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The Increasing Debtor Status of the U.S.

The Net International Investment Position (NIIP) of a country reflects the difference between foreign assets owned by domestic residents and domestic liabilities held by foreign residents. The difference, positive or negative, determines a country’s status as an international creditor or debtor. The U.S. position, which has been negative for many years, has deteriorated sharply in recent years. When scaled by GDP, the U.S. NIIP/GDP doubled from -18.6% in 2010 to -39.6% in 2015, and fell further to -71.1% in 2021 (data from FRED). What accounts for the decline, and does it represent a vulnerability for the U.S. economy?

Changes in the NIIP can reflect a country’s current account balance, as a surplus (deficit) leads to the accumulation of more assets (liabilities), as well as valuation changes in the existing holdings. Changes in the valuations are due to either price changes in the assets and liabilities or fluctuations in the exchange rates that covert them to a common currency. An appreciation of the U.S. dollar, for example, would lower the value of the assets denominated in foreign currencies without affecting the value of the dollar-denominated liabilities. Daniel Fried of the U.S. Congressional Budget Office (CBO) provides an examination of the components of the U.S. NIIP and the factors that drive it in the CBO working paper, “CBO’s Model and Projections of U.S. International Investment Holdings and Income Flows” (2021).

The U.S. balance sheet for many years was characterized as “long equity, short debt,” i.e., its assets were largely composed of foreign direct investments (FDI), and its liabilities existed primarily in the form of debt (bonds, such as U.S. Treasury securities, or bank loans (see here). The U.S., therefore, borrowed to fund its foreign holdings, and Pierre-Olivier Gourinchas of UC-Berkeley and Hélène Rey of the London Business School characterized the U.S. as the world’s “venture capitalist”. Moreover, since the returns on the equity assets were larger than those paid on the debt liabilities, the U.S. recorded surpluses In the international investment income component of the current account despite its debtor status.

Andrew Atkeson of UCLA and Jonathan Heathcote and Fabrizio Perri of the Federal Bank of Minneapolis examine recent changes in the U.S. balance sheet in their NBER paper, “The End of Privilege: A Reexamination of the Net Foreign Asset Position of the United States.” They point out that the sharp decline in the U.S. position over the last decade occurred at a time when its current accounts deficits were small and stable. The deterioration, therefore, was due to valuation changes. They then note that U.S. equity (FDI and portfolio) liabilities have grown over the last decade and now exceed non-equity liabilities, and show that the change in valuations came mainly from this equity position. When they examine U.S. and foreign equity stock indices, they find that the U.S. stock price index more than quadrupled over the 2010-2021 period, a significantly higher gain than that of foreign equity. They conclude that the dominant factor behind the valuation changes that drove down the U.S. NIIP was the relative outperformance of U.S. equities. They then explore the reasons for this divergence in equity returns, which they attribute to a rise in the profitability of U.S. firms.

More evidence of the factors that drive the U.S. external position was offered by Zhengyang Jiang of Northwestern University’s Kellogg School of Management, Robert Richmond of New York University’s Stern School of Business and Tony Zhang of the Federal Reserve Board in their NBER working paper, “A Portfolio Approach to Global Imbalances.” They utilize a model of asset demand to examine the factors that drive the currrent account. They demonstrate that the gap between global savings and demand, as well as central bank reserve holdings and monetary policy, have played important roles in the determination of the U.S. position. They also show that after 2010 there was a rise in the international demand for U.S. equity, which further increased the U.S. debtor position.

The evidence seems clear that the composition of the U.S. balance sheet has shifted in the last decade, and valuation effects due to U.S. equity prices have driven the increase in the negative net position. Is this a cause for concern? Gian Maria Milesi-Ferretti served at the IMF for many years, including as Deputy Director in the Research Department from 2014-2021. Currently a Senior Fellow at the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution, he addressed this issue in “The U.S. Is Increasingly a Net Debtor Nation. Should We Worry?” He points out that the U.S. position is very different from those debtor nations where the deterioration in their NIIPs is due to increased borrowing, sometimes denominated in a foreign currency. The U.S. valuation effect, on the other hand, reflects relatively strong performance by U.S. firms. Moreover, the U.S. continues to record a positive net international investment income balance due to the higher return on its assets vis-à-vis its liabilities.

