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Minyan Mailbag: Foreign Investments



Prof. Succo,

Wish I could get you out on the clay courts down here, the weather is mighty tasty! Perhaps just a walk along Coconut Grove's main drag to view the persistent illusion of luxury.

Seriously, I am muddling through this article my girlfriend gave me, and she suggested I forward it to you for further insight, as much as I would like to trust Harvard minds, I have my doubts!

Enjoy the Holidays sir!

Minyan William


"Dark Matter" was published in the FT last week and I commented on it. Let me do so again.

The article claims that the U.S. is really not a debtor nation because the net interest component of the current account "deficit" is the same as it was in 1980, a positive $30 billion. If the U.S. is a net debtor, how can it still be earning positive income between the assets it owns abroad and the liabilities it owes foreigners?

First as an aside, the net income has deteriorated since then as a percentage of GDP: it has dropped 16 to 29 percentage points depending on how it is measured.

But how can this still be. The total cumulative amount of traded goods bought by the U.S. versus what it has sold the world is now around $2.5 trillion. To make up this by definition, means that the U.S. owns $2.5 trillion assets less than the liabilities it owes. How can it be earning more on this small amount of assets relative to its liabilities?

The answer lies in the nature of the assets it owns versus the liabilities it owes. In a nutshell, the assets it owns, like equity and real estate, emerging market debt and companies, is far riskier than the liabilities it owes, like almost exclusively treasury debt. Secondly, the drop in the dollar has made the return (denominated in foreign currency) on those assets "look" much better, while making the interest paid on the debt we owe much better from our perspective as well.

U.S. investors own assets abroad because they are viewed as investments. They were bought with dollars exchanged into foreign currency. The dollar has fallen since 1980 against several currencies, so the capital gains when translated back into dollars looks great. Returns have also been market returns (real estate and companies).

Foreign investment in the U.S. is in treasuries. This foreign investment is done by central banks to facilitate low interest rates in the U.S. Returns are risk-free rates (very low) and there have been capital losses (e.g. the yen has appreciated against the yen).

So U.S. investment abroad looks smart and foreign investment in the U.S. has looked stupid. This is for good reason: U.S. investment in foreign assets makes sense, while foreign central bank investment in the U.S. doesn't.

The reason the world has put up so long with making stupid investments in the U.S. is because the U.S. has enjoyed the status of world reserve currency. This has simply meant that foreign central banks have been willing to make stupid investments in the U.S. (earning a negative return after currency translations) because they view the U.S. as driving growth. One main thing we have been asking is how long can they keep this up? We already see that foreign central banks are backing away from these bad investments: They are now trying to buy higher returning assets like stocks and real estate. I have said that if we let them, it may alleviate the imbalances over time without a back-breaking volatility event. So far, we don't know how protectionist we will act when it comes to that.

So the positive spin put on by the Harvard economists in the end supports the view that this situation cannot last. The deterioration is not evident in the explicit number of net interest, and that is why markets have not yet reacted violently. The deterioration is there nonetheless.


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