The U.S. has long held an external balance sheet that is comprised of foreign equity assets, mainly in the form of direct investment (DI), and liabilities held abroad primarily in the form of debt, including U.S. Treasury securities. This composition is known as “long equity, short debt.” Pierre-Olivier Gourinchas of UC-Berkeley and Hélène Rey of the London Business School claim that this allocation has allowed the U.S. to serve as the “world’s venture capitalist,” issuing short-term debt in order to invest in high-yield assets. But the U.S. direct investment position has changed from a surplus to a deficit, with uncertain consequences for the international monetary system.
There is more than one reason for the change. To see this, it is important to understand that the U.S. Bureau of Economic Analysis, which reports these data, uses several methods to value direct investment. One of these utilizes stock market prices to calculate the market values of the assets and liabilities. The second method is the use of the historical costs of the investments when they were made. The third is the current, or replacement, costs of the direct investment assets and liabilities.
Direct investment includes equity and debt instruments. The latter is based on intra-company borrowing. Historically, the equity component has registered a net positive position that outweighed the negative debt position. But the net direct investment equity position, which had been falling for several years, plunged in late 2017. The falloff continued in 2018 and led to a negative balance, which combined with the negative net direct investment debt position, turned the overall net direct investment balance negative.
What was the cause of the dropoff in direct investment equity? An examination of the assets and liabilities based on their market value shows both falling, with the decline in asset values outweighing a fall in the value of liabilities. These drops are based in large part on last year’s domestic and foreign stock market declines.
But an examination of the assets and liabilities valued at historic costs reveals that there was also a decline in direct investment assets. This fallback is due to the repatriation of earnings that U.S. based multinationals had accumulated and kept abroad in order to avoid paying corporate taxes on them. When changes in U.S. tax laws went into effect last year, many firms brought their earnings back, which led to negative U.S. direct investment outflows. Our direct investment assets fell, therefore, both because of the fall in their market value but also due to the reduction in U.S. foreign holdings. Inward investment, on the other hand, continued to grow.
What does this portend for the future? U.S. direct investment outflows became positive again in the second half of 2018. But they are unlikely to return to the same amounts as they had registered before the change in the tax laws due to concerns of the firms over U.S. trade policy. This year’s rising U.S. stock market will increase the value of our liabilities, most likely at a faster rate than the corresponding change in the market value of our assets. Consequently, the net debtor DI position will continue at least for the short-term.
This imbalance in our direct investment assets and liabilities contributes to the deterioration in the U.S. net international investment position. In addition, once the repatriation of foreign earnings is complete, the positive income we receive on our net foreign assets that partially offsets the deficit in the trade balance may fall. Moreover, the ability to serve as the world’s venture capitalist will weaken, which will affect our response to the next major financial crisis. The U.S. may not undertake the stabilizing role it has played in the past, and there is no other nation that can or will take on that role. At a time when the U.S. is withdrawing from political commitments that it has maintained since the end of World War II, this change is yet one more sign of a self-imposed diminution in our ability to deal with global issues.
(Note: a major thanks to the economists at the Bureau of Economic Analysis for guiding me through the data on direct investment.)