But Milesi-Ferretti, writing in 2021, did acknowledge that the fiscal stimulus following the pandemic would increase the need for foreign savings. The current account deficit, which was less than 2% of GDP before the pandemic, widened to 4.8% at the end of 2021. Moreover, while this year’s correction in the U.S. stock market lowers the value of the equity liabilities, similar declines in foreign equity markets have lowered the value of the U.S. foreign equity assets. The appreciation of the dollar further decrease the value of U.S. foreign assets. In addition, interest rates in the U.S. are rising, which raises the cost of servicing the debt liabilities.

Consequently, there are several factors at play that may cause a further deterioration of the U.S. international position that are less benign that that of recent years. As they play out, the net debtor status of the U.S. may face further scrutiny. All this will take place at a time when the outlook for the global economy has turned “gloomy and uncertain.”

Measures of Global Income

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The difference between the income generated by the domestic production of goods and services and the income received by the residents of a country is the basis of the distinction between Gross Domestic Product (GDP) and Gross National Income (GNI). The latter measure includes net foreign-sourced income, the income domestic residents receive from foreign sources for providing productive resources (such as labor) minus the income paid to foreign residents in exchange for their productive resources. Net foreign income is also called “net primary income,” and is a component of the current account of the balance of payments. However, GNI and net primary income exclude one form of income from the foreign sector that has become increasingly important: personal transfers, also called remittances.

The two measures do include the wages paid by foreign firms to domestic workers who travel across borders to their place of employment. But the determination of who is a “domestic worker” depends on residency, not citizenship, and residency can be an ambiguous concept. The IMF’s Balance of Payments and International Investment Position Manual formulated a criterion for establishing it:

“A household is resident in the economic territory in which household members maintain or intend to maintain a dwelling or succession of dwellings treated and used by members of the household as their principal dwelling. Being present for one year of more in a territory or intending to do so is sufficient to qualify as having a principal dwelling there.”

By this benchmark, a worker who travels to the U.S. during the harvesting season and then returns home is treated as a resident of her home country, and her wages appear in her country’s GNI. But if she moves to the U.S. and stays here for more than one year, then she is considered to be a resident of the U.S. and her income would be included in U.S. GDP.

Governments can provide exceptions to the one-year residency rule. The U.S., for example, includes as residents: “owners or employees of U.S. business enterprises who reside abroad to further the enterprises’ business and who intend to return within a reasonable period; U.S. government civilian and military employees and members of their immediate families; and students who attend foreign educational institutions.” (Concepts and Methods of the U.S. National Income and Product Accounts, U.S. Bureau of Economic Analysis) But in general workers who sign multiyear contracts to work abroad establish de facto residency in their host countries, even though they are not entitled to the privileges of citizenship.

If a worker in the host country sends money to family members in her home country, the funds would be counted as personal transfers, which appear in “net secondary income” in the current account with official transfers. Personal transfers have grown in size in recent decades as migration has grown, and were remarkably resilient last year despite the disruption of the pandemic. Therefore, excluding them from a country’s GNI can underestimate the income available to those who reside in the country. (The World Bank’s definition of remittances as the sum of compensation to employees of foreign employers and personal transfers drops the distinction between the two.)

There is a measurement of national income, however, that does include transfers: Gross National Disposable Income (GNDI). It adds net transfers, private and official, received by residents from non-residents, to GNI. Clara Capelli of MICAD – University of Bethlehem and Gianni Vaggi of the University of Pavia wrote about the importance of such payments in their 2016 article “Why Gross National Disposable Income Should Replace Gross National Income” in Development and Change. They make the point that GNDI is a more comprehensive indicator of the resources available to a country’s residents than GNI.

Capelli and Vaggi report data for GDP, GNI and GNDI for a range of countries. In most developing economies, GNDI is larger than GNI, and in some cases the differences between GNI and GNDI are significant. For example, GNDI exceeded GNI in Egypt in 2014 by 10%, in Pakistan by 9%, and in the Philippines by 8%. Consequently, potential living standards are higher in those countries than GNI indicates.

Capelli and Vaggi also point out that surpluses in net secondary income often offset deficits in the trade balance as well as in net primary income. The latter are dominated by net investment income, and in these countries usually reflect income payments on FDI (see here). Transfers are also more stable than investment income.

