From a bondholder's perspective, the United States is in a precarious financial position. This is true even though there is a growing consensus among bond market participants that the economy will turn weaker in the near term and that, with a stabilized dollar, long-term Treasury rates will decline to around the 8 percent level.
This may occur, but the release of the data noting the growth of foreign-owned U.S. debt to $263.6 billion at the end of 1986 is a warning of ominous events, both in our economy and in our financial markets.
To better understand the problem we must take a brief look at a couple of parts that make up the larger picture known as the "international balance of payments." The balance of payments records all U.S. transactions vis-a-vis foreigners and includes two main components: the current account and the capital account.
The current account primarily is made up of the merchandise (trade) sector and the service sector, also known as the "invisibles." The major components of the service sector are tourism, income received and paid on investments (dividends and interest on debt -- payments for use of capital) and the unilateral transfer of funds (U.S. pensions, gifts etc. sent abroad).
The current account deficit is a measure of capital inflows and also is an indicator of how much the external debt will increase . To be technically correct, however, this figure must be adjusted for errors and omissions, exchange rate changes and asset value changes.
Therefore if we have a current account deficit of $137 billion in 1987, that figure, added to the existing $263 billion, produces a $400 billion external or foreign-owned U.S. debt. Consequently, even though the trade sector may improve, the service sector will deteriorate because the overall foreign debt will continue to grow and must be serviced.
In essence this is analogous to our federal budget deficit where the debt keeps growing as the interest paid on the debt keeps expanding to service the ever-expanding debt.
The rub comes when the current account is in deficit. Because the overall balance of payments always adds up to zero, and if the current account is in deficit, then the other major sector, the capital sector, must be in surplus. This raises the question -- how? How high will interest rates have to be to attract funds and at what level will the dollar have to be to make this come about?
Historically, the classical way to correct a BOP problem is for a nation to go into a recession. This could mean the United States would have to accept a lower standard of living, consume less than we produce and send more of our production overseas to eliminate our trade deficit. This is also the type of situation that could force Congress to pass protective trade legislation, especially when they are unable to deal with the heart of the problem, the federal budget deficit.
Make no mistake, the implications are bad and the specter of a weaker dollar, rising interest rates and a lower standard of living are definitely in the cards. James E. Lebherz has 28 years' experience in fixed-income investments.