Their Money, Our Strength
Dabblers in the dismal science are sounding the alarm: Foreigners are losing their enthusiasm for American securities, with potentially disastrous implications for funding the U.S. current-account deficit. But a closer look at the evidence presents a very different picture.</br></br>The U.S. is indeed running record trade and current-account deficits. This is associated with a record flow of capital to the U.S. from abroad, much of it from Asia. True, the most recent data from the U.S. showed that foreigners reduced their net purchases of long-term securities to $56.4 billion in May, down 26% from April's figure -- the lowest monthly total in seven months. But net purchases in May were weak only in comparison to their strength in the previous six months. Foreigners heavily increased their long-term commitment to the U.S. in late 2003 and early 2004, while lightening up in May.</br></br>---</br></br>What those hitting the panic button fail to mention is that the excess of net long-term foreign financing over the current-account deficit had reached an all-time record $302 billion in the 12 months through April (the widest point on the graph nearby). Because longer- term debt went up by more than the current account deficit, the effect was to lengthen the maturity of the U.S. external financing, adding to its stability. The strength of the dollar in recent weeks in the face of concerns, probably temporary, about a U.S. slowdown should help undercut the handwringing over the lower level of purchases in May.</br></br>The Big Questions are whether U.S. expansion is dependent on Asia's savings or at risk due to the trade imbalance. The answer to both is no. The expansion is driven primarily by domestic developments: the increasing flexibility of the economy and improvements since 2001 in the value of the dollar, interest rates and tax rates. America is in the early stages of a relatively long expansion, in which inflation and innovation will be more important variables than the trade deficit or foreign-capital flows.