The U.S. Foreign Investment Miracle, RIP

For the past half-century, the U.S. witnessed a foreign investment miracle. The breakup with Western allies and trade wars can end it.

By 2025, foreign countries invested $62.1 trillion in the U.S.  This is 213 percent of U.S. GDP, 56 percent of world GDP, and 31 percent of U.S. family wealth. The U.S. also owns assets abroad, worth $35.9 trillion, and so the net foreign investment is $26.2 trillion, 90 percent of GDP and equivalent to four years of U.S. gross domestic investment.

Ironically, the source of the foreign investment miracle is the currently vilified trade deficit (technically, the current account deficit). When the dollar value of imports exceeds that of exports, the worldwide difference cannot but be invested in U.S. assets.

Foreign investment is everywhere: Treasuries, stock market equities, over-the-counter stocks, investment funds shares, interest in partnerships, mortgage-backed securities, corporate bonds, commercial paper, loans to U.S. businesses from foreign banks, foreign loanable funds in U.S. banks, and foreign direct investment in manufacturing capital stock and technology startups.

Depending on the category, 60 percent to over 90 percent of foreign investment is by the U.S. Western allies--European, Asian-Pacific, and Canadian. This is their contribution to U.S. fiscal, financial, and productive capacity, economic growth, and prosperity. So much for the neo-Marxist postcolonial grievances and victimhood of the Trump administration that Western allies exploit, rip-off, freeload on, and take advantage of the United States,

- The largest category is stock equities and investment funds shares, $18.4 trillion, 23 percent of the U.S. total. Western allies own 84 percent of these holdings.

- Foreign direct investment is $17.8 trillion at market value. On a historical-cost basis, 92 percent was invested by Western allies who trust the U.S. with their illiquid assets.

- Foreigners held $4.3 trillion of corporate bonds, 27 percent of the total corporate debt, and 78 percent of foreign holdings were by Western allies.

- Foreign banks and their U.S. branches extended $4.0 trillion in loans and leases to U.S. borrowers, compared with $12.6 trillion by U.S. banks, and so 24 percent of the total loans. Foreign loanable funds deposited in U.S. banks added over $3.5 trillion, 20 percent of the total loanable funds in the U.S.

- By 2025, of the $36.2 trillion of U.S. government debt and of the $28.8 trillion held by the public, foreign governments and private investors financed $8.5 trillion, 23 percent of the total, 30 percent of public debt. Western allies financed 64 percent of the foreign share. By extension, of the $1.9 trillion of U.S. federal budget deficit, foreigners financed $440 billion, more than half of defense expenditures or Medicare.

In short, foreign countries provide close to one-quarter of cash flow from financing to U.S. business and federal budget deficit, and Western allies, a fifth. For Western allies, the U.S. offers more than the safe harbor investment premium. Studies show that for the last hundred years, Western political, military, and financial alliances strongly overlapped. This is a mutual insurance policy utilizing comparative advantages, U.S.’ in providing nuclear security and global deterrence and Western allies’ in saving and investing in the U.S.

Considering the contribution of foreign, primarily Western, investment to the U.S. economy, the U.S. nuclear umbrella for Western allies and global security has been one of the greatest investments the U.S. has ever made. But this foreign investment miracle may be over.

The problem is, foreign investment is borrowed investment. Its stock constitutes foreign debt. The net foreign debt of $26.2 trillion is the other side of the net foreign investment. Both derive from foreigners applying their trade surpluses to purchase U.S. assets. It is a two-faced Janus.  If security alliances and trade relations are good, it is foreign investment. The flows continue and the stock grows. If security alliances break up and trade wars break out, it is foreign debt. The flows dwindle, discontinue, and unwind, and the stock is unloaded.

The path has been entered. Trade wars will diminish imports and squeeze and eventually end the new flows of foreign investment. The European and other Western rearmament and the buildup of their own nuclear umbrella will rebalance their economies and divert their savings from U.S. investment to defense spending. Eventually they may need to divest their stock of U.S. assets. Unloading foreign holdings of Treasuries, equities, corporate bonds, and bank loans will crash stocks and 401ks, raise borrowing costs, and constrain domestic capital formation. Depleting foreign deposits in U.S. banks will require their bailouts by the Fed and may precipitate a financial crisis.