Despite the worries of some economists, America’s record foreign debt is no threat to the nation’s economic well-being.
In 2000 we Americans bought $368 billion more goods and services from other countries than we sold to them. This trade deficit has rocketed tenfold since 1992 and is universally seen as a sign of economic strength. As consumers in the largest and strongest economy in the world, it’s hardly surprising that we routinely buy more from other countries than they buy from us.
But the “flip side” to our burgeoning trade deficit has many people spooked. Every dollar that goes abroad eventually flows back to the United States, enabling foreigners to buy valuable economic assets. Foreigners now own over $8.6 trillion of U.S. assets (93 percent of gross domestic product, or GDP), up from $725 billion, or 22.2 percent of GDP, in 1982 (see table). Since 1998, foreign companies have been acquiring U.S. companies at a pace that brings back memories, and anxieties, of twelve years ago when Japanese investors were gobbling up U.S. real estate.
In recent years, Mercedes bought Chrysler, the Deutsche Bank took over Bankers Trust, the international activities of RJR Tobacco (Camel cigarettes, among other brands) were purchased by Japan Tobacco, and a Dutch supermarket firm, Royal Ahold, bought a New York supermarket chain, Pathmark, comprising 132 stores. Earlier this year the Netherlands media company VNU announced that it had completed its $2.3 billion acquisition of American market research giant ACNielsen. Nestlé is trying to obtain Federal Trade Commission approval to acquire Ralston Purina, and the U.S. NASDAQ stock exchange may become a target for the London and Frankfurt exchanges.
That’s only a sample. Foreign companies have spent $900 billion in the past three years buying U.S. companies, while U.S. companies have spent $419 billion buying foreign companies, according to Thomson Financial Securities Data. That is a significantly greater spread than during the rest of the 1990s.
Foreigners also own a record 38 percent of the U.S. Treasury market (see fig. 1). Excluding securities owned by the Fed, foreigners own an astounding 44 percent of the liquid government securities market. They also own a record 20 percent of the U.S. corporate bond market. To put these figures in perspective, foreigners own just 8 percent of the U.S. equity market (see fig. 2)—14 percent if you include foreign direct investment in U.S. companies. Simply put, the American bond market will be on the front line if international investors decide to shun dollar-denominated assets (see fig. 3).
The inflow of foreign capital is the unsung hero of America’s impressive economic performance in recent years. Foreigners’ willingness to send money to the United States has lowered bond yields and provided fuel for the massive investment and consumption spree that has propelled the American economy to record heights. Americans who work for foreign-owned companies typically make 10 percent more than those who work for U.S.–owned companies, reflecting the larger relative size and productivity of multinational corporations. Today approximately 20 percent of the U.S. GDP is produced in companies with majority foreign ownership.
Could a darker scenario unfold? The U.S. current account deficit increased to a record 4.4 percent of GDP in 2000, up from 3.6 percent in 1999. This trend worries international-trade economists, many of whom think that economies typically hit the breaking point at 4.2 percent of GDP. Indeed, the current account deficit could be the chink in America’s economic armor: were foreigners at the margin to become less willing to send capital here on favorable terms, interest rates would rise and the dollar would fall. That would be more bad news for the stock and bond markets.
But are the traditional “breaking points” relevant today? Not if foreigners believe that the U.S. economy is pulling away from the rest of the world (as it has) or that (1) America has the only economy large enough to absorb their investment dollars and (2) our productivity lead over the rest of the world is still growing, which it is. Foreigners have grown convinced that the mature U.S. economy can grow more rapidly than the traditional 2 to 3 percent annual rates without causing inflation. The consensus is that foreign companies have grown convinced that their U.S. competitors are so far ahead in digital, biotech, and other new technologies that the only way to close the gap is to buy the knowledge. That means buying the company.
And despite the recent slowdown, the sheer size and depth of the U.S. economy mean that the United States will continue to be the destination of choice for foreign investors.
In the world of national economic accounting, however, foreign purchases of U.S. companies, real estate, and securities are counted as “borrowing” from abroad. Accordingly, the United States has become the world’s largest debtor. As a result of twenty consecutive years of external deficits, the United States has shifted from a net creditor nation of $350 billion in 1980 to a net debtor of $1.7 trillion in 2000. Critics worry that interest, dividend, and other service payments on the external debt represent a perpetual drag on the U.S. economy and a burden on future generations of Americans.
Much of what foreigners invest in the United States, however, cannot realistically be described as any kind of debt on American citizens. Almost half of the $8.7 trillion in foreign-owned assets at the end of 1999 was in the form of equity investments—either long-term direct investment in U.S. corporations and real estate or portfolio investment in corporate stock. Such investments are not debt in the sense of an obligation to pay a fixed amount no matter what. When a German company buys an American automaker, or when Japanese investors buy U.S. real estate, or when a British company adds 100,000 shares of Microsoft to its portfolio, no American is under any legal obligation to repay anything. On the contrary, equity investors receive only what the market says they should receive. They are hostage to the good fortune of the U.S. economy and have a strong incentive to keep it healthy.
Moreover, the size of America’s overall international investment is not alarming when compared to the total U.S. economy. At the end of 2000, America’s net foreign debt of $1.87 trillion represented approximately 18.8 percent of that year’s GDP. In other words, Americans were producing enough every ten weeks to buy back the difference between what foreigners own in this country and what we own abroad. Our debt service payments are also quite modest as a percentage of the overall economy. In 2000 Americans paid $359.1 billion in dividends and interest to foreign investors and received $345.4 billion from U.S. investments abroad, for a net payments deficit of $13.7 billion. As a share of what we produce, the payments deficit amounted to less than one-fifth of 1 percent of GDP. That’s equivalent to a family earning $75,000 per year paying creditors $103.
A second, persistent worry is that growing foreign ownership of U.S. assets will leave America vulnerable to foreign influence and manipulation. The fear is that America’s principal creditors, Japan in particular, could wield influence over U.S. government decisions by threatening to sell their U.S. government bonds or to cease further purchases.
It is true in theory that foreign governments could attempt to exert political pressure on the United States by threatening to sell their large central-bank holdings of U.S. Treasury debt, but such an act would harm their own economies as well. Americans would lose, of course, because a withdrawal of capital would drive up domestic interest rates while the falling dollar would make imports more expensive, which would reduce the purchasing power of American workers. But America’s creditors would suffer if their alternative investments were less profitable. Foreign investors would be further harmed if the U.S. economy were to tip into a recession. Falling demand in the United States would quickly translate into falling exports to the U.S. market, and a depreciating U.S. currency and slumping economy would depreciate the value of foreign-owned assets remaining in the United States.
The foreign-influence scenario also assumes that individual investors would follow the lead of their governments, but such an orchestrated withdrawal of credit seems unlikely. Private investors in industrialized countries do not usually act at the behest of their governments. Even in Japan, a government decision to dump dollars or withdraw funds from U.S. markets would not mean that private companies and individuals would necessarily do likewise.
The fact is, when foreign investors act precipitously and in unison, they usually end up losers. For example, Japan charged into U.S. real estate in the late 1980s, just in time to pay top dollar for properties such as the Rockefeller Center. And when Deutsche Telekom proposed a $51 billion acquisition of VoiceStream at the peak of the U.S. stock market last year, Telekom shares dropped because investors feared that European companies were overpaying for U.S. firms.
When an economy is as large and as important to the global economy as is that of the United States, its chief creditors have a stake in keeping it healthy. They have a strong incentive to act prudently with their investments so as not to undermine their own positions. If any country wields leverage, it is the world’s chief debtor, the United States.
Edwin S. Rubenstein is director of research at the Hudson Institute.