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The US External Debt in Perspective

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
June 1988
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Jahangir Amuzegar

Much is being made in the news media and semi-academic literature of the fact that the United States has now become the world’s largest debtor nation. After 70 years as the world’s leading creditor, the United States is now indebted to foreigners to the tune of about $500 billion, and heading for $900 -1,000 billion by the early 1990s. Some commentators have expressed anxiety over the United States losing its economic independence and fear that foreigners might unduly influence future American policies by virtue of their creditor position. There is also apprehension about a potential threat to international financial stability should foreign creditors suddenly decide to cease financing America’s voracious appetite for imports, or to liquidate their dollar holdings. There are concerns that the burden of the present generation’s spendthrift ways—and public debt—will be shifted onto unborn generations. The notion that the United States might lose its global politico-economic leadership because of its debtor status has added to these concerns. And, above all, there is among Americans a certain disbelief that America has now joined the ranks of the developing countries by carrying a foreign debt larger than the liabilities of the four largest debtors (Argentina, Brazil, Mexico, and Venezuela) combined—a predicament that may imply a drop in American standards of living for years to come.

Questions of valuation

While some aspects of the US foreign debt are, indeed, worrisome, much misunderstanding and confusion surrounds the subject, and many of the fears are unfounded. If left unanswered and unexplained they may in time become a source of social unease and policy miscalculation.

Conceptually, the US foreign debt—what the Department of Commerce calls “net negative international investment position” —is the difference between the value of overseas assets owned by Americans and the value of US assets owned by foreigners. These assets consist of commercial bank deposits, foreign exchange holdings, corporate securities, real estate, physical plant, and other direct investments. The value of all US overseas assets at the end of 1986 was estimated at about $1,100 billion while the assets held by non-Americans in the United States were valued at about $1,365 billion. The difference between the two sums is the net US foreign “debt” of about $265 billion (compared to a net credit of $171 billion in 1982).

But this “debt” is far more complex than that of a typical developing country debtor. First, part of the foreign-owned US assets (about $300 billion) is made up of the obligations (of various maturities) of the US Treasury or US corporations that are traded daily in world financial markets. Their worth, unlike the face value of the debt of a developing country, is subject to constant change in the market. Another part of the debt (about $300 billion) is in real estate, direct investment in physical plant and equipment, and other properties whose market value at any given time may be different from their original cost. These assets, as a rule, have no specified rate of return or fixed maturity. The rest is in bank deposits ($450 billion) and shares of stock ($300 billion).

Second, there are no uniform accounting standards or procedures to assess US foreign assets or their yields. These assets are often measured at book value which results in an estimated undervaluation of some $100-200 billion. On the other hand, capital flows into the United States are probably underre-corded. Third, US assets abroad reportedly earn more in interest and dividend per dollar of investment than foreign holdings in the United States: foreign-owned assets in America earned an estimated $67 billion in 1986 while the smaller US balances abroad yielded $88 billion.

Finally, the real worth of overseas assets and liabilities is not independent of domestic economic developments. Part of the increase in the US foreign debt from $112 billion in 1985 to $265 billion in 1986 was clearly due to the soaring value of the US stock and real estate markets.

Distinctions

As can be seen from the above, because of its particular characteristics and fluctuating value, the US foreign debt is not readily comparable to that of most developing countries. To begin with, as generally reported, developing country debt refers to gross liabilities because lack of information makes it difficult to net out foreign assets owned by nationals and corporate entities of developing countries. These countries’ foreign obligations, further, almost totally consist of borrowing from other governments, private banks, and international organizations for specific programs or projects; these debts have specific rates of interest, finite maturities, and payments schedules. Further, they typically result from specific initiatives by the government or corporate entities and are not commonly marketable.

In the case of the United States, by contrast, the “chain of transactions” is not easy to detect. When the US foreign debt increases as a result of its trade deficit, who initiates the process? Do the US dollars, acquired by Japanese and European exporters and deposited in US banks, swell the US foreign debt? Or does the debt increase because insufficiency of domestic savings to finance the federal budget deficit attracts foreign purchases of US Treasury obligations which must then be paid for by expanded exports to America? Does foreign capital, fleeing the world’s unstable economies in search of a safe and attractive investment haven in the United States, set the debt wheel in motion?

A disregard of the relative significance and relative size of the US foreign debt is another source of confusion and adverse reaction. Current US net liabilities may indeed surpass those of the four largest developing country debtors in absolute terms, but they are still small in terms of other economic indicators. For example, total net US debt in 1986 amounted to only 6 percent of the GNP in the United States, as against more than 40 percent for Brazil, upward of 50 percent for Mexico, and over 60 percent for Venezuela. The annual service cost of the US debt is less than 1 percent of US exports of goods and nonfactor services (and is expected to remain so even with larger debt). The corresponding cost, on average, for the three major developing country debtors mentioned above is estimated at more than 32 percent. And, finally, net foreign liabilities amount to only 5 percent of total US debt—domestic and foreign, public and private—of $7.5 trillion and less than 3 percent of total US wealth.

The most distinctive characteristic of the US foreign debt, however, is its denomination: a feature that derives from the fact that the US dollar is the world’s principal reserve currency. In theory, at least, this implies that at any point in time the United States could discharge its foreign obligations through the issuance of new dollar obligations, or in cash, without the necessity of earning foreign currencies through an export surplus.

