from Follow the Money

Statistical manna from heaven

June 16, 2007

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The BEA's current account data contained two surprises.  One that I expected.   Another that I did not.  

The "expected" surprise was that the 2005 and 2006 data looks to have been revised to show much (and I mean MUCH) higher central bank purchases of US assets.   The "unexpected" surprise -- at least to me -- was that the data on income payments was also revised down quite significantly and a result of the large change in the income balance, both the 2005 and 2006 current account deficit were revised down.  The latest data puts the 2006 deficit at close to $810b, well below the $855 in the last BEA release

The q1 income balance was consistent with the revised 2006 income balance.  The ongoing surplus in the income balance offset a portion of the trade deficit, contrary to my expectations.    As a result, the overall q1 current account deficit ($193b) was somewhat lower than I expected. 

My guess is that both changes reflect, at least in part, the data in the most recent "survey" of foreign portfolio investment in the US.   The June 2005 to June 2006 survey showed two things.  One was a much larger increase in "official" holdings of US debt than had been reported in the ongoing "TIC data."  and the other was a much smaller overall increase in foreign holdings of US debt than reported in the TIC data. 

Daniel Gros of the Center for European Policy Studies has argued that the fact that a certain amount of US debt sold to foreigners "disappears" every year after the survey -- he calls this "disappearing into a black hole" -- is evidence that the US current account deficit is underreported.   Others argue that this "statistical manna from heaven" (See John Kitchen and Bill Cline) shows that the US current account deficit can be sustained for far longer than pessimists think - as ongoing trade deficits simply haven't produced either a significant deterioration in the United States net international investment position (the broadest measure of the US external position -- one that includes equity investments as well as debt) or the United States income balance.

That said, the revisions to the income balance seem to come far more from more interest income on US lending than from lower payments on US borrowing -- and above all from higher dividend income (counting reinvested earnings) on US direct investment abroad and lower dividend payments (counting reinvested earnings) on foreign investment in the US.   And the changes in the "income" of US direct investment abroad and foreign direct investment in the US do not fall out of the survey. 

There is little doubt that the data on "official purchases" were revised quite significantly.   The last release for 2006 showed "official purchases" of $200b in 2005 and $300b in 2006. (data here)   The revised data puts official purchases at $270b in 2005 and a rather impressive $440b in 2006.  That is a big change, but one that is very consistent with my world view.   I have consistently argued that the US data tends to understate ongoing central bank inflows to the US. 

It is worth noting that the $440b in official financing provided over half the net inflow needed to cover the revised $810b US deficit.  The $440, incidentally, likely will be revised up -- the q3 and q4 data for 2006 don't yet reflect the additional official purchases that tend to show up in the survey data.

In q1, central banks were even more generous, providing about $150b in financing ($147.8b) - an annualized pace of close to $600b.   That provided about 3/4s of the financing needed to sustain the US external deficit in q1.   And if anything, the current data likely still understates official inflows.  The revisions to the initial data releases on "official inflows" have consistently revised the data up, and the various measures of global reserve growth that I track suggest that central banks had a ton of cash to lend to the US in q1.

Central bank inflows inq1 incidentally are far stronger now they were than back in 2004, when Japanese financing of the US was very widely discussed in the US media. 

Incidentally, US companies invested way more abroad in q1 ($75) and foreign companies invested in the US ($25).   That implies that the US needed to sell about $250b in securities to the rest of the world to cover the US current account deficit (a bit under $200b) and the capital outflow that stems from US direct investment abroad.

That is the bad news.

The good news is that the income balance was also revised, in a way that shifted the 2006 income balance from a deficit to a surplus.   That reduced the 2006 current account deficit.   It also kept the income balance in surplus in q1.   Lower payments on foreign direct investment in the US helped -- foreign investors continue to get a very raw deal on their investment in the US, at least if you believe the payments reported in the US data.  

But the q1 income surplus is generally consistent with the revised data.  That is where the big changes came.   The amount of income the US received on its investment abroad was revised up by about $30b, from $620b to $650b (with about 1/2 the gain coming from higher returns on direct investment and 1/2 the gain from other source), and the amount the US paid on investment in the US (and borrowing from abroad) fell by about $25b, from $630b to $605b.   Most of the fall came from lower returns on direct investment, not from smaller debt payments.

The revisions to the data certainly were not consistent with my expectations.   And to be honest, the gap between the return on the reported return on US FDI abroad (decent) and the reported return on foreign direct investment in the US (terrible) strikes me as a bit too big to be plausible.     But if the data consistently goes against your expectations, it is also worth looking a bit more closely at your assumptions, and trying to understand the data a bit better.  I hope to do so over the next couple of weeks.

To be honest, I think I understand the downward revisions in US interest payments on US debt held abroad -- a reflection of the debt that seems to disappear in the Survey -- far better than I understand the revisions to the data on the returns of US FDI abroad and the returns on foreign FDI in the US.   i remain confident of one thing though.   The striking fact is not high returns on US FDI abroad, but rather the very low returns on foreign direct investment in the US. 

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