OK, I am not really ready to give up. But the 2005 net international investment position (NIIP) data sure didn't provide me much to work with.
For a couple of years now I have been warning against the long-term consequences of big external deficits. And specifically, I have argued that big trade deficits mean big external debts – and that if the US wants to keep its external debt from rising, it needs to implement a set of policies to bring its deficit down. Bringing the US trade deficit down isn’t just a US responsibility, of course. Policy changes in the rest of the world could help. Deficits don’t exist without surpluses elsewhere.
But it is hard to make that case when US net debt – here I am using net debt as a synonym for the net international investment position, a measure that includes the equity claims – just doesn’t rise.
The net international investment position of the US just hasn’t deteriorated since the end of 2002, despite deficits of nearly $525b in 2003, $670b in 2004 and almost $800b in 2005. US net debt was around $2.3 trillion at the end of 2002. And it was around $2.55 trillion (valuing equity investment in the US and US equity investment abroad at market value) at the end of 2005.
The story that emerges is that the US is just borrowing against the risings value of its existing foreign investments abroad. Just like US households are borrowing against the rising value of their homes. Debt is only a concern if it isn’t backed by assets. External debt matched by rising external assets isn’t a worry.
At least not so long as the US can count on:
- Enough financing from the world to allow it to borrow against the rising value of its external assets (as opposed to say selling those assets to finance ongoing deficits); and
- Continued rises in the market value of its external assets
I still have some doubts about both points. At least in the long-term.
But first things first. If the data holds, I pretty much have to concede 2005 to the don't worry crowd.
It isn’t hard to figure out why the net debt position of the US didn’t deteriorate in 2003 and 2004. The fall in the value of the dollar (rise in the euro and similar currencies) in 2003 and 2004 led to a rise in the dollar value of US investments abroad, particularly US investment in the UK, Canada, Switzerland and the Eurozone. This generated a $415b currency windfall in 2003, and $270b in 04.
I thought 2005 might be different. In 2005 the dollar rose. A lot. The US was going to giving up a big chunk of the gains of 2003 – and all the gains of 2004. 1.17 is a lot lower than 1.35. Indeed, the dollar’s rising value reduced the dollar value of US investments abroad by $390b in 2005.
But that didn’t drive the data. In 2005, the market value of US investment abroad – in euros, yen and a host of other currencies – soared. They rose by nearly over $900b.
Even in the face of currency losses. So the US got a $500 billion valuation gain on $10 trillion external assets. Actually, nearly all the gain came from the nearly $6 trillion in US equity investment abroad (FDI and portfolio). Not bad. Particularly when the market value of foreigners’ $12.5 trillion in claims on the US fell by around $90b…
At least in dollar terms.
Rising US interest rates cut into the market value of all the long-term debt foreigners held.
And the market value of foreign direct investment in the US actually fell in 2005.
So why worry? The value of US assets abroad keeps rising. Even when the US dollar is rising. The US really is the cunning capitalist – borrowing from the world for low rates, pushing all the risk of dollar depreciation on to its creditors, and earning big capital gains on its investment in the rest of the world.
At least if you believe the data. Mandel doesn’t trust the data I was using to analyze income flows (I was using the BEA’s data on the US balance of payments), since he thinks this data understates US earnings on its intangible assets abroad (I think it probably understates foreign earnings on their intangible assets in the US even more).
And I’ll follow his lead. I too have some doubts about the official US data. In this case, the US net international investment position data. Perhaps doubts is the wrong word. Suspicions. Things that don't make intuitive sense.
I am not convinced that the US net international investment position data is telling the full story. The fall in the market value of foreign direct investment in the US is a bit suspicious. US equity markets were up in 2005, though not by as much as many other markets – and the BEA uses market moves to estimate the value of non-traded direct investment in the US. I wonder if they were doing something like using GM and Ford’s performance to estimate the change in the market value of Toyota and Honda. A net capital gain of a $600b on US equity investment abroad even after currency moves is far larger than I expected – it seems too good to be true.
I really do wonder what Philip Lane was expecting. (Paging Philip Lane, Paging Philip Lane)
Daniel Gros of CEPS also may be on to something. He has argued that the US survey data that is used to estimate the net international investment position misses some foreign holdings of US debt.
Rather than looking at the changes in the US net international investment position since 2002, let’s go back to the end of 1999.
At the end of 1999, the US net international investment position showed a deficit of around $1 trillion – that is, US liabilities exceeded US assets by around a trillion dollars. Since then, financial flows added about $3.3 trillion in claims on the US, mostly debt. That would have pushed the US net international investment position up to around negative $4.3 trillion.
Of course, there were offsetting valuation changes. But the overall impact of currency moves since the end of 2000 has been small: currency changes worked against the US in 2000, 2001 and 2005, even as they worked in favor of the US in 2002, 2003 and 2004. Currency changes have reduced overall US net debt by around $100b.
The rise in the market value of US investment abroad (relative to the market value of foreign investment in the US) has cut into the US net debt by about $1,060b. But almost all that gain came in 2005. And somehow, I don’t think 2006 will be quite as good. Some foreign markets have tanked, especially in dollar terms.
Other changes have reduced net claims on the US by $620b. See this table. Gros thinks this is debt that the US sells abroad that subsequently disappears from the survey data. Some folks just don’t want to report all their holdings of US debt. That story makes sense to me – though I need to look into it. Certainly, there is a gap between the stock of say Russian holdings of US debt and the sum of the recorded purchases of US debt by Russians.
Still, I have to concede 2005 to those who argue there isn’t much to worry about. At least in aggregate.
I kind of doubt those Americans who invested abroad and had a spectacular 2005 are the same Americans who are taking out lots of external debt. Those who have external assets – firms – are not borrowing. Those who don’t – households and the government – are.
And I do suspect that the United States’ luck will run out someday.
After all, its luck hinges primarily on the fact that the US has been a spectacularly bad place for foreigners to invest. Particularly since 2002. Since then foreign assets have appreciated in price by more than US assets. And the dollar has fallen, further reducing the value of foreign investment in the US.
The total gain, both currency gains and market appreciation, since 2002 from investing abroad rather than the in US – at least if you had foreigner’s portfolio of US assets and the United States’ portfolio of foreign assets -- is around $1 trillion.
Maybe Larry Summers has a point. Poor countries should invest in world markets themselves rather than just lending out their reserves at a negative rate of return to the US of A.
Indeed, judging from the 2005 data, Larry certainly has a point.
And another $600b of debt just disappeared from the US books over the same period. At some point, the world will get a bit better at collecting this kind of data.
But no matter. Another year, another record deficit and just before July fourth, the NIIP release once again provides due cause for celebration. The US managed to defy gravity. It ran a huge deficit, and didn’t pay for it.