DOLLAR'S NEXT VICTIM: INVESTMENT

Foreign investors have become a powerful influence in the U.S. money and capital markets.

During the past four years there has been a surging flood of foreign

investments in the United States. From the close of 1982 through the third quarter of 1986, total financial assets held by foreigners in U.S. government and corporate securities and other financial assets have risen from $414.8 billion to $907.6 billion, an increase of nearly 119 percent. Of the total:* Foreign holdings of U.S. government securities jumped from $149.4 billion to $263.4 billion, or 76.3 percent.

* Total foreign holdings of U.S. corporate bonds increased from $41 billion to $133 billion, or 224 percent.

* Total foreign holdings of U.S. corporate equities rose from $76.8 billion to $144.1 billion, or 87.6 percent.

* Total direct investment by foreigner sin the United States increased

from $124.7 billion to $191 billion, or 53.2 percent.

At the end of 1982 the total liabilities of foreigners to the United States amounted to $518.1 billion and total foreign holdings of financial assets in the U.S. were $414.8 billion, so that the United States was a creditor country by $103.3 billion.

At the close of the third quarter of 1986 the total liabilities of foreigners to the United States amounted to $650.9 billion and the total

financial assets held by foreigners in the U.S. amounted to $907.6 billion, so that in less than four years we had swung from a creditor country in the amount of $103.3 billion to a debtor of $256.7 billion.

The flood of foreign funds into our markets is to a very high degree a function of our foreign trade deficit. But as a matter of public policy we and our main trading partners are seeking to reduce the U.S. trade deficit by means of a decline in the foreign exchange value of the dollar and a coordination of national economic policies designed to make the trade surplus countries better markets for U.S. products and services.

Since the November trade statistics increased the fear that depreciation of the dollar is not yet having the desired effect, we have seen a further sharp drop in the past few weeks and it appears we may well go through a further substantial drop in the dollar.

These developments raise several questions. If it is assumed the decline of the dollar, which has occurred, plus any further decline that may occur, finally begins to reduce our trade deficit, then logically the flood of foreign funds into our markets should begin to recede.

The question then is whether, with the volume of foreign investment leveling out and possibly declining, we can find a sufficient supply of funds domestically to finance the explosion of debt in the United States. This is especially pertinent if the effect of rising import prices increases our overall inflation rate to the point that the Federal Reserve is forced to retreat from a highly accommodative credit policy.

In the climate that seems to be developing, with a further anticipated decline in the dollar and a concern that the U.S. inflation rate will increase, how long will foreign investors find U.S. government and corporate bonds attractive on a total return basis, including not only the coupon rate but also the decline of the dollar in foreign exchange markets and the appreciation or depreciation in the market value of bonds.

So far the flood of foreign funds into our markets has been concentrated in fixed-income investments. But the flow of foreign funds seems to be changing. During 1983-85, inclusive, the average annual increase in foreigners' holdings of U.S. corporate equities was only $2.5 billion.

However, since the fourth quarter of 1985 foreign investors have greatly increased their holdings of U.S. corporate equities. Based on the first three quarters, foreign investors increased their holdings of U.S. corporate equities by about $24.5 billion in 1986, so that there has been a big shift in equities that seems likely to continue under present conditions.

Moreover, although the estimates of 1986 do not so indicate, it seems logical that direct foreign investment by foreigners in U.S. real estate, manufacturing plants and other properties is bound to increase more strongly than in the past.

It seems, then, that possible changes in the flow of foreign investments into the United States this year will be the dominant force in both the U.S. fixed-income and equities markets. Certainly the behavior of the foreign exchange value of the dollar and changes in the flow of investment funds from abroad will become an even more crucial factor in Federal Reserve policy.

The prospect of some decline in the total volume of foreign investment in the United States as our trade deficit begins to decline, as well as the likelihood of a continuing shift of foreign investment from U.S. fixed-income

investments into U.S. corporate equities and direct investments, greatly increases the urgency of achieving the beginning of a meaningful reduction in our Federal budget deficit and makes imperative the keeping of inflation under con trol despite rising import prices.

It is particularly imperative that neither our own government policies nor those of our major trading policies encourage the expectation by foreign investors that ahead of us is a further large drop in the value of the dollar and a serious rise in the U.S. inflation rate. Accordingly, this is a year in which U.S. government economic policies, and coordination of our policies with those of our trading partners, are likely to be put to the sternest test.

For the full story: Log In, Register for Free or Subscribe