By contrast, a developing country debtor cannot service its foreign obligations without first generating foreign earnings and foreign reserves. In earning these reserves through a trade surplus a developing country has to cope, often with difficulty, with changes in the terms of trade, currency fluctuations, and interest rates—factors that are largely beyond its control. Hence, developing country debtors have, from time to time, exhausted their ability to continue servicing their external debt. This cannot occur in the case of the US debt since it cannot run out of its own currency to service its dollar debts; it can never default. Hence the problem for the US Treasury is not the settlement of existing debt even though it may have difficulty in obtaining new ones.

There is also no discernible economic difference between US international and internal debt. For instance, when the US Treasury issues a $1,000 bond with an 8.5 percent coupon rate, it promises to pay a fixed sum to the bondholder—whether a man in a small town in the American midwest, an investment bank in New York, a widow in Singapore, or an insurance company in Caracas. There may be legal distinctions in tax liability between Americans and non-Americans, but the annual interest cost to the Treasury will be the same—$85 a year in US dollars—irrespective of whether the value of the dollar rises or falls against other currencies. Changes in ownership of US debt have no direct effects on the United States GDP, productivity, or competitiveness, even though they may affect foreign perceptions of the US economy.

Control and stability

Misgivings about other aspects of the US foreign debt have also been somewhat exaggerated. For example, fears of foreign control and manipulation of the US economy have been well publicized. This apprehension is largely rooted in the 19th Century history of colonialism, and in more recent charges against the global spread of multinational corporations in the 1960s and 1970s. But given the size of the US economy, these fears are unfounded. If anything, foreign investors and depositors are more captive to US laws and regulations than Americans are prey to foreign economic influence and interference. America’s economic independence may have diminished, not because of its foreign debt but because the United States is a major player in an increasingly integrated and interdependent world economy.

The threats to the soundness of the US banking system, and the stability of US financial markets, in the event foreigners should suddenly decide to withdraw their American assets may, again, be somewhat overblown. Physical plants, equipment, and real estate owned by foreign nationals are clearly immune to such transfers: foreign-owned office buildings, farms, factories, and other productive facilities can obviously not be transported back to the countries of the asset holders.

Liquid financial assets, and returns on direct investments, may of course be transferred abroad. But the sale and transfer of any dollar assets (or the returns on such assets) results in a change in the ownership of dollars from one person (or entity) to another. For every seller of a dollar asset, there must be a buyer. The problem, hence, is not in the transfer of assets, but in the potential insistence by creditors that the United States denominate its new borrowings in another currency than the dollar, or in gold. True enough, if foreign holders of dollar assets begin to use these assets to purchase foreign currencies, the value of the dollar may decline, causing a rise in US interest rates and having other consequences. But the net foreign position of the United States would remain unchanged.

Further, a flight from the dollar has little to do with the existing foreign investments in the United States. In such an eventuality (brought about by expectations, whether justified or not, of a dollar devaluation, or future inflation, or other motivations) dollar-denominated foreign investments would be liquidated whether or not there existed a large foreign debt. Nor is the lure of speculative gains a foreigner’s monopoly: American nationals, too, would act with similar agility to sell dollars short—as has frequently been the case in the past (e.g., in the late 1970s).

Either way, an escalating foreign debt cannot continue indefinitely because at some point all dollar holders—foreign and domestic—will begin demanding a higher return, causing interest rates to rise, and the economy to face other serious problems. America’s standard of living may also diminish—again not because of its obligation to pay back its debt, but because of its inability to raise its productivity and competitiveness.

Dangers of debt

The foregoing does not imply that there are no legitimate causes for concern —financial, economic, political, psychological, and moral—about a rapidly rising foreign debt. From the financial angle, the interest cost of foreign debts is a drag on the balance of external payments. This cost is currently about $50 billion a year. Possible future reluctance on the part of US creditors to accept dollars as payment could, as already indicated, create other difficulties. An increasing volume of world trade and payments no longer denominated in dollars would involve substantial losses for American companies, banks, and other private US debtors.

Politically, as the foreign debt grows and becomes increasingly unpopular, vested interests and injured economic groups could exert pressure for measures that may not be well considered. The first casualty would be the free trading and exchange systems. Pressure could build up in favor of protectionism, some form of exchange control, restrictions on capital flows, and similar actions. Even if these policies were somehow avoided, resort to higher real rates of interest and a slowdown in economic activity could ensue. Or, an inflation tax could become irresistible.

Furthermore, a large debtor country could not remain a major reserve-currency economic power for long. As history has shown, financial debt is bound to undercut political leadership. Some observers have rightly maintained that a heavily indebted United States might not be able to play a leading role in solving the global external debt problem, stabilizing the world trading system, or promoting a coordinated international economic strategy. Others have claimed that growing foreign ownership or control of industries that are considered to be strategic or are part of the American business lore is also a justifiable cause for concern.

Psychologically, large external liabilities —even for a reserve-currency country— are not a source of national esteem. Foreign debt imparts a sense of unease to the population; being indebted to smaller and less powerful nations may be a source of embarrassment. A perennial debtor status is seen as weakening a major economic power’s leadership role especially as external indebtedness implies a transfer of resources from other—including poorer—countries.

In sum, while the US net foreign obligations may not create for the US economy or polity the same problems that the debts of developing countries have presented for their economies, it is not an issue that should be ignored. A persistent growth of foreign debt at the 1987 rate (equal to 3.5 of GNP) would produce nearly $2 trillion of net liability by the end of the century. However, an appropriate and realistic way of looking at America’s current debt is to see it as a mirror of large deficits, reflecting the low rate of national saving. And therein should lie the uneasiness and apprehension about foreign debt.

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