- The Washington Times - Saturday, June 24, 2006

In 1985, when a strong dollar was causing America’s trade-related current-account deficit to soar to a once-unimaginable $118 billion that year, or 2.8 percent of U.S. gross domestic product (GDP), the net inflow of foreign savings required to finance the current-account deficit exceeded $100 billion. The current-account deficit, which is the broadest measure of America’s activity in both international trade and finance, essentially represents the amount by which overall U.S. demand exceeds its production. In 1985, Americans were effectively borrowing about $300 million every day to finance the current-account deficit. Fast forward to the present. The Commerce Department recently reported that the current-account deficit for the first quarter of 2006 totaled $209 billion. That represents an annual rate of $836 billion (6.4 percent of GDP), which will require America to borrow $2.3 billion from foreign sources every day of the year to finance the amount by which current U.S. demand exceeds its production.

Amazingly enough, the latest data on the current-account deficit were greeted as good news. That is because the current-account deficit for the fourth quarter was $223 billion, which reflected an annual rate of nearly $900 billion (7 percent of GDP). In absolute terms, however, the deficits for the last two quarters were each significantly higher than an previous deficits. The first-quarter current-account deficit, for example, was 9 percent higher than last year’s January-March deficit and 43 percent higher than the deficit in the first quarter of 2004. Moreover, analysts expect that higher oil prices during the current quarter will raise the deficit for the April-June period.

As indicated above, the arithmetical counterpart to a current-account deficit is a financial-account surplus. To finance the trade deficit, America borrows from abroad by running a financial-account surplus, which represents the difference between financial outflows (the net purchases of foreign assets by U.S. investors) and financial inflows (the net purchases of U.S. assets by foreign investors). When the United States runs a financial-account surplus, the amount of U.S. assets purchased by foreign investors exceeds the amount of foreign assets bought by U.S. investors. This difference reflects the massive financial-capital inflows into America that have been necessary to finance the current-account deficits. The U.S. financial-account surpluses totaled $582 billion in 2004 and $785 billion in 2005. Last year, for example, America’s $791 billion current-account deficit was effectively financed by the $785 billion difference between $427 billion in net U.S. financial outflows and $1.212 trillion in net foreign financial inflows.

What form do these foreign financial inflows take? The data differentiate between inflows of ?foreign official assets? (such as those owned by foreign central banks) and ?other foreign assets,? which generally represent holdings of private foreign investors (although it is not uncommon for foreign governments to purchase U.S. assets through private intermediaries). Last year, foreign central banks made net purchases of $72 billion in U.S. Treasury securities (compared to $263 billion in 2004) and $85 billion in other U.S. government securities, such as government-agency (e.g., Freddie Mac) bonds. Net purchases of U.S. Treasury securities by private foreign investors totaled $200 billion last year. Private foreign net purchases of other U.S. securities, including corporate stocks and bonds and U.S. government-agency bonds, totaled $474 billion in 2005. In the first quarter of 2006, this category set a quarterly record of $183 billion, including $54 billion in U.S. stocks, $88 billion in U.S. corporate bonds and $41 billion in U.S. government-agency bonds.

How indispensable are these financial-capital inflows? In 2004, the latest year for which all of the following data are available, the U.S. financial-account surplus totaled $582 billion. The size of this inflow equaled 87 percent of net (after depreciation) business investment of $224 billion and net residential investment of $443 billion. For 2005, all depreciation data are not yet available; so we cannot calculate what percentage of net business and residential investment was financed by foreign financial-capital inflows. We do know that net national saving was 0.8 percent of GDP last year, which was significantly below the 2004 saving level. It is therefore likely that last year’s $785 billion U.S. financial-account surplus effectively underwrote an even larger percentage of net U.S. business and residential investment than in 2004.

It would be one thing if America’s foreign borrowing and asset sales to foreign investors were used to finance a surge in business investment spending, whose growth-generating output could be used to service the foreign debt. That, unfortunately, has not been taking place in recent years. In fact, gross business investment for the 2003-2005 period averaged 11 percent of GDP. For the 1998-2000 period, when America was far less dependent on foreign savings, gross business investment averaged 12 percent of GDP. Not only has business investment declined as a share of GDP; personal consumption expenditures have increased from 68.1 percent of GDP (1998-2000) to 70.6 percent (2003-2005). In other words, America in recent years has been going deeply into debt to foreigners to finance a consumption binge.



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