This Wallstreet Journal article is one of many recent news accounts claiming that America's debt fuelled economic expansion is due to end. It briefly explains why America has recently been able to borrow so continuously and cheaply (minus any historical background, unfortunately) through the sale of US bonds despite the fact that these bonds are a lousy investment. This has in turn enabled consumer spending in the US to continue, along with its massive military budget and tax cuts. There's also an entertaining quote describing America as the world's largest hedgefund. However, one wonders if such warranted alarm is already being put to work with the appearance of specialist statements to the nation like this: "Your standard of living is going to be reduced unless you work much harder". Disregarding that for the past several decades the US has compelled countries like China to lend to them, this situation is here being treated as if individual Americans simply maxed out their collective credit card and now will have to pay it off.
Sept. 25, 2006
U.S. Foreign Debt
Shows Its Teeth
As Rates Climb
Net Payments Remain Small
But Pose Long-Term Threat
To Nation's Living Standards
By MARK WHITEHOUSE
September 25, 2006; Page A1
Over the past several years, Americans and their
government enjoyed one of the best deals in
international finance: They borrowed trillions of
dollars from abroad to buy flat-panel TVs, build homes
and fight wars, but as those borrowings mounted, the
nation's payments on its net foreign debt barely
budged.
Now, however, the easy money is coming to an end. As
interest rates rise, America's debt payments are
starting to climb -- so much so that for the first
time in at least 90 years, the U.S. is paying
noticeably more to its foreign creditors than it
receives from its investments abroad. The gap reached
$2.5 billion in the second quarter of 2006. In effect,
the U.S. made a quarterly debt payment of about $22
for each American household, a turnaround from the $31
in net investment income per household it received a
year earlier.
The gap is still small within the context of the $13
trillion American economy. And the trend could reverse
if U.S. interest rates decline. But economists say
America's emergence as a net payer illustrates an
important point: In years to come, a growing share of
whatever prosperity the nation achieves probably will
be sent abroad in the form of debt-service payments.
That means Americans will have to work harder to
maintain the same living standards -- or cut back
sharply to pay down the debt.
"Our net international obligations are coming home to
roost," says Catherine Mann, a senior fellow at the
Institute for International Economics. "It's as if on
our personal MasterCards we have run up large
obligations and never had to make payments. You can't
believe that's going to last forever."
If the trend persists, it could also raise concerns
about the nation's creditworthiness, putting pressure
on the U.S. currency. "It's an additional challenge
for the dollar," says Jim O'Neill, chief economist at
Goldman Sachs in London. "Economists have been warning
about this for so long that people have gotten bored,
but now we're starting to see the deterioration."
Since the end of 2001, when the current economic
expansion began, the nation's consumption, investment
and other outlays have exceeded income by a cumulative
$2.9 trillion -- the largest gap on record. That
current-account deficit contributes directly to the
nation's total foreign debt, the value of all the U.S.
stocks, bonds, real estate, businesses and other
assets owned by non-U.S. residents. As of the end of
2005, total U.S. foreign debt stood at $13.6 trillion
-- or about $119,000 per household. Net foreign debt,
which excluded the $11.1 trillion value of U.S.-owned
foreign assets, was $2.5 trillion.
Exactly how the U.S. has managed to load on so much
debt without seeing its net payments rise remains
something of a mystery. Even in the second quarter,
the U.S., in effect, was paying only a 0.4% annualized
interest rate on its net debt. "It's still quite a
good deal," says Pierre-Olivier Gourinchas, an
economics professor at the University of California,
Berkeley.
In a recent paper, Harvard economists Ricardo Hausmann
and Federico Sturzenegger went so far as to suggest
that the U.S. might not be a net debtor at all.
Instead, they surmised, the U.S. might actually have
income-producing assets abroad, such as know-how
transferred to foreign subsidiaries, that have evaded
measurement -- assets they call "dark matter," after a
similarly elusive quarry in physics. Mr. Sturzenegger
says the latest data haven't changed his view.
