Our Debts Abroad Will Put a Crimp in Living Standards

It now looks to us as if the trade deficit has at last begun to shrink as the falling dollar makes American goods more attractive in world markets. This is good news for our industries that have lost export markets and competed unsuccessfully with imports from abroad. But it also means that for the United States as a whole there will be a slower growth of our standard of living over the coming years.

Although everyone agrees that our trade situation is terrible, for most Americans the five-year deterioration in our trade position has been relatively painless--until now. That’s because, except for workers and shareholders in trade-sensitive industries, the increasing trade deficit has actually meant more total consumption of goods and services and lower prices for imports than would have been possible in a more balanced trade position. The necessary future transition back to trade balance will therefore inevitably involve a slowdown in the rising standard of living of most Americans.

The dramatic decline in the U.S. trade position developed only in this decade after many years of trade surpluses. But in just the last five years foreigners have shipped to the United States more than $500 billion in goods that we as a nation have yet to answer with reciprocal trade. In just 1986 alone our trade deficit reached a staggering $170 billion.

The increase in the U.S. merchandise trade deficit from $25 billion in 1980 to $170 billion in 1986 is equal to 3.5% of our current gross national product. These extra net imports from the rest of the world make it seem that the economy has grown by 3.5% more over these years than it actually has. Thanks to borrowing from abroad, the goods and services that are available in the United States have increased faster than the volume of goods and services that are actually produced here.

But the bill for all this foreign credit eventually has to be paid. In order to meet that bill, American net exports must rise and U.S. consumers must forgo a corresponding share of the goods and services produced here at home.

In addition to giving up American-made products to repay our foreign creditors, we also will be hurt by the rising prices of our imports from abroad. In recent years the strong dollar has meant that import prices have been low in relation to the prices of American-made goods, and U.S. consumers have been able to get more foreign goods per dollar than they had in the past. Now that the dollar is reversing, imports from the rest of the world are becoming more expensive. We now get less of foreign goods per dollar than before. The fall in the dollar thus reduces our buying power in the world market and further slows the rise in living standards.

Our trade deficit in these past few years has been financed by an enormous inflow of foreign capital. As a result, we have had a growing accumulation of debts to foreigners and a growing level of foreign investment in the United States. We have switched from being a net creditor at the beginning of the decade to being a net debtor with $200 billion of net debt to the rest of the world. Last year alone that debt rose by about $140 billion.

This is a phenomenal rate of increase, and it isn’t stopping yet. The International Monetary Fund has estimated that by early in the next decade the United States will be more than $800 billion in debt to the rest of the world unless the dollar falls significantly from its current level. Just to pay the interest and dividends on that debt will absorb about $60 billion a year, or more than 1% of each year’s total GNP.

This incredible accumulation of debt might have been justified if we had been using it to finance a higher-than-normal rate of investment in plant and equipment that would earn a future return. But in fact there has been nothing to show for this borrowing. The enormous capital inflow has been used to finance the federal budget deficit while the previous low rate of net investment merely has been maintained.

For several foolhardy years the temporarily high dollar allowed shortsighted policy-makers, concerned more with election returns than with long-run growth, to avoid most of the cost of running a huge budget deficit by postponing payment to the 1990s. But now that the dollar is reversing and our trade deficit is starting to shrink, the country is going to have to endure a period of a substantially slower rise in the standard of living. It’s going to be bitter medicine.