The pattern of transfer surpluses and investment income deficits are consistent with relative labor abundance and capital scarcity in the countries that Capelli and Vega write about. Conversely, the transfers often come from capital abundant advanced economies that are the source of FDI outflows or oil exporters where unskilled labor is scarcer. The flows of the factors of production among these countries are consistent with the Hecksher-Ohlin model’s predictions for international trade.

GNI, therefore, may underestimate the standard of living available to a country. Similarly, the use of the trade account as a proxy for the current account omits consideration of the role of secondary income. Transfer payments as well as the movement of workers across borders have been disrupted by the pandemic, but labor migration will resume as the work forces of many advanced income countries continue to age. Remittances will account for increasingly larger parts of the current accounts of nations that serve as global sources of labor.

The New Trade Wars

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The U.S. and China are headed down a road of retaliatory trade restrictions. Stock prices are falling in response to the impact of such measures on corporate profits, while U.S. firms reconsider their global supply chains. But one curious aspect of the situation is why it has taken this long to flare up.

The “global imbalances” of the early 2000s were the Chinese trade surpluses and the U.S. deficits. These received a great deal of attention, but the effects of the U.S. deficit on the domestic economy was not always acknowledged. Those who complained about the loss of manufacturing jobs in the U.S. were met with responses that technology was the true culprit, or that Americans benefitted from the influx of cheap imports. Only in recent years has the evidence that there was an impact on U.S. employment been widely accepted.

Arvind Subramanian, currently an economic advisor to the Indian government, and Martin Kessler of the World Bank, in 2013 wrote about China’s emergence as a large-scale trading nation—in their words, a “mega-trader”—in the 1990s. They compared the impact of this development on the U.S. with the effect of Japanese exports to the U.S. in the 1980s and that of Mexican exports in the 1990s. They use different measures, including the average amount of imports and the change in imports, scaled either by the number of working age adults or domestic absorption. On all these measures, the Chinese shock exceeded the earlier ones by several orders of magnitude. Yet it did not draw the same level of indignation that occurred during the Reagan administration or the Clinton administration in response to the earlier surges in imports. There were calls for the IMF and/or the U.S. Treasury Department to sanction China in some fashion for the undervaluation of its currency, but both the Fund and the U.S. government were reluctant to criticize the Chinese government.

Subramaninan and Kessler examine several reasons for the relative silence. The one which seems most relevant is the stance of U.S. businesses towards China. For many years, these firms viewed Chinese markets as a sort of “El Dorado” of immense consumer markets that would yield large profits as the Chinese economy grew. Moreover, U.S.-sourced foreign direct investment contributed to the Chinese export expansion. U.S. firms were willing to sacrifice some U.S. jobs, particularly if this put pressure on domestic wages.

However, there has been a growing realization that business conditions in China have not evolved as U.S. firms wished. There are profits for firms, particularly those with global brand names, but the Chinese government has carefully controlled access to its markets. Moreover, there are long-standing allegations of intellectual property theft. As a result, U.S. firms have become much less optimistic about their future in China and increasingly concerned about competition from Chinese businesses.

Subramanian and Kessler viewed the situation in the following way: “At the risk of overgeneralizing, the challenge in the trade arena can be summarized as follows: China is happy with the status quo and the United States is not.” But the response of the U.S. to impose tariffs will not be effective, and will have adverse domestic effects. Subramanian and Kessler argued that a common position with other nations would be the most effective negotiating tool: “Multilateralism ensures that China’s trading partners will have enough heft to negotiate with China in a more balanced manner. For example, China might be willing to open its markets in return for the United States, European Union, India and Brazil opening theirs…The opprobrium of being a deviant from multilateral norms is China’s great fear, rendering multilateralism the best weapon the word can deploy against a dominant China.”

But the Trump administration has alienated potential allies that have similar concerns and could join it in formulating an effective response. When even Canada is treated as a threat, then there can be no joint position. The Chinese government can justifiably claim that it faces a government with a deep and profound ignorance of how international trade functions.

Trump may settle for a face-saving public statement that seems to satisfy his demands, much as he has done with North Korea. Many of his advisors, however, are advocating a hard stance, as the Chinese government considers its options. If the situation continues to deteriorate, the U.S. will have squandered an opportunity to make a case for fair and effective rules on intellectual property rights, and instead will precipitate a period of chaos and disruption.

