Thursday, September 28, 2006

American investment falls into the red

The US' net investment income has fallen into the red after five years of record-making in the black:

Over the past several years, Americans and their government enjoyed one of the best deals in international finance: They borrowed trillions of dollars from abroad to buy flat-panel TVs, build homes and fight wars, but as those borrowings mounted, the nation's payments on its net foreign debt barely budged.

Now, however, the easy money is coming to an end. As interest rates rise, America's debt payments are starting to climb -- so much so that for the first time in at least 90 years, the U.S. is paying noticeably more to its foreign creditors than it receives from its investments abroad. The gap reached $2.5 billion in the second quarter of 2006. In effect, the U.S. made a quarterly debt payment of about $22 for each American household, a turnaround from the $31 in net investment income per household it received a year earlier.
We did have a great deal. While foreign governments in Europe and Asia indulged in low-yielding US treasury bonds, US companies and American citizens reaped the benefits of strong foreign growth, especially in China. Rock-bottom interest rates, as low as 1%, made borrowing money a great way to make money.

Imagine today, with the prime rate sitting at 5.25%, the bank down the road is willing to lend to you at 2% APR. So you borrow as much as the bank allows you to, and on the same day take that money and stick it in Paypal's money market account, currently returning just over 5%. What a deal! On a national level, the US has basically been doing the same thing. Even though we've been borrowing more at 2% than we're sticking into the 5% investment, the benign disparity in returns have made up for the absolute shortfall. But with interest rates having risen steadily over the last several months and a deceleration in international equity returns, it's catching up with us.

The net investment number pales in comparison to the US national account balance (the actual payments that flow to and from countries), which was $218 billion in the red last year. Even if we manage to get marginally back in the black in terms of our net investment income, so long as we keep buying more than we sell, the US' net foreign debt (what we owe others versus what others owe us) will keep accreting. Continuing with the analogy, even if our $1,000 in investments return 5% a year, if we've borrowed $10,000 (and continue to borrow more each year than we put into new investments) at a lower rate, we're hardly in good shape.

This net investment deficit is symbolic even though it's not of great consequence. The NYSE and the NASDAQ together comprise about two-thirds of the world's total market capitalization of just over $43 trillion, most of it in American companies, yet we've still fallen into the red on returns. We gave up net exporting four decades ago. Now we're even giving up the benefits of the wealth we accrued in the past.

I can't pretend to know what debts, deficits, and net investment losses portend economically for the US or the rest of the world. The US' current national debt as a percentage of GDP is still only half of what it was following the conclusion of WWII and bests that of Israel, Japan, Italy, Greece, Singapore, Canada, France, Germany, and Austria. I hope the argument that expanding total economic activity will keep us out in front of ballooning debts and deficits holds true. It's a recondite science for sure.

I can, however, offer a few suggestions that might help:

- Scrap the federal income tax. It discourages economic activity by penalizing productivity. It costs over $400 billion in compliance, 10,000 relatively bright IRS employees who could be engaged in something more constructive (not to mention a good portion of the 450,000-plus college-educated bean counters working for the Big Four), and more odiously still causes businesses and individuals to make decisions based not on pure economic utility but instead on utility post tax-consequence.

I held off on purchasing a house for three months longer than I would have otherwise as I waited for the 366th day of ownership on a stock that had done well to roll around so that I'd only be subject to a 15% tax on the gain. On a macro leve, that's silly, even though it was in my best interest. The federal income tax sorely lacks 'goal congruence' in regards to invidual entities and the nation as a whole (note also that $11 trillion is held by wealthy Americans and businesses in offshore accounts for tax reasons).

Replace the federal income tax with a national sales tax (also referred to as a 'consumption tax') levied on new items and services. Tax us on what we spend instead of what we earn, and we might start earning more than we spend! This would instantly propel the US back into the top spot in global competitiveness as production costs would fall by 35% of profits (essentially the current corporate income tax rate) for companies operating stateside and make the US an even stronger magnet for entrepreneurs the world over. Plutocrats, stick your money here instead of in Bermuda!

It would make used items 23% (the estimated federal sales tax rate) cheaper relative to new items than they are today, rendering the cheap consumables dumped on our shores less attractive. The 50 million foreign visitors the US hosts each year would start contributing to our federal coffers. Illegal immigrants paid under the table wouldn't be able to mooch as much off the net taxpayer as they would pay in at the cash register instead of not at all (couple this with Charles Murray's idea of a monthly governmental stipend in place of the myriad of contemporary governmental welfare services, and illegals would really lose the economic advantage they enjoy over natives).

- Standard 401(k) and similar retirement plans should become opt-out programs rather than opt-in programs. Force workers to expend effort to increase immediate consumption instead of to increase savings.

- End unskilled immigration and institute a merit immigration system for legal immigrants to increase per capita wealth and productivity.

- Repeal Sarbox and disenegrate the LLC to encourage more companies, especially newer ones, to list publicly. In tandem with the 401(k) opting-in, this is a solid way to 'lift all boats'.



JSBolton said...

The huge differential between the earnings of US overseas holdings, and what foreigners get on what they lend us, is itself a spotlight on the enormity of dollar support coming from foreign central banks.
It does not mean that American investors are brilliant, and Asian ones strangely unlucky when they 'invest' here.
It shows how especially EAsian governments work their growth programs via export manufactures.
Someone please say 'moral hazard' though!
It is not good for us to receive stolen goods.
The free trade system is polluted by this.
If the US central bank carried out currency support for a foreign country, would there be difficulty in figuring out that this had to involve an increase in aggression on people here?
One day, or decade, the music will stop, and the net taxpayers will have to say something about the freeloaders, who will then be carried entirely on what can be raised domestically.

crush41 said...

Patriot bonds to raise capital domestically and lessen foreign debt?

You're right, it's not sustainable.