Is the United States economy living off debt?

By Bharat Jhunjhunwala

NEW DELHI (JP): Why do the U.S. stock markets continue to rise to dizzying heights despite a global slowdown? The reason, it appears, is that investors across the globe are looking for a safe haven and find the U.S. Treasury Bonds safest among other alternatives. As a result money from across the globe is flowing into the U.S.

It is this foreign money which is being used to finance the U.S. imports as well as foreign investment. The U.S. is acting merely as a conduit to recycle foreign money back to other countries. The advent of the Euro might just herald the withdrawal of foreign money from U.S. Bonds. In that case U.S. economic supremacy may be quickly eroded.

According to the Economic Report of the President, 1998 the U.S. Treasury Bonds held by foreign governments increased by US$111 billion in 1995-1996, the last year for which dates were given. Those held by private investors increased by $141 billion. The total increase in such bonds held by foreigners was $252 billion. This was the amount transmitted by foreign government and private investors into the U.S. This inflow at low rates of return of around 5 percent occurs because of the psychology of stability that surrounds the U.S. economy.

This was the situation in 1995-1996. If anything these flows have become more pronounced since then. As one country after the other has fallen, private investors have moved their money into the U.S. economy.

The Treasury Bonds represent a U.S. debt. The U.S. government promises to redeem these bonds at the specified rate of interest after, say, five years. This has the same impact on the U.S. economy as borrowing from the IMF would have had.

The question is what did the U.S. do with this massive inflow of $ 252 billion? Data given in the Report indicates that $70 billion of this money was used to finance foreign investments and $182 billion to finance imports. This becomes clear once we look at the investment and foreign trade figures.

The foreign investment flowing into the U.S. in 1996 was $378 billion. This represents the money invested by Europeans, Indi ans, Japanese and Bangladeshis in the U.S.. If an Indian investor feels insecure in holding his wealth in scripts listed on the Bombay Stock Exchange, he sends that money through to New York and buys shares in IBM and similar corporations on the New York Stock Exchange. Or, he may buy U.S. real estate. On the other hand the U.S. investors such as General Motors invested $448 abroad. The net foreign investment by the U.S. was, therefore, $70 billion.

The U.S. imports in 1996 were $803 billion and exports $612 billion. Net imports into the U.S. were $182 billion.

Of the inflow of $252 billion received by the U.S. from the sale of U.S. Treasury Bonds, $70 billion were used for foreign investment and $182 billion used to finance imports from other countries.

The U.S. is undoubtedly the largest foreign investor and importer of last resort. With foreign investment of $448 billion and imports of $803 billion its primacy in the world economy cannot be questioned. The problem, however, is that neither these investments nor the imports are financed by the U.S. from its own earnings. It is the purchase of U.S. Treasury Bonds that make available the money with which the U.S. invests and imports. Other countries purchase U.S. Treasury Bonds and give money to the U.S. The U.S. returns that same money to them in the form of foreign investment and imports. In other words, the money invested by U.S. investors abroad was actually not their money at all. It was Indian money sent back to India.

Why is the world so foolish? Why does an Indian investor first send his own money to the U.S. and then run after getting it back in the form of investment or export payments? Why does he not retain that money and use it for investment himself?

The reason it seems is that the world is not convinced about the benefits of global integration. The U.S. remains one of the least globally integrated economies. The Report admits this in so many words: "trade remains a much smaller component of the U.S. economy than in most countries: in 1995 only four countries had smaller ratios of trade to GDP than the U.S.." The Report attributes this low integration to three factors: (1) the large size of the U.S. economy; (2) the diversity of U.S. resource endowments; and (3) distance from major trading partners.

The implication is that the charm of the U.S. as a safe haven arises because it is less integrated with the global economy and is large in size. Because the U.S. economy is more isolated from global connections, therefore, it is attractive. For the global investor it represents a country which is most likely to weather any global meltdown.

The strength of the U.S. economy consists of its large size and its diverse endowments which enable it to plow through with nominal linkages to the global economy.

The present buoyancy of the U.S. rests not on its own inherent strength as much as in foreign-derived inflows. Should the Euro challenge the dollar as the world's reserve currency these inflows into the U.S. may abate and the U.S. would not be able to make either foreign investment or imports. Whether the European Union is able to make those same foreign investments and imports would depend on the use that it puts these inflows to.

It is but a matter of time before the global investor realizes that the U.S. is accumulating a massive debt which it just might not be able to repay. It will not be surprising if a run occurs on the U.S. dollar. In any case the U.S. economy may be in for some surprises soon.

The writer obtained his PhD in economics from the University of Florida, United States. He taught at the prestigious Indian Institute of Management. Presently he is a freelance columnist based in New Delhi.