The US Economy Plods Under Burden of Foreign Debt

By , H. Erich Heinemann is chief economist of Ladenburg, Thalmann & Co., investment bankers in New York.

THE United States earned dubious distinction as the world's largest debtor during the Reagan administration. Under George Bush, the nation has slipped deeper into red ink. According to the Federal Reserve's balance sheet of the US economy, US net foreign debt was $694 billion at the end of 1990. In 1981, when President Reagan came to office, the US had a net creditor position of $125 billion.

This accumulation of debt is likely to have several consequences:

First, growth in US gross national product, will be slower and real living standards (adjusted for inflation) will rise less quickly than if the nation had retained its creditor position.

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Second, the debt burden will lead to a restructuring of the economy: less consumption and more investment, fewer imports and more exports.

Third, manufacturing firms are likely to be on the cutting edge for decades to come. The US service economy may have reached high tide in the 1980s.

The good news was that the increase in US foreign debt last year came to a mere $25 billion, the best performance in almost a decade. Foreign ownership of American industry and property will likely continue to rise in the years ahead, but almost certainly at a pace well below the 16.8 percent compound rate of gain that was typical during the 1980s.

The extraordinary buildup of US foreign debt reflects a host of fundamental economic problems. These include a low level of net national saving and investment, a long-term slowdown in economic growth, and huge federal deficits.

Unfortunately, the Reagan administration spent far more energy attacking the statistics on US foreign debt than in dealing with the underlying causes of the problem. While Commerce Department figures on US foreign debt are riddled with inconsistencies, such failings are not true of the Federal Reserve's national balance sheet, a treasure-trove of valuable information.

Federal Reserve economists systematically adjust Commerce Department statistics - which are based on original costs - for changes in market value and in the relationship of US and foreign currencies. Though still imperfect, the Fed's data are a useful guide.

On the domestic front, the Fed reported a whopping jump in corporate debt. With assets counted at historical cost, nonfinancial corporations had a debt/equity ratio of 89.5 percent last year. That was up from 87.5 percent in 1989 and 51.6 percent in 1980. Consumers followed the same pattern, but more cautiously. Household debt was 22 percent of net worth last year, up from 20 percent in 1989 and 16 percent in 1980.

The leveraging of America will play a critical role in the 1990s. At present, foreign investors are still eager to lend and invest in the US. Indeed, in recent weeks central banks have been active in the foreign exchange market in an effort to put a lid on the surging dollar.

However, over time the real cost of servicing US international debt will rise. Moreover, the threat of a political backlash against the buildup of foreign assets in the US is clear. Gross foreign-owned assets in the US came to $1.64 trillion in 1990, up from $401 billion in 1980 and only $99 billion in 1970.

The Fed's analysis of the US corporate balance sheet was especially disturbing. Based on replacement values - with assets written up to reflect current values - stockholder investment in US corporations came to $3.9 trillion, or about 70 percent of GNP. A decade earlier, current-cost corporate equity equaled 100 percent of GNP.

This decline of 30 percentage points means that companies piled up record levels of debt but failed to acquire earning assets needed to service that debt. Rather, firms borrowed during the 1980s to play financial games - to pay down their own equity or that of other concerns.

The rationale for increased leverage is to improve profitability. If the cost of borrowing is less than the rate of return on the assets acquired with those funds, then the amount earned on investment will go up. This did not happen.

One of the iron laws of economics is that savings and investment are equal - not sometimes, but always. If profitability declines, then savings will decline. If savings decline, then investment will decline. If investment declines, the trade balance will not improve. Then, both the dollar and US living standards will gradually erode relative to other nations.

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