Most economists, however, see a more prosaic
explanation: Foreigners have been willing to accept a
much lower return on relatively safe U.S. investments
than U.S. investors have earned on their assets
abroad. Take, for example, China, which since 2001 has
invested some $250 billion in U.S. Treasury bonds
yielding around 5% or less -- part of a strategy to
boost its exports by keeping its currency cheap in
relation to the dollar.
By contrast, U.S. direct investments abroad -- which
would include things like glass maker Corning Inc.'s
liquid-crystal display plants in Taiwan or Intel
Corp.'s chip-making subsidiary in Ireland -- have
returned an average 8% since 2001, according to U.S.
Commerce Department data. Meanwhile, U.S. investors in
emerging-market stock funds earned an average annual
return on their investments of 22.3%, according to
financial-research firm Morningstar Inc. (The Commerce
Department counts only part of that as income).
Because the U.S. has tended to borrow in bonds and
similar interest-bearing instruments while investing
in stocks and longer-term foreign projects, it has
benefited vastly from the low interest rates of recent
years. "The U.S. has been exceptionally lucky," says
Goldman's Mr. O'Neill, "It's like the world's biggest
hedge fund. It's borrowing cheap money and getting
leveraged returns from the things it's investing in."
Foreigners' willingness to lend at low rates has also
encouraged Americans and their government to borrow
and spend. By buying U.S. Treasurys, foreign investors
put up more than four-fifths of the $1.3 trillion the
federal government has borrowed since 2001 to help pay
for tax breaks, the new Medicare prescription-drug
benefit and wars in Afghanistan and Iraq. Over the
same period, foreigners put more than $700 billion
into various types of U.S. mortgage-backed securities,
providing the money for millions of Americans to buy
new homes -- or extract cash from their existing homes
to spend on goods such as washing machines and
Hummers.
Now, the interest-rate picture is changing. Long-term
rates remain low, but the Federal Reserve has raised
short-term rates to 5.25% from a low of 1% in June
2004. As a result, payments on U.S. government debt,
much of which is short-term, have risen. In the second
quarter, for example, the government's debt payments
to foreigners rose 10% to $36 billion, accounting for
most of the change in the balance of income.
The nation's growing debts have made its finances more
vulnerable to interest-rate changes. Cedric Tille, an
economist at the Federal Reserve Bank in New York,
estimates that a mere one-percentage-point rise in the
relative return on U.S. foreign debt would increase
the country's net debt payments by 1.1% of gross
domestic product. Back in 1995, when the U.S.'s
foreign liabilities were smaller, the effect would
have been only half a percentage point.
Even without any major changes in rates, economists
expect the burden of foreign-debt payments to rise.
Estimates of that burden 10 years from now range
anywhere from 0.5% to 2% of GDP, depending largely on
whether the U.S. manages to curb its current-account
deficit. If the deficit expands significantly and the
U.S. stops earning a premium on its investments
abroad, the burden could reach 5% of GDP, according to
calculations made by John Kitchen, an economist in the
White House's Office of Management and Budget.
The size of the nation's debt payments matters because
it represents a share of income that American
consumers, companies and government won't be able to
spend or save. The higher the debt payments, the
harder it will be for the U.S. to prosper.
"Your standard of living is going to be reduced unless
you work much harder," says Nouriel Roubini, chairman
of Roubini Global Economics. "The longer we wait to
adjust our consumption and reduce our debt, the bigger
will be the impact on our consumption in the future."
To be sure, by some measures the U.S. foreign debt is
still relatively manageable. As a share of GDP, for
example, the nation's net debt stood at about 20% at
the end of 2005, compared with the 15% average of the
12-nation euro zone. The United Kingdom's net debt is
17% of GDP. Mexico's is 44%.
Among economists' biggest concerns, though, is the
fast pace at which the U.S. is accumulating new debt.
As that leads to larger interest payments, it will
make the current-account deficit harder to control --
a vicious cycle that could accelerate if worried
foreign investors demand higher interest rates to
compensate for the added risk.
"You end up having to pay more and borrow more," says
the University of California's Prof. Gourinchas.
"Things could get out of hand very quickly."
Write to Mark Whitehouse at mark.whitehouse@wsj.com1
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