Tenderloin Heights

On Borrowed Dollars: America�s Debt to the World

by Jim Forbes

0407

As we head rapidly toward a November presidential election—the outcome still very much in doubt—the future of the Bay Area real estate market also seems rather uncertain, regardless who our president is next year.

In terms of values, no one factor will have a greater impact than interest rates, primarily because nothing else has impacted values more. Even though we’ve had an unprecedented stretch of microscopic borrowing rates, with houses and income property worldwide selling at historically high prices, there is inherent risk in this market. As The Economist magazine stated, this market “is an even bigger risk to the world economy than oil.”

According to the editors at The Economist, the risk is that the bubble will burst, much like the popping of the dot-com bubble, and will drag consumer confidence down with it. The editors point out that real estate prices are high everywhere, not just in the United States, let alone in the Bay Area. However, the fact that an Indian may have to pay more for his home in Bangalore or a British tourist for her summer home in Spain, does not give me much comfort. The Great Depression was global; today a downturn that hits two or more of the world’s major markets could no doubt cause a similarly gigantic meltdown that could easily crush real estate prices here.

I still, however, keep returning to interest rates. As the United States has lowered its interest rates to spur demand at the domestic level, other countries have had to do the same with their rates in order to compete. We not only have historically low interest rates here but also globally low ones as well. The question is, are these rates abnormally low?

Some people I know who control far greater wealth than I do, believe that despite a gigantic debt load by the government, the size of our economy is adequate to service it. Therefore, low interest rates should not be threatened as long as there is not any inflation.

To test this theory, I looked to the past. For instance, in 1953 while still paying off debts caused by World War II, our federal debt was as high as 72 percent of gross domestic product (GDP) and by 1960 receded to 55 percent. Despite these high percentages, the economy grew during each of these years. The federal debt is currently at 59 percent of GDP.

In terms of total nonfinancial debt (all debt except that owed by banks), the situation looks a little dicier. In 1953, Americans owed 121 percent of GDP to various lenders. The country’s debt level stayed below 140 percent of GDP until 1984, when it started a steep rise. Now the debt level is at $22 trillion, nearly double a GDP of over $11 trillion. This is the unknown. Never have we owed so much relative to what we have.

What I also find alarming is how much we owe foreigners (no, I am not a xenophobe). Until 1981 other countries owed us. Then, propelled by the seemingly unquenchable thirst of our federal government, we started borrowing from rich foreigners and, by January 2004, owed them some $4.3 trillion, while they owed us only $664 billion.

Now in a seamless global economy, this should not make much difference. A lender is a lender. The reason I think all this debt has not caused an upward push on borrowing rates is that there is so much capital out there, especially in newly rich China.

With China sitting on hundreds of billions of greenbacks, along with the usual suspects like Japan and Saudi Arabia, there is plenty of money to make the loans we demand and, therefore, keep interest rates down. But this foreign borrowing also complicates the analysis. For now, instead of just looking at domestic issues, we need to be aware of what happens abroad, which is about time in my opinion. For instance, China is currently cracking down on its easy-money policies. This could impact our interest rates, as their lenders receive higher returns domestically and might be less likely to loan us funds at current levels.

Owing so much to so many also complicates our political position in the world. Diplomacy with China and Saudi Arabia, two volatile dictatorships, is weakened when we owe them trillions of dollars as we now do. It also complicates global trade. As long as we buy goods from abroad, we enrich our offshore lenders and are ensured of a cheap borrowing base. Based on recent trade deficit figures, this year we will apparently spend $500 billion more than we take in, which (interestingly) is approximately equal to the federal deficit for the same period.

So the circle of dollars flows like this: U.S. consumers buy Chinese goods or Middle East oil, and then the profits are lent to the U.S. government. Yet, this means the rest of the world is draining off American wealth, which could result in a very unhappy day of reckoning if it continues.

Since the mid-1990s, the nonbank obligations of the United States have increased $10 trillion, much of this coming from equity in our real estate, which has increased in leaps and bounds over that period as we know so well. This brings us back to the editors’ worries at The Economist. If much of the wealth created by inflated real estate prices has been borrowed and then spent on imported goods—much of it turned into IOUs to foreign governments and investors—are we not caught in a vicious circle that could only result in problems if not reversed in time? I think so. Further, if much of the cash that has been loaned to us also comes from inflated real estate prices abroad, a softening there could dry up the spigot of money we need, causing interest rates to go up as well.

Now I am not saying that the sky is falling, but I do worry that our whole culture of borrow rather than save could come to haunt us sometime soon, and if real estate prices do not stay artificially high, it could be very painful.

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the San Francisco Apartment Magazine. Jim Forbes is a real estate investor, broker and activist. He can be reached via email at jim@urbanforbes.com or visit www.urbanjmf.com. Copyright © 2004 by San Francisco Apartment Magazine. All Rights Reserved.