SYNOPSIS:

Long-Term Capital Vanishes. During the last three months of 1990, foreign direct investment in the United States fell to just over $ 1 billion, an astonishingly low level considering the fact that $ 21.5 billion in offshore capital was pumped into this country a year earlier. The collapse of long-term overseas investment may defuse the political furor over rapidly growing foreign ownership of U.S. assets. But it is not good economic news.

There are two kinds of international investment. Portfolio investment, such as the purchase of U.S. government bonds by Japanese pension funds, aims to secure future income but does not establish working control of an asset. Direct investment, on the other hand, includes foreign purchase of companies and the creation of new subsidiaries. The good thing about direct investment is that it represents long-term commitment. Portfolio investment is a purely paper transaction that can be quickly reversed -- especially if the investment is in short-term assets like bank deposits and overnight money. The speculators who have put their money into dollars today because the United States won the gulf war can easily shift their money into Japanese yen or German marks tomorrow. Michelin Tire, which has spent years building a cluster of plants in the United States and the management and distribution structure that supports them, will not be as capricious an investor. A country is like a company. A firm that is financed primarily with short-term debt is much more vulnerable to financial crisis than one with a strong equity base and committed stockholders.

Financing the U.S. Trade Deficit. In the late 1980s, there was a huge surge in foreign direct investment into the United States as Japanese and European firms scooped up American corporations and real estate. Two years ago, direct investment supplied 65 percent of the money the United States needed to finance its continuing deficit in foreign trade. It seemed that offshore funds would continue to flow into this country forever. The last thing anybody expected was that foreigners would simply stop investing here.

Yet that is what has happened. Foreigners making longer-term investments do not believe that the American economy is a good bet. Nonetheless, the United States still needs foreign money, despite the fact that the nation's trade deficit has declined from $ 162 billion in 1987 to almost $ 100 billion last year. To close this gap, the United States had to borrow or sell assets. Only 26 percent of the shortfall was filled by foreign direct investment; in the fourth quarter of 1990, the number plummeted to just 4 percent.

What kind of foreign investors is the United States now attracting? The answer is fairly disturbing. In 1990, America ran a positive ''statistical discrepancy" of $ 73 billion. The discrepancy is the difference between the deficit on goods and services and recorded inflows of capital. Most experts believe that this discrepancy arises when foreign investors put their money in very-short-term assets like bank deposits. These investments are harder to keep track of than purchases of stocks and bonds. The huge discrepancy tells us that although the dollar is currently strong and the United States is able to finance its continuing deficits with ease, we are living on inflows of hot money -- money that moves in and out of financial markets as the economic news changes. Many analysts believe the Federal Reserve Board should cut interest rates because the dollar is so vibrant. But the Fed shouldn't be deceived by hot money when it makes monetary policy.

Watch for a Weakening Dollar. Today's situation resembles that of late 1984 and early 1985, when the dollar was strong because of inflows of short-term money and the United States was attracting little long-term investment. The superdollar proved ephemeral, and the ensuing plunge ended only when the weak dollar, which made U.S. assets look like good buys to foreigners, began attracting direct long-term investment. Now the direct investment has dried up. This suggests that the dollar -- despite its current muscle -- is vulnerable. It also indicates that foreigners are reluctant to make long-term financial commitments to the U.S. economy.

Foreign fortunes

Foreign ownership of U.S. companies, especially in manufacturing, increased steadily during the 1980s.

Percentage of U.S. manufacturing controlled by foreign firms

Assets Employment

1977 5.2 pct. 3.5 pct.

1978 5.7 pct. 3.9 pct.

1979 6.6 pct. 4.8 pct.

1980 7.2 pct. 5.5 pct.

1981 9.6 pct. 6.5 pct.

1982 9.8 pct. 6.6 pct.

1983 10.1 pct. 7.2 pct.

1984 10.2 pct. 7.1 pct.

1985 10.8 pct. 7.6 pct.

1986 11.4 pct. 7.3 pct.

1987 12.2 pct. 7.9 pct.

1988 14.0 pct. 9.1 pct.

Missing money

During 1990, however, the rate of foreign direct investment in the U.S. plunged.

Inflows of foreign direct investment

Millions $

1989

4Q $ 21.5 bil.

1990

1Q $ 5.5 bil.

2Q $ 7.2 bil.

3Q $ 11.9 bil.

4Q $ 1.1 bil.

Deficit damage

During the late 1980s, foreign direct investment helped cover much of America's trade deficit; now it no longer does.

Foreign direct investment, percentage of U.S. current account deficit

1985 16.9 pct.

1986 25.6 pct.

1987 32.6 pct.

1988 46.2 pct.

1989 65.6 pct.

1990 25.9 pct.

Originally published, 4.29.91