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Jewish World Review
Oct. 11, 2006
/ 19 Tishrei, 5767
Better to Borrow or Lend? Rethinking conventional wisdom
Charles Lamb wrote a famous essay, "the two races of Men." In it he refers to those who borrow and those who lend. Most people are brought up to believe it is better to lend than borrow. I certainly was. My father said to me, "Never borrow money. Never have an overdraft. Only take out a mortgage on your first home, and pay it off as soon as you can. Always pay bills by return post." I have followed this advice all my life. But is it good advice?
My friend Jimmy Goldsmith took the opposite view. He and I first met when he was 16 and had run away from school (Eton College). He'd won an accumulator bet at the horse races and thought it was time he began enjoying life. When he died, Goldsmith was a billionaire (in dollars). I once asked him, "What is the key to your financial success?" He replied, "Borrowing. I have become rich on other people's money."
OPPOSITE ENDS OF THE SPECTRUM
The argument lend (save) or borrow? applies to countries as well as to individuals. The Chinese, for instance, have traditionally been savers. It's an axiom of Chinese culture that a prudent man saves 40% of his net income. This axiom also applies nationally, in that China's policy has traditionally been to export the maximum and import the minimum. This approach led to trouble in the 19th century. Western countries, led by Britain, imported vast quantities of Chinese luxury goods but found it nearly impossible to sell anything there in return. Opium was the one exception and the Chinese authorities did their best to forbid its sale to their citizens. Ultimately, Britain fought a series of wars, which became known as the Opium Wars, in order to force China to allow its sale.
Chinese financial culture has not changed all that much, even though the country is now becoming a major manufacturing power. China runs an enormous balance-of-payments surplus by pegging its currency low, so that its exports are cheap and its imports dear. This makes the Chinese feel good, morally. But, as in the past, there is a price to pay. Pegging its currency below market value means that China must spend more than $100 billion of foreign currency (chiefly U.S. dollars) annually in buying securities and other assets, largely in the U.S.
This brings me to American financial culture spending and borrowing which is just the opposite of China's. This culture was evident even in the colonial days of the early 17th century. If figures were realistically presented, I think they'd show that America has usually run a current accounts deficit. King James I's ministers persuaded him not to ban smoking in England because tobacco was the only crop earning the growing American colonies enough profit to pay for their imports of luxury and manufactured goods from England. Americans have traditionally spent up to the limit and beyond of their credit, believing that G-d, or the world economy, would provide. And it has. Like Jimmy Goldsmith, the U.S. has become the world's richest nation by using other people's money to finance its own spectacular and continuing growth.
In the 15 or so years since 1990 the U.S. current accounts deficit has gone from 0% to 7% of GDP. America is able to do this by offering the rest of the world the biggest choice of wealth storage options bonds and other assets that they can buy with their savings, knowing these instruments are secure and will give a good return on investment. The truth is, if you make a lot of money by making cheap goods, as the Chinese do, or by selling expensive oil, as the Arabs do, you either have to spend your money, riotously, or save it. And if you choose to save, you have to put those savings somewhere that is secure and rewarding.
Thanks to its political and social stability and its record of a continually growing economy, the U.S. has become almost unconsciously rather than through set policy the biggest and most successful wealth-storage economy in history. It exports wealth-storage facilities in exchange for net imports of goods. A recent calculation by the American Enterprise Institute shows that foreign storage claims of U.S. assets are $13.5 trillion, or about 25% of U.S. wealth (about 10% of global wealth).
However, as with Jimmy Goldsmith, this borrowing has enabled the U.S. to become richer and richer. The U.S. also invests abroad and now holds about $11 trillion in foreign assets. That leaves net foreign claims on U.S. assets of about $2.5 trillion. But this is only 20% of one year's income for America's enormous GDP. Moreover, while wealth stored in the U.S. is mostly in short-term assets, American wealth stored abroad is chiefly in long-term assets, and those will grow in value and grow faster than wealth stored in the U.S.
The fact is, in the international economy there is no such thing as absolute borrowing or absolute lending; they are intertwined. As an individual, however, I prefer to stick with my father's advice, for I put peace of mind before other considerations. But for a giant nation like the U.S., the Goldsmith approach may make more sense.
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© 2006, Paul Johnson