Measured in dollars, the US is by far the most indebted country in the world. As this column describes, however, the country still has a positive capital income in spite of its high net debt position, and its external debt position is much smaller than one would expect based on cumulated current account deficits. Furthermore, fluctuations in the dollar exchange rates have a strong direct effect on the country’s international investment position. As long as it can finance its external obligations in dollars, its international debt position is no cause for concern for the US. For the rest of the world, however, the story may be different.
By Wim Boonstra*
Measured in dollars, the US is by far the most indebted country in the world. Due to ongoing current account deficits of its balance of payments in the past, the country has accumulated a negative net international investment position (NIIP) of $8,318 billion (-43.5 % of GDP), the highest level ever recorded by the US.
Figure 2 Net international investment position (NIIP) and cumulative current account (CUMCA), (percent of GDP)
A closer look unveils a number of remarkable facts.
- First, the US still has a positive capital income, in spite of its high net debt position (Figure 1).
- Second, the US external debt position is substantially smaller than one would expect based on cumulated current account deficits (Figure 2).
- A third observation is that fluctuations in the exchange rate of the dollar have a strong direct effect on the international investment position of the US.
After a discussion of these facts, I will come back to their consequences for US international debt sustainability.
Indebted, but with positive capital income
Usually, a country with a negative NIIP has a negative balance of primary income (part of the current account). However, the US has a substantial surplus here, as has been observed by other authors. Hausmann and Sturzenegger (2005), for example, suggest that the surplus on the capital income account implies that the US external investment position must be much better than official statistics indicate. They argue that there must be more US international assets than captured by official statistics, which they label ‘dark matter’. However, one doesn’t need ‘dark matter’ to explain the surplus on the capital income balance.
A closer look at the composition of the US’ international assets and liabilities is enough (Figure 3).
The US NIIP is the balance of its international assets, which are huge, and its international liabilities, which are even larger. If you look at the composition, the differences are striking. The US’ international assets have a strong emphasis on direct investment and portfolio equity investments, while its liabilities are overwhelmingly in debt securities and ‘other investments’ (basically, loans and deposits). The large share of relatively high-yielding investments in US international assets on the one hand, and the large share of low-yielding categories in its liabilities on the other, explain why the US has a positive balance of primary capital income. It receives more in dividends and profits on its investments abroad than it has to pay on its (lower-yielding) external liabilities.
International debt is smaller than cumulative current account deficits
In 1976, the first year for which the Bureau of Economic Analysis reports the US NIIP, the US had a net asset position of $85 billion. Since then, the cumulative current account deficit has reached an impressive $10,500 billion. In contrast, the country’s NIIP has ‘only’ deteriorated during this period to -$8,100 billion. There is gap of $2,400 billion between these figures, which should be explained. Again, the answer lies not with faulty statistics, but in the composition of US assets and liabilities.
In the past, international economy textbooks stated that the current account balance of a country is the driving factor behind the development of that country’s international wealth position; some textbooks still do. A surplus on the current account enables a country to repay foreign debts and/or increase its international assets. A deficit, on the other hand, results in increasing debts and/or decreasing reserves.1
The problem with this approach is that once a country has built up cross-border assets and liabilities, their value can change without being registered on the balance of payments (which is based on registered flows). Stock exchanges go up and down, just like the market values of foreign direct investments and bond prices. The larger the size of the gross international positions, the larger such value changes are.2
When we get the formula right, we take account of value changes of international assets and liabilities. These value changes reflect only capital changes, as dividends, profits, and interest rates payments are already included in the current account balance. As with the positive capital income balance, the composition of US assets and liabilities explains why the US NIIP moves more or less independently from the current account balance. Capital gains on the asset side, especially on US investments in equity and FDI, are often higher than capital increases on its liabilities (overwhelmingly bond, loans, and deposits).
Of course, in years in which stock exchanges are very volatile, the NIIP can fluctuate in a very erratic way. In 2008, when stock markets collapsed after the demise of Lehman Brothers, the US NIIP deteriorated by no less than $2,700 billion. In 2009 it improved again by $1,300 billion, only to deteriorate again by $1,000 billion in the following two years. Such fluctuations dwarf the current account deficit, which actually since 2008 has markedly improved due to increases in net services trade and capital income. The conclusion is that for a country with large gross international assets and liabilities, the importance of the current account balance as the explaining factor behind a country’s NIIP declines rather strongly (Figure 4). The short-term forecasting power of the current account balance suffers in particular.
But the dollar may be even more important
The US is not a normal indebted country; it still has the world’s most important currency. Although the euro is an important currency as well, it is dwarfed in all respects by the US dollar (ECB 2017). One of the consequences is that a huge part of US external liabilities is denominated in dollars, while substantial parts of its foreign assets are denominated in foreign currencies. This means that when the dollar decreases in value, the US gains on its foreign assets, while the value of its foreign liabilities, expressed in dollars, is more or less unchanged (see Figures 5 and 6). As a result, its NIIP improves. On the other hand, a stronger dollar has a negative impact on the US NIIP. As a rule of thumb, a 10% depreciation of the US dollar results in an improvement of the US NIIP by $1,000 billion. This means that the moment that markets start to worry about the US debt position, which may result in a weaker dollar, the problem for the US more or less solves itself. The rest of the world, of course, experiences a decline in value of their US assets.
As long as the US dollar remains the dominant global currency, the US has no need to worry much about its debt position. Only when markets would require the US to finance its deficits in foreign currency – as they did for a short period during the 1980s, when the US also borrowed in Japanese yen – might this situation change. But today, such a situation is far off. In spite of the US financial situation, there is simply no market with a size and liquidity comparable to the market for US treasuries. And anyway, currency risks can be hedged. For the time being, there is no serious competition from the euro or the renminbi, which actually plays a negligible role in world financial markets.
A weakening of the dollar quickly helps the US external investment position to improve, not so much via the traditional trade channel, but via currency gains on its foreign liabilities. The beneficial composition of its international assets and liabilities also helps to explain why its net international investment position is less negative than one would expect from looking only at the cumulative deficits on the current account. This second factor also explains why the US, in absolute figures the largest debtor country on the planet, still earns more capital income on its foreign assets than it has to pay on its foreign debt. On a net basis, the international debt position of the US is not a drag on the current account.
The conclusion is that, as long as it can finance its external obligations in dollars, the country’s international debt position is no cause for concern for the US. For the rest of the world, of course, the story may be different.
About the author:
* Wim Boonstra, Special Adviser, Raboresearch; Professor in Economic and Monetary Policy, Vrije Universiteit Amsterdam
ECB (2017), “The International position of the euro”, Frankfurt, July.
Hausmann, R and F Sturzenegger (2005), “‘Dark Matter’ Makes the US Deficit Disappear”, Financial Times, 8 December.
 In formula: NIIPt = NIIPt-1 + CAt
 So the correct formula is: NIIPt = NIIPt-1 + CAt + ktIAt-1 – ktILt-1