U.S.'s debtor status worsens dramatically

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By David M. Dickson

In the midst of the longest, and probably deepest, postwar recession last year, the U.S. investment position with the rest of the world sharply deteriorated.

At the end of 2008, America's net international investment position was minus $3.47 trillion, the Commerce Department reported Friday. That represents the difference between the value of U.S. assets owned by foreigners ($23.36 trillion) and the value of foreign assets owned by Americans ($19.89 trillion).

At the end of 2007, the U.S. net international investment position was minus $2.14 trillion. Thus, America's net indebtedness with the rest of the world increased by $1.33 trillion, or 62 percent, during 2008. It was by far the biggest annual increase in data that go back to 1976.

Foreigners now hold nearly 50 percent of the federal government's publicly held debt. If foreign investors significantly reduce their purchase of future U.S. Treasury debt securities, without even dumping their current holdings, U.S. interest rates could soar and the dollar could collapse, analysts fear.

At minus $3.47 trillion, America's net debtor status with foreigners represents nearly 25 percent of U.S. gross domestic product, the highest level in history.

"Three decades of massive [trade] deficits have converted the United States from the world's banker - able to 'pay any price and bear any burden in the cause of freedom' - to the world's largest debtor, utterly dependent on China and other foreign interests," said Charles McMillion, chief economist of Washington-based MBG Information Services.

Essentially, America's net international investment position is driven by what the United States borrows from the rest of the world to finance its ongoing trade deficit, said Brad Setser, a fellow for geoeconomics at the Council on Foreign Relations.

Over the 2003-07 period, however, foreign equity markets outperformed the U.S. stock market, and the dollar steadily depreciated. These two factors reduced the annual deterioration in America's investment position that otherwise would have been dictated by massive U.S. trade deficits during this period.

"Both of those factors reversed themselves last year," Mr. Setser said. The dollar appreciated, and foreign stock markets suffered bigger declines than America's. As a result, America's net debtor status worsened significantly more during 2008 than its nearly $700 billion trade deficit would have dictated, Mr. Setser explained.

Over the years, America's status as a creditor or debtor has changed enormously. In the early 1980s, America's net international investment position averaged $350 billion, or 11 percent of GDP, making the United States the world's largest creditor. Today, it is the world's largest debtor - by far.

As recently as 1996, America's net debtor status was minus $456 billion. Since 1996, it has increased by more than $3 trillion, or 660 percent, as America's 12-year cumulative trade deficit soared by $5.7 trillion.

Foreign governments have taken notice - in particular, China, which now holds more U.S. Treasury debt than any other country. In the 12 months through April, China's portfolio of Treasury debt securities has soared by more than a quarter of a trillion dollars to nearly $800 billion.

In its annual financial stability report issued on Friday, China's central bank once again declared there were serious problems with the global monetary system's reliance on a single dominant currency - the dollar. An estimated 65 percent to 70 percent of China's $2 trillion in foreign exchange reserves, the world's largest stockpile, is held in dollar-denominated assets.

The People's Bank of China also warned the United States on Friday about its very expansionary monetary and fiscal policies.

"We are so deeply in debt and this money is so liquid that it hamstrings our monetary, fiscal and trade policies," Mr. McMillion said. "We've really mortgaged our financial future."