VIEWPOINTS : Will the United States Be Pulled Under in the Sea of International Debt? : <i> Impending Apocalypse Is a Chicken Little Story </i>

Economic reporting is a counter-cyclical industry--the worse the economy, the better the story. Recessions are good stories; failures of character, especially of chief executives, are better, and impending national disasters are best of all. This apparent bias toward bad news is perfectly natural--after all, who tells the story about the building that didn’t burn? No one. Economic journalists have really lucked out this time. Just as the growth issue died out and tax reform proved too technical for widespread coverage, the richest nation in the world--the United States--became a net debtor nation. What better story could one ask for? Not only is this seen to reflect a failure of character on a national scale, but it portends an apocalyptic collapse as well. At the risk of offending the cognoscenti, I believe the media will be doing us a disservice by yet again overdramatizing an economic story.

Congress will not act quickly, and when it then becomes clear that life goes on despite inaction, the United States may fail again to do anything constructive at all, and the media will lose a little more credibility. The technical response to those who again see apocalypse now in this economic story is, poppycock !

Surely our memories are not so short that we have forgotten the warnings of impending disaster that would result from our moral decay during the energy crises of 1973-74 and 1979-80; the rampant inflation of the late 1970s, and the $100 billion to $200 billion federal deficit run up since 1980.

The United States becoming a debtor nation is the latest in a growing list of stories that generate enormous noise and heat, but too little thought. Somehow we survived the other so-called lapses in character, and I expect we’ll survive this one as well.

The flaw in apocalyptic stories transcends the media’s tendency to dramatize and moralize. It also reflects a failure of basic economic analysis. Market economies don’t usually collapse, and ours is especially resilient. We absorbed the energy price shocks, we adapted to double-digit inflation, and we are handling the federal budget deficits. True, we might have done some things better, but apocalypse didn’t occur. Thus, the historical record suggests that it won’t this time either.

Private market economies are adaptable, and, in my view, the current trade posture probably reflects the world’s economies adapting to changing fortunes.

Consider this question: Why should the United States be a creditor nation? If you were to rank businesses by their asset position, would you argue that the richest should be net creditors and the poorest net debtors? Of course not. Big, successful firms borrow enormous amounts, because they have attractive prospects, as perceived by themselves and by lenders. They have plans to use the borrowed financial capital to earn profits over and above the interest they will have to pay on their debt. Were this not the case, lenders would not make the loans.

The same is true across international boundaries. Savers who make investments choose industries, firms, product lines and countries where they will get the best combination of security, income and growth.

It’s one thing to be concerned about poor countries with large debts who are surprised by a sudden increase in real interest rates, and quite another to worry about the U.S. economy borrowing during a rapid expansion.

Today’s net U.S. debt position is an accumulation of recent--and continuing--years of trade deficits in goods and services (net flows of goods and services into the United States) paid for by dollars that are then returned to the United States as net financial capital in the form of investments. What else should foreigners do with American dollars? Some dollars are useful for foreign exchange and international loans, but not many more can be used abroad now.

Typically, some countries are net importers and others net exporters of goods, which means the latter will be receiving financial claims on the former. This is nothing new.

Over most of the post World War II period the United States was a net goods exporter. This was natural since we were an industrial giant producing goods for other countries while they paid us with their currency, which we returned to them in the form of financial investments. This trade imbalance helped Europe, Asia and other parts of the world join the industrial revolution, and we were repaid with profits on our loans and new markets for our products.

Many such countries are now industrially mature, and the old pattern of net exports and financial investments to them no longer holds. Today’s U.S. trade deficit, to the extent that it is a fact, (and statistical anomalies in the data suggest that it is overstated), reflects three sets of forces: (1) the behavior of private individuals and firms, (2) government policies, and (3) recent historical and political events. Compare, for example, Japan to the United States. Private Japanese savings’ rates are significantly higher than those in the United States, yet the U.S. economy is growing much more rapidly.

Thus, American firms, given our expansion, require financial capital much more than Japanese firms. If the U.S. government were retiring its debt by running federal budget surpluses, then this would provide some of the needed financial capital for American industry.

But, of course, our federal budget is in deficit and thus our government absorbs much of the already inadequate U.S. savings pool. The Japanese government, meanwhile, runs relatively modest budget deficits while its domestic economy is relatively sluggish. What can the Japanese savers do with their money? The answer, of course is save it in the United States.

Policy may go part of the way in explaining these different savings and investment rates. American consumers get tax deductions if they borrow to spend and pay taxes on nominal interest earned on savings. U.S. firms get huge tax breaks for investment in plants and equipment. On the contrary, Japan taxes capital heavily and discourages personal debt finance for mortgages.

The United States encourages mortgage finance with federally funded mortgage intermediaries and instruments such as Fannie Maes and Ginnie Maes.

Another aspect of federal policy that has contributed to the current U.S. posture as a net exporter of goods and an importer of investments is the Federal Reserve’s very successful disinflation policy, which has kept real--or inflation adjusted--U.S. interest rates abnormally high both by world and historical standards.

These high U.S. rates imply a world demand for U.S. investments and a heavier burden of debt owed to the United States by Third World countries. These debt obligations also result in financial flows to the United States from debtor countries, which strengthen the dollar.

Most critics of the U.S. trade situation rail against the federal deficit as the source of the problem.

And they are partly correct--the huge federal deficits combined with tight monetary policy, until recently, have attracted foreign financial capital to the United States. Partly, then, the trade deficit reflects federal deficit finance and a period of tight monetary policy.

However, a case can be made that this foreign debt burden--which will be incurred as real interest payments are made in the future to foreign holders of U.S. debt obligations--is a perfectly legitimate means of financing the Reagan mix of federal spending; namely, a large strategic defense buildup offset by small cuts in social programs.

The main political cause of our federal deficit today is that President Reagan refused to compromise with his own Senate leaders who wanted him to cut defense spending and raise taxes.

Thus, defense spending is being paid for indirectly by future generations via the foreign debt. But, who benefits from strong defense? We do, but so do future generations of Americans. By financing the defense buildup with a deficit, we impose some of the cost on future generations of Americans who will have benefited from it.

Furthermore, it is still possible that we will reduce the real value of future claims on American borrowers by re-inflating the dollar.

Were this to surprise those foreigners, they would earn a lower than expected return on their U.S. investments. Dirty pool, perhaps, but one could even defend this shift of the burden of our defense system onto foreigners. Who benefits from the U.S. strategic umbrella, if not our trading partners?

Thus, neither the economics nor the ethics strike me as alarming. I, like a lot of people, would prefer tax reform, smaller federal deficits, and freer trade--but, hey, the world’s not perfect.