The Assets and Liabilities of the World’s Biggest Debtor
We saw earlier that the current account balance measures the flow of new net claims on foreign wealth that a country acquires by exporting more goods and services than it imports. This flow is not, however, the only important factor that causes a country’s net foreign wealth to change. In addition, changes in the market price of wealth previously acquired can alter a country’s net foreign wealth. When Japan’s stock market lost three-quarters of its value over the 1990s, for example, American and European owners of Japanese shares saw the value of their claims on Japan plummet, and Japan’s net foreign wealth increased as a result. Exchange rate changes have a similar effect. When the dollar depreciates against foreign currencies, for example, foreigners who hold dollar assets see their wealth fall when measured in their home currencies.
The Bureau of Economic Analysis (BEA) of the U.S. Department of Commerce, which oversees the vast job of data collection behind the U.S. national income and balance of payments statistics, reports annual estimates of the net international investment position of the United States—the country’s foreign assets less its foreign liabilities. Because asset price and exchange rate changes alter the dollar values of foreign assets and liabilities alike, the BEA must adjust the values of existing claims to reflect such capital gains and losses in order to estimate U.S. net foreign wealth. These estimates show that at the end of 2012, the United States had a negative net foreign wealth position far greater than that of any other country.
Until 1991, foreign direct investments such as foreign factories owned by U.S. corporations were valued at their historical, that is, original, purchase prices. Now the BEA uses two different methods to place current values on foreign direct investments: the current cost method, which values direct investments at the cost of buying them today, and the market value method, which is meant to measure the price at which the investments could be sold. These methods can lead to different valuations because the cost of replacing a particular direct investment and the price it would command if sold on the market may be hard to measure. (The net foreign wealth data graphed in Figure 13-2 are current cost estimates, which are believed to be more accurate.)
Table 13-3 reproduces the BEA’s account of how it made its valuation adjustments to find the U.S. net IIP at the end of 2012. This “headline” estimate values direct investments at current cost. Starting with its estimate of 2011 net foreign wealth (-$3,730.6 billion), the BEA (column a) added the amount of the 2012 U.S. net financial flow of -$439.4 billion—recall the figure reported in Table 13-2. Then the BEA adjusted the values of previously held assets and liabilities for various changes in their dollar prices (columns b, c, and d). As a result of these valuation changes, U.S. net foreign wealth fell by an amount smaller than the $439.4 billion in new net borrowing from foreigners—in fact, U.S. net foreign wealth only declined by $133.3 billion. The BEA’s 2012 estimate of U.S. net foreign wealth, therefore, was -$3,863.9 billion.
This debt is larger than the total foreign debt owed by all the Central and Eastern European countries, which was about $1,240 billion in 2012. To put these figures in perspective, however, it is important to realize that the U.S. net foreign debt amounted to about 25 percent of its GDP, while the foreign liability of Hungary, Poland, Romania, and the other Central and Eastern European debtors was about 67 percent of their collective GDP! Thus, the U.S. external debt represents a much lower domestic income drain.
Changes in exchange rates and securities prices have the potential to change the U.S. net foreign debt sharply, however, because the gross foreign assets and liabilities of the United States have become so large in recent years. Figure 13-3 illustrates this dramatic trend. In 1976, U.S. foreign assets stood at only 25 percent of U.S. GDP and liabilities at 16 percent (making the United States a net foreign creditor in the amount of roughly 9 percent of its GDP). In 2012, however, the country’s foreign assets amounted to roughly 138 percent of GDP and its liabilities to roughly 163 percent. The tremendous growth in these stocks of wealth reflects the rapid globalization of financial markets in the late 20th century, a phenomenon we will discuss further in Chapter 20.
Think about how wealth positions of this magnitude amplify the effects of exchange rate changes, however. Suppose 70 percent of U.S. foreign assets are denominated in foreign currencies, but all U.S. liabilities to foreigners are denominated in dollars (these are approximately the correct numbers). Because the 2012 U.S. GDP was around $15.7 trillion, a 10 percent depreciation of the dollar would leave U.S. liabilities unchanged but would increase U.S. assets (measured in dollars)
by 0.1
0.7
1.38 = 9.7 percent of GDP, or about $1.5 trillion. This number is approximately 3.4 times the U.S. current account deficit of 2012! Indeed, due to sharp movements in exchange rates and stock prices, the U.S. economy lost about $800 billion in this way between 2007 and 2008 and gained a comparable amount between 2008 and 2009 (see Figure 13-2). The corresponding redistribution of wealth between foreigners and the United States would have been much smaller back in 1976.
Does this possibility mean that policy makers should ignore their countries’ current accounts and instead try to manipulate currency values to prevent large buildups of net foreign debt? That would be a perilous strategy because, as we will see in the next chapter, expectations of future exchange rates are central to market participants’ behavior. Systematic government attempts to reduce foreign investors’ wealth through exchange rate changes would sharply reduce foreigners’ demand for domestic currency assets, thus decreasing or eliminating any wealth benefit from depreciating the home currency.