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The miracle economy

Accounts of the U.S. economic "miracle" of the 1990s typically omit one embarrassing detail: its dependence on massive amounts of foreign money. Here's a graph making that point: the net foreign debt of the U.S. (net meaning the difference between U.S. claims on foreigners and foreign claims on the U.S.). From the end of the First World War until the early 1980s, the U.S. was a net creditor to the rest of the world. Creditorhood is often thought to be the financial manifestation of imperial power; Britain was the world's major creditor country during its 19th century heyday, and the shift in financial power in the 20th century from Britain to the U.S. correlated well with what happened in the geopolitical sphere.

With the explosion of the U.S. budget and trade deficits in the early 1980s, this all changed, as the U.S. government, corporations, and financial institutions borrowed heavily abroad. In 1982 - the year that Wall Street's great bull market began - the U.S. international debt account dipped solidly into the red, with net debts equivalent to 1.1% of GDP. (Debt doesn't figure in the calculation of GDP - it's just a way of making comparisons over time.) Since then, the U.S. debt position has gone deeper into the red every year except 1991 and 1993, reaching -22.6% in the second quarter of 1999, or just over $2 trillion. The slippage has continued even though what was once blamed as the culprit, the federal budget deficit, has turned into a supposedly virtuous surplus.

There's no doubt that this inflow of borrowed funds - $1.3 trillion worth since Bill Clinton took office - has greatly stimulated both the real economy and the financial boom, by allowing people to borrow to consume (this is the most consumption-intensive expansion in post-World War II history) and by allowing people and corporations to borrow to buy stock.

People used to worry about this a lot in the 1980s; worry has been more muted in the 1990s, though Alan Greenspan does muse on it now and then. Last May, in a speech in Chicago, he said:

A more distant concern, but one that cannot be readily dismissed, is the very condition that has enabled the surge in American household and business demands to help sustain global stability: our rising trade and current account deficits. There is a limit to how long and how far deficits can be sustained, since current account deficits add to net foreign claims on the United States.

It is very difficult to judge at what point debt service costs become unduly burdensome and can no longer be sustained. There is no evidence at this point that markets are disinclined to readily finance our foreign net imbalance. But the arithmetic of foreign debt accumulation and compounding interest costs does indicate somewhere in the future that, unless reversed, our growing international imbalances are apt to create significant problems for our economy.

The risk is that at some point, the capital inflow will reverse, and leave the U.S. without a source of borrowed funds to power fresh consumption and stock-buying and with lots of bills to pay. That's not unlike what happened to Mexico in 1994 or Thailand in 1997. But those are weak countries, not an imperial colossus. What happens to a colossus when it gets cut off is very hard to predict. Maybe it will luck out; Asia and Europe could recover, and the U.S. could export its way out of debt by selling them 747s, Windows 2000, and Shania Twain CDs. Or maybe the U.S. in the early 2000s could be like Japan in the 1990s - stuck with a massive hangover from a burst bubble. Hard to say.

More on this in LBO #92, forthcoming.

Data source: Federal Reserve, flow of funds statistics, September 15, 1999, release. The Fed reports on the "rest of world" sector - that is from the point of view of foreigners. This page converts the Fed's perspective to a U.S. one by reversing the signs. That is, a rest-of-world credit becomes a U.S. debt, and vice versa.

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