from Follow the Money

US net foreign debt on track to rise to $3.7 trillion, 30% of US GDP, at end of 2005

June 30, 2005

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That, of course, that is not what the Bureau of Economic Analysis reported today.

Rather, the BEA reported that at the end of 2004, the net external debt of the US (with FDI at market value) was only $2.54 trillion, or about 22% of US GDP.

Score one for the modern day Panglosses.

The US Net International Investment Position (NIIP) - the difference between the United States’ external assets and its external liabilities - only rose by $170 billion last year, despite a current account deficit of between $660-670 billion. Valuation gains on US external assets cut about $420 billion off the US net external debt.

US ran a large current account deficit, and its net external debt fell as a share of its GDP. US external assets still generate more income than the US has to pay on its debt. A 6.5% to 7% of GDP current account deficit would be a cause of concern for a normal country, but the US is not a normal country.

The dollar’s rally can continue, the trade deficit can widen, US interest rates can stay low, fueling a housing-based "asset-pump" that drives up US consumption and keeps US workers employed. There is no problem.

Roach, Volcker - and yes Roubini-Setser - have it all wrong. We do live in the best of all possible worlds.

What happened? Why is the NIIP to GDP ratio lower now than at the end of 2003?

Four things:  The Treasury Department’s annual survey of US investment abroad discovered more US assets abroad, to the 2003 NIIP was revised down.

 The US has more equity - both FDI and corporate stocks - outside the US than foreigners have equity in the US, so a global stock market rally increases the value of US external assets more than US external liabilities.  Foreign stock markets did a bit better than US stock markets in 2004.

 And, above all, the US has a ton of European assets - and those assets are worth more when one euro buys $1.35 than when one euro buys $1.26. It is not just the euro either - falls in the dollar’s value against the pound and the Canadian dollar also helped. Look at the work of Gourinchas and Rey for more on the impact of valuation changes on the US net international investment position. The problem?

Simple. A euro is not worth $1.35 any more. More like $1.21. The US has given up not only the $270 b in currency gains from 2004, but also some of the gains from 2003.

Unless something changes, the Commerce department will report big valuation losses next June.

Say those losses are around $350b.

I expect that the 2005 current account deficit will be at least $820 b.

That puts the 2005 US net international investment position at negative $3.7 trillion, or 30% of expected 2005 US GDP.

After that, it only gets worse. With a $900 billion current account deficit in 2006 (that probably is low if oil stays at $60 a barrel and the US continues to grow), the end 2006 net international investment position would be around [$4.8 trillion, or 35%] OOPS, BAD ADDITION, SHOULD BE $4.6 TRILLION, 34% of US GDP.

And so on. Remember, if the US current account deficit tops 7% of GDP in 2006 and then starts to gradually decline, the deficit may be 6.5% of GDP in 2007, 6% of GDP in 2008, and so on. I have not run the numbers, but I would bet that if the trade and transfers deficit rises to 7% of US GDP in 2006 and then falls by 0.5% of GDP a year for fourteen years (bringing the trade and transfers deficit - but not the current account deficit down to zero in 2020) US net external debt would stabilize at between 60 and 70% of US GDP.

Actually, a bit less -- since in that scenario, the dollar falls further against the euro, the pound, the swiss franc and the yen -- not to mention many emerging market currencies, and the dollar’s fall increases the value of the United States’ external assets. Or at least the value of the assets the US has not sold off to finance deficits along the way.

This, remember, is the "good," soft landing scenario. Gradual adjustment implies the US net external debt will keep on rising for some time. It took time for the US trade deficit to rise to its current levels; it also will take time for it to fall back to levels consistent with a stable external debt to GDP ratio.

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