Current Account Deficits and Safe Assets

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The International Monetary Fund has issued its External Sector Report for 2017, and among its key findings: “Global current account imbalances were broadly unchanged in 2016…” The U,S. continues to record the largest deficit, $451.7 billion, which is equal in value to 2.4% of U.S. GDP. The continuing deficits contribute to the increase in the U.S. debtor status in its net international investment position (NIIP), currently valued at $8.1 trillion, which is equal to 42% of GDP. The Fund is concerned that these imbalances, as well as the persistent surpluses in Germany and other nations, “…raise the risk of disruptive corrections down the road, including due to diverging stock positions.” But as long as the dollar serves as the world’s reserve currency, a U.S. current account deficit will be an inherent feature of the international financial system.

The share of U.S.-dollar denominated liabilities in the foreign reserves of central banks continues to hold at over 60% of all reserves. Foreign central banks own about $4 trillion of U.S. Treasury debt, and foreign private residents another $2 trillion. Andreas Steiner of the University of Gronigen (see also here) has demonstrated that the reserve currency status of the dollars lowers the current account balance as foreigners exchange goods and services for U.S. securities. John Benedetto of the U.S. International Trade Commission has shown that the U.S. current account deficits of the last decade were largely financed by the purchases of foreign governments of U.S. government debt.

The increases in foreign official holdings of Treasury securities have been partially offset in the capital accounts of many emerging market economies by private capital inflows. Laura Alfaro of Harvard Business School, Sebnem Kalemli-Ozcan of the University of Maryland and Vadym Volosovych of Erasmus University Rotterdam (see also here) pointed that developing countries with high productivity growth have received equity inflows. The “uphill” capital flows in the opposite direction are due to the official purchases of Treasury debt by these countries’ central banks. These patterns are consistent with the “long debt, short equity” composition of many emerging markets (see here).

The foreign purchases of U.S. Treasury securities have had an impact on their return. Balazs Csonto and Camilo E. Tovar of the IMF have estimated that a percentage point rise in these holdings reduces the term premium on securities with maturities of 3 years or less by about 2.0-2.4 basis points. The fall in the cost of borrowing, while advantageous for U.S. borrowers, distorts domestic consumption and investment.

However, the supply of U.S. Treasury securities may not be sufficient it meet the demand. Ricardo J. Caballero of MIT, Emmanuel Farhi of Harvard and Pierre-Olivier Gourinchas of UC-Berkeley have examined the demand for “safe assets,” which they define as a “debt instrument that is expected to preserve its value during adverse systemic events.” Before the global financial crisis, these included the mortgage-backed obligations of U.S. government-sponsored enterprises, such as Freddie Mac and Fannie Mae, as well as privately-issued asset-backed securities that had been rated AAA. But their status as “safe assets” vanished once the crisis hit, and the resulting fall in the supply of “safe assets” has bolstered the appeal of U.S. Treasury debt.

The role of the U.S. in supplying financial assets to the world was examined in the 1960s by Emile Despres of Stanford University, Charles P. Kindleberger of MIT and Walter S. Salant of the Brookings Institution. They characterized the U.S. as a “world banker,” which performed a vital financial intermediary service in providing liquidity to foreign asset-holders in return for outflows of U.S. capital into foreign long- and intermediate-term investments. Pierre-Olivier Gourinchas and Hélène Rey updated this analysis in 2007 to highlight the U.S. role as a “world venture capitalist,” which holds foreign equity in exchange for safe, fixed-income liabilities. The U.S. equity holdings allowed their issuers to share the cost of the global financial crisis when they fell in value on the balance sheet of the U.S.

How long will foreign nations be willing to accept U.S. debt? Robert Triffin drew attention in 1960 to the inherent instability in the Bretton Woods monetary system due to the discrepancy between the amount of gold owned by the U.S. government and the growing quantity of dollars held outside the U.S., which could be exchanged for the U.S. gold. That linkage was discontinued in 1971 by President Richard Nixon.

U.S. government securities continued to be held outside its borders, in part because of the lack of any widely-accepted alternative. Ludiger Schuknecht of the German Ministry of Finance, however, believes that there may be a tipping point along a “safe assets Laffer curve” when an increase in the amount of government debt will result in increasing concerns about its safety and consequently a decline in the availability of safe assets. He points to the fall in the ratings of the government debt of many advanced economies in recent years as evidence of mounting concern about the creditworthiness of their obligations.

