With the announcement the other day of another record quarterly U.S. current account deficit, the Debt Doomsday crowd wasted no time in coming out to warn Americans, yet again, that our country is headed down the road to financial ruin. For the umpteenth time, these modern-day Cassandras let it be known that the economic apocalypse lies just around the corner. Unless we learn to control our out-of-control spending, they say, we are surely doomed.
It mattered little that the prior week's report showed a sharp contraction in the October trade deficit -- a sign, perhaps, that things are improving. No way. Even the most sanguine of the pessimists, like Ray Stone, chief economist for Stone & McCarthy Research, found it hard to muster any enthusiasm at all for the biggest improvement on the trade front in 14 months. In a note to his clients, Stone wrote, "There is a lot more improvement that is necessary before the vulnerability of the U.S. financial markets to foreign interests is materially improved." While Mr. Stone may feel that U.S. financial markets remain vulnerable, foreign investors are exhibiting no such angst. In fact, they are gobbling up U.S. financial assets at a record pace.
Some of you may think that that was exactly Mr. Stone's point: Indeed, foreign purchases of U.S. financial assets have been pushing up our markets, and if investors abroad decided to sell, our markets would tank. As plausible as this may seem to some, it's not likely to happen for a variety of complicated reasons. For one thing, all foreigners would have to offer their dollar assets for sale at the same time that Americans, in concert, chose not to step up to the plate to buy.
For purposes of edification, the current account is only a part of the overall balance of payments position of the United States. It includes the sum total of exports and imports of goods and services, plus interest payments, grants and other monetary transfers.
The other part of the balance of payments is the capital account, which includes American-owned assets abroad and foreign capital inflows to the U.S. (The latter go for the purchase of stocks, bonds, businesses and other investments.)
When Mr. Stone and others like him talk about America being "vulnerable to foreign interests," they're usually referring to the potential impact of foreign selling of U.S. Treasuries on interest rates. I know this because Mr. Stone said so while visiting my radio show the other day. (I've interviewed many other Debt Doomsday proponents, too.)
While I will concede that foreign selling of Treasuries probably has some short-term effect on interest rates, I'd add that the effect is marginal (almost unnoticeable, in fact) and rather fleeting.
Case in point: Since the end of 2004, foreign investors have been buying fewer and fewer Treasuries, and yes, interest rates on the benchmark 10-year Treasury have climbed a bit. But just a bit. They now stand at 4.6%, compared to the 4.23% yield that an investor would have gotten in December 2004. That's not too big a difference.
However, over that same course of time, the Fed raised interest rates 12 times, pushing the Fed funds rate to 5.25% from 2.25%. In my opinion, anyone who thinks that this didn't have as much (or more) of an impact on the trend in long-term rates as foreign selling did is delusional. But I digress; the point I'm really trying to make is about all the current account deficit hysteria.
Until recently, whenever you tried to tell the Debt Doomsday crowd that the current account deficit was "balanced" by capital account surpluses, they would say one or all of the following:
- "Those inflows are only foreign central banks buying Treasuries, so it doesn't count."
- "Those are just loans -- they're lending us money."
- "It is not investment by individuals, it's investment by governments."
- "They're buying bonds, not stocks."
The data shows that foreign investors have continually invested in U.S. stocks and businesses -- but a major shift has taken place in the past two years. Foreign investors have been fleeing Treasuries in order to get in on where the real action is: stocks! They are buying up chunks of equity in American corporations to hold for the long term. This is a great vote of confidence in America; if you don't believe me, just look at the data. This year alone, through the end of October, nearly half a trillion dollars ($480 billion) has poured into the stock market, surpassing the full-year total hit in 2000 (last year also surpassed 2000, but 2006 has set a new high).
Trends like this make this contrarian a bit wary. However, as long as I still hear the Debt Doomsday crowd continue with their cries of impending disaster, I'll stay bullish on the American stock market.
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Fool contributor Mike Norman is an international economist and founder of the Economic Contrarian Update. He can be seen on Fox News, where he appears as a business contributor. In addition, he hosts a radio show on the BizRadio Network.