America for sale

America For Sale

It's not just Wall Street bailouts. Foreign ownership of U.S. assets is accelerating - and that's a worrisome trend.

(Fortune Magazine) -- The big foreign-money purchases of stakes in Citigroup, Merrill Lynch, and Morgan Stanley are merely a hint of what's ahead in 2008. Foreign buyers, such as sovereign wealth funds from countries like Kuwait and Singapore, will continue to make headlines by grabbing major U.S. assets this year, and the trend is much broader than investments in Wall Street firms that need a capital infusion. What's important to understand is why this is happening - the reasons go beyond what most people realize - and why it may be even more worrisome than it seems.

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The overlooked part of the answer goes back a decade to when Americans started buying a whole lot more from other countries than they were buying from us. We'd been running a trade deficit since the 1970s, but it took off in the late 1990s and has been galloping ever since. All those dollars we send into the world come back to us - some as purchases of our goods and services, and the rest, equal to the trade deficit, as investments. For many years those investments have been mostly in U.S. bonds, which is the usual pattern in these situations. After a while, though, foreigners who hold tons of another country's bonds start to get nervous. They realize that the government might be tempted to make its debt a little less burdensome by inflating the currency, rendering the foreigners' holdings less valuable. So the foreign creditors hedge their bets by buying direct ownership stakes of the debtor country's assets (see, for example, much of Argentina's history).

That's what is happening in America today, and we can expect much more of it for two reasons. First, the Fed's rate cuts - four since September - are inflationary and will spook foreign creditors further, spurring more equity buying. Second, our trade deficit remains massive, probably exceeding $700 billion last year; that's money that will have to come back as investment in the U.S.

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But here's why the trend is troublesome, and more so now than ever. According to the Bureau of Economic Analysis, the rest of the world currently owns way more of America (stocks, bonds, real estate, etc.) than America owns of the rest of the world, by a margin of $2.6 trillion (as of year-end 2006; a 2007 figure is due in July and will be larger). Net foreign ownership is increasing very rapidly; it has multiplied by a factor of five in just the past decade. As it grows, we must send more dividends and interest to foreign owners, giving them more money with which to buy more U.S. assets, earning more dividends, and so on.

This compounding effect is small when net foreign ownership is low, but at today's levels the effect is becoming significant and ever harder to reverse. Where it leads is grim: As a nation we eventually cease to be capitalists and become simply wage earners. As Warren Buffett put it in a prophetic Fortune article more than four years ago, a country that goes too far down this road can be "colonized by purchase rather than conquest."