The Current Account Deficit and Dark Matter: Market to Book Differences or Transfer Pricing
Via Brad Setser comes U.S. AND GLOBAL IMBALANCES: CAN DARK MATTER PREVENT A BIG BANG? by Ricardo Hausmann and Federico Sturzenegger:
The Bureau of Economic Analysis (BEA) indicates that in 1980 the US had about 365 billion dollars of net foreign assets (that is the difference between the foreign assets owned abroad and the local assets owned by foreigners). These assets rendered a net return of about 30 billion dollars. Between 1980 and 2004, the US accumulated a current account deficit of 4.5 trillion dollars. You would expect the net foreign assets of the US to fall by that amount, to say, minus 4.1 trillion. If it paid 5 percent on that debt, the net return on its financial position should have moved from a surplus of 30 billion in 1982 to minus 210 billion dollars a year in 2004. Right? After all, debtors need to service their debt. So let’s look at how much is the actual return on the US net financial position. The number for 2004 is, yes, you’ve guessed it, still a positive 30 billion, just like in 1982! The US has spent 4.5 trillion dollars more than it has earned (which is what the cumulative current account deficit implies) for free! How could this be? Here the official story becomes murky. Part of the answer is that the US benefited from about 1.6 trillion dollars of net capital gains so that instead of owing 4.1 trillion, it owes “only” 2.5 trillion (which, at best, cuts the puzzle in half, leaving a whole other half to be explained). The other part of the official answer is that the US earns a higher return on its holdings of foreign assets than it pays to foreigners on its liabilities.
A nice statement of the puzzle, which they explain thusly:
We start by assuming that if an asset consistently pays more than another asset, then it is worth more, even if they both have the same historical cost or “book value”. We choose to value the assets on the basis of their returns … We know that the US net income on its financial portfolio is 30 billion dollars. This is a 5 percent return on an asset of 600 billion dollars. So we would say that the US is a net creditor to the tune of 600 billion dollars or about 5 percent of its GDP. Since
the income flow has remained fairly stable over the last 25 years, we would say that so have the US net foreign assets.
Brad seems to have a commentary in store based on our posts here and here. And yes, Brad is thinking about transfer pricing manipulation. But consider the EuroDisney example offered by Hausmann and Sturzenegger where they note that U.S. created intellectual property is generating a lot of income in France. While this income is counted in U.S. GNP, the actual recognition of this income per the GDP accounts for the U.S. and France depends on Disney’s intercompany pricing policy. While the IRS might rightfully argue that this income be counted on the financials of the U.S. parent, the French tax authorities might convince Disney to leave much of it on the financials of the French subsidiary. If the French tax authorities prevail, the net income from abroad accounting that Hausmann and Sturzenegger rely upon for their valuation exercise is distorted. As Brad has his thinking cap on, I eagerly await his contribution to this discussion.