriorating market conditions of the past two years have cost America and
Americans alike, and a grim picture has been painted as to the future direction of our debt
and deficits. According to the Congressional Budget Office, the nation be forced to
borrow up to $9.3 trillion over the next decade, nearly $2.3 trillion dollars more than
previously expected.20
“We’re requiring more things to be paid for and to have tough
18
Wallerstein.
19
Patrick Creadon, I.O.U.S.A. DVD. Directed by Patrick Creadon 2008. Roadside Attractions, 2008.
20
Gerald Seib, “Deficit Balloons Into National-Security Threat,” Wall Street Journal Online, February 2,
2010, http://online.wsj.com/article/SB10001424052748703422904575039173633482894.html (Accessed
February 9, 2010).

10. spending discipline. It’s just got to be done,” said Senator Kent Conrad, chairman of the
Senate Budget Committee.21
Adds Senator Judd Gregg, the spending pace of America
“clearly creates a scenario where the country’s going to go bankrupt…. it’s about that
simple.”22
In coming back to the Chinese holdings of American currency, it is important to
recognize that the Chinese are not so much concerned with the exchange rate of the dollar
and the yuan, rather, they are worried about the inflation that may result from budget
deficits America is running. If these worries turn to action, the dollar will be fled from,
and further increase the suspected inflation.23
With deficits clearly becoming uncontrollably large, the fat will need to be
trimmed in terms of spending. Unfortunately, one logical place for these cuts is in the
national defense realm. Long term defense spending is the first ideal spot to look for
these cuts, and this will only weaken the foundations that America has been building up
and enjoying the fruits of for years. America has been the global hegemon because of
our strong military and unwavering ability to establish political relationships by reaching
out to those in need. Slowly, that aura is dying with our lack of funds to support such a
standard.
With the complexity of life in the 21st
century, national security risks can range
from energy dependence to addressing the concerns of climate change. In this broad
spectrum, Americans must address our debt in order to, in addition to numerous other
things, guard against foreign pressures, combat the rising economic powers of the world
21
Lori Montgomery, “Deficit Projected To Swell Beyond Earlier Estimates.” Washington Post, March 21,
2009.
22
Ibid.
23
Martin S. Feldstein, “Economic Conditions and U.S. National Security in the 1930’s
and Today,” NBER Working Paper Series, Working Paper 15290, August 2009.

11. (including China), and to be able to continue the practice that has led America to
establish itself as a global leader. Says Richard Haass, the president of the Council on
Foreign Relations and a senior national-security adviser for Bush, “what’s so
discouraging is that our domestic politics don’t seem to be up to the challenge…and the
whole world is watching.”24
It is important to think about the economic downturn and its implications now,
rather than when the debt of the US has soared and our national security is compromised.
History lends some insight into the issue, as the Great Depression helped fuel the rise of
Nazi German and Fascist Italy. Although this example is extreme, the rise of world
powers through or due to economics is not outrageous in the least. It is merely one aspect
of what the United Stated needs to be prepared for.
Finally, one obvious concern and threat to national security is the threat of
terrorist attacks on the United States. With the decrease in security spending that could
incur from trimming budgets, many people may be concerned that the door to terrorist
activity could be opened. This threat however, is less likely than the other threats arising
from the economic downturn. In all, spending on homeland security pales in comparison
to the U.S. defense budget, and rightfully so. In the most lucrative year for terrorist
attacks on the United States, 2001, more than twelve times as many Americans died from
the flu than did terrorist attacks. This figure includes the tragedies of 9/11. 25
People
often have a skewed view of the risk to their own security and the public generally
believes that there can never be enough spent on security. The costs of protection are
often deemed irrelevant on an aggregate scale, when in fact it is this spending that will
24
Seib.
25
Feldstein.

12. jeopardize America more than the benefits of protection each individual with limitless
cash from a terrorist attack. The fact is, terrorism is extremely expensive, difficult and
complicated. A clear, objective risk assessment must be achieved in order to efficiently
enhance U.S. national security. In the words of Ben Friedman, an MIT PhD student,
“conventional pundits of homeland security worry that the public will become
complacent…we should worry that it won’t.”26
Since the world economy was turned upside down by the collapse of the United
States financial system, sweeping changes have occurred in nearly every aspect of our
nation and nations across the world. With a transforming political and economic
landscape, new threats to national security are arising in the forms of debt, financial
warfare, and soured political relationships. The United States faces pressures from all
directions to cure the economic cold it seems to have caused, and these pressures may
affect the well being of Americans. What’s more is that the rising economic powers of
the world, specifically China will have increasing influence in United States policies,
which may lead to unfavorable actions in terms of national security. The future of the
United State’s security will be dictated by our ability to efficiently combat the trend of
shifting power that the economic downturn has exacerbated.
Bibliography
26
Ben Friedman, “The Real Cost of Homeland Security,” Alternet, February 9, 2006.
http://www.alternet.org/module/31514 (Accessed February 9, 2010).

13. Bergsten, Fred C., “The Dollar and the Deficits.” Foreign Affairs, November/December
2009, 35.
Creadon, Patrick. I.O.U.S.A. DVD. Directed by Patrick Creadon 2008. Roadside
Attractions, 2008.
Feldstein, Martin S. “Economic Conditions and U.S. National Security in the 1930’s and
Today,” NBER Working Paper Series, Working Paper 15290, August 2009.
Friedman, Ben, “The Real Cost of Homeland Security,” Alternet, February 9, 2006.
http://www.alternet.org/module/31514 (Accessed February 9, 2010).
Gielten, Tom. “Downturn Raises Risk of Global Financial Warfare.” National Public
Radio, http://www.npr.org/templates/story/story.php?storyId=100832254
(Accessed March 01, 2010).
Jess, Kevin. “IMF: Total Cost of Financial Crisis at $11.9 Trillion,” Digital Journal,
http://www.digitaljournal.com/article/277282 (Accessed February 9, 2010).
Montgomery, Lori. “Deficit Projected To Swell Beyond Earlier Estimates.” Washington
Post, March 21, 2009.
Seib, Gerald F. “Deficit Balloons Into National-Security Threat,” Wall Street Journal
Online, February 2, 2010,
http://online.wsj.com/article/SB1000142405274870342290457503917363348289
4.html (Accessed February 9, 2010).
Shachtman, Noah, “U.S. Could Use Crisis to Wage ‘Financial Warfare’,” Wired, March
16, 2009, http://www.wired.com/dangerroom/2009/03/finance-threat/ (Accessed
March 01, 2010).

14. Suddath, Claire. “A Brief History of the U.S. Deficit,” Time, August 25, 2009,
http://www.time.com/time/nation/article/0,8599,1918390,00.html (Accessed
February 9, 2010).
Wallerstein, Mitchel B., “Losing Controls.” Foreign Affairs, November/December 2009,
13.