Unemployment remains stubbornly high and new company startups remain stubbornly low.  New regulations and laws, whose only clarity seems to be that it will burden business and hiring in many ways yet unseen, combined with a record deficit and fear of inflation has many investors sitting on their cash rather than deploying it.  Tight credit, lower real estate collateral values, and restricted banking practices does not help.

Reduced investment flows from foreign and domestic sources is also a result of these policies and a further cause of economic stagnation. In America’s Troubling Investment Gap (Townhall.com 7/10/11), David Malpass notes:

It is true that foreign direct investment rose to $236 billion in 2010 from $159 billion in 2009. But that was still well below the $310 billion invested in 2008. The White House also neglected to disclose that in the first quarter of 2011 foreign investment fell by 51% from the first quarter of last year, according to data released last month from the federal Bureau of Economic Analysis. Foreigners of late have not found the U.S. to be a receptive, high-return home for investment.

Much more worrisome is that Americans are taking their investment dollars abroad at a faster pace than foreigners are bringing capital to these shores. In 2010, for example, U.S. investment abroad was $351 billion—$115 billion higher than foreign investment here. Economic recoveries are periods when investment capital usually surges into a country, but since this weakling rebound began in the middle of 2009 the U.S. has lost more than $200 billion in investment capital. That is the equivalent of about two million jobs that don’t exist on these shores and are now located in places like China, Germany and India.

This is a recent and dramatic reversal of fortune. Huge net inflows of productive capital into the U.S. in the 1980s and ’90s helped finance the 25-year boom in jobs and broad-based prosperity from 1982-2007. Over that period, foreigners invested just over $6 trillion more in the U.S. (in total capital) than Americans invested abroad, according to the Bureau of Economic Analysis, with most of it going into businesses.

That’s only part of the story behind the disappointing recovery we now face. To be sure, foreigners still park a huge amount of money in this country, but in the last several years they’ve shifted their investment toward U.S. Treasury securities and government-guaranteed bonds, and away from the private-sector staples—corporate bonds, intellectual property, ownership of businesses—that create sustainable jobs. Since 2009, foreigners have invested just over $1 trillion in U.S. Treasury bonds, according to the Bureau of Economic Analysis.

Some economists argue that investing in low-interest-rate government bonds works fine for America because it allows the government to boost spending on programs—the latest doozies are windmills, high-speed rail and 99 weeks of unemployment benefits. The low interest rates, this argument goes, prove there is no negative “crowding out” from America’s near $1.5 trillion deficit.

That misses the point. To produce rapid growth, most capital must be allocated by markets. The effect of $4.5 trillion of borrowing since 2009 is that foreigners and Americans are buying Treasury bills instead of investing in the next Google, Oracle, Wal-Mart or biomedical company. Today, foreigners are financing food stamps and the next bridge to nowhere while Americans are building state-of-the-art production systems abroad. This is the real pernicious “crowding out effect” of the federal government’s borrowing.

America may be attracting some capital because as bad as our economy is, other places are as bad or even worse.  But at some point it may no longer be acceptable to be the least worst.  This factor may keep us from getting worse for the time being, but it is not helping us get better.

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