by Joseph Joyce
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.”