Barry Eichengreen of UC-Berkeley has examined the rise of the U.S. dollar, and pointed out that a multi-reserve currency system could be a viable alternative to the current arrangement. The use of China’s renminbi as a regional currency will grow, much as the euro serves countries that trade with members of the Eurozone. But the lack of broad and liquid financial markets for those currencies has left the demand for U.S. Treasury obligations intact for now. Consequently, there is a structural component of the U.S. current account deficit that does not respond to domestic policies. The U.S. NIIP deficit will continue to widen, and the IMF projects that with current policies the U.S. net debtor position will deteriorate, “…exceeding 50% of GDP by 2021.”

But this could change if there were a reappraisal of the “safety” of U.S. assets. What could bring about such an adjustment? The political chaos in Washington is contributing to a reevaluation of the role of the dollar. Assaults on our institutions lead to questions about the stability of our political process. Moreover, if Congress can not agree to raise the federal debt ceiling, foreign bondholders will reevaluate the ability of the government to fulfill its obligations. In that case, there may not be any “safe” assets, and the next financial crisis could be even more unsettling than the last one.

America’s Current Accounts Deficits: Not Quite Déjà Vu

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The U.S. current account deficit has narrowed since 2006, when it reached $807 billion, which represented 5.8% of U.S. GDP. By 2013 the deficit had fallen to $400 billion, worth 2.4% of GDP. But the IMF last October projected it would reach $484 billion in 2015, 2.6% of GDP, and would continue rising after that. Are we headed for a return to the global imbalances of the last decade?

Part of the rationale for the expected rise in the deficit is the strength of the U.S. economy. The U.S. recovery (finally) appears robust, particularly compared with those of Japan and the Eurozone. This relative strength of the U.S. economy has stimulated an appreciation of the trade-weighted exchange rate. The combination of increased expenditures and a currency appreciation will fuel a decline in net exports, although the drop will be cushioned by a decline in oil imports.

This development benefits those countries where domestic demand remains weak. In January the IMF lowered its forecasts for global growth in 2015 and 2016 to 3.5% and 3.7% based on reassessments of the prospects for China, Russia, the Eurozone and Japan (although recent reports see some improvements in Europe and Japan). The U.S. was the only major economy with better growth projections. Martin Wolf of the Financial Times points out that current account surpluses would help out these countries.

But which countries would absorb their goods and services? The emerging markets and developing economies will not be able to finance current account deficits through capital inflows if a rise in U.S. interest rates brings about capital outflows from these countries. This leaves the U.S. as the residual deficit country. Wolf concludes “…U.S. spenders will, once again, have to pull not only their own economy but much of the rest of the world.”

There is another factor contributing to the U.S. deficits: the continuing acquisition of dollars by central banks. Joseph Gagnon of the Peterson Institute for International Economics attributes the purchases to the desire of government to maintain their own current account surpluses. Andreas Steiner of the University of Osnabrueck investigated balance of payments data and found that the demand for dollar reserves lowered the U.S. current account balance by 1-2% relative to GDP. Similarly, Stephen Cecchetti of the Brandeis International Business School and Kermit Schoenholtz of NYU’s Stern School estimate that the foreign official demand for U.S. assets results in a continuing current account deficit of 2% of GDP.

A rise in U.S. interest rates will lead to an increase in private capital inflows that could further increase the current account deficit. The impact on the U.S. economy depends in part on the composition of these capital flows. Eduardo Olaberría of the OECD has studied the impact of capital inflows, and reported that debt-based flows are more likely to be associated with increases in asset prices than equity flows.

But concerns over credit booms currently center on China, not the U.S. The increase in credit reflects governmental policy to stimulate the economy after the global financial crisis of 2007-09. It is these policies, not capital inflows, which are responsible for the increases in Chinese debt.

It is ironic that the Chinese economy is seen as a source of instability at a time when the U.S. current account deficit is rising. Financial outflows have weakened the renminbi despite an increasing trade surplus, and the Chinese currency may fall further. The U.S. external position is as much a sign of foreign weakness as it is of U.S. vigor. Moreover, the U.S. economy is not immune to global fragility. Federal Reserve officials are well aware that their optimistic projections could be thrown off by a stagnant world economy.

Capital Ebbs and Flows

Global Finance and How It Shapes Our World

Tag Archives: current account

The Increasing Debtor Status of the U.S.

Measures of Global Income

The New Trade Wars

Current Account Deficits and Safe Assets

America’s Current Accounts Deficits: Not Quite Déjà Vu