Thursday, September 4, 2014

The US Net International Investment Position (IIP)

The graph below shows the Net International Investment Position (IIP) as a share of GDP for the US, since 1976. The last report by the Bureau of Economic Analysis (BEA) is available here. Note that by the first quarter of the year the IIP corresponded to US$ 5.5 trillion, or slightly more than 30% of GDP.
The IIP position has been negative since the late 1980s, which is the reason why economists argue that the US is a debtor country. The negative position follows as a result of the persistent current account (CA) deficits, which imply that foreigners accumulate dollars and dollar denominated assets. A negative IIP means that foreigners have more financial claims on residents than vice versa, and is seen often as a problem for most countries.

The conventional view also suggests that CA deficits are not dangerous if they finance domestic investment, which leads to growth, and presumably higher exports, even though this is often not explained by mainstream authors that tend to forget that most countries borrow in foreign currency. In this case, in which the CA deficits allow for higher exports in the future, a negative IIP is seen as sustainable. On the other hand, if the CA is used to finance consumption, then the negative IIP would be unsustainable. Many analysts think that the US IIP is not sustainable and from time to time someone suggests that a run of the dollar is possible. For example, Paul Krugman famously predicted that a run on the dollar would eventually occur, what he termed a 'Wile E. Coyote moment,' in which agents holding dollars would finally get that the floor was gone, and the dollar would depreciate sharply (this was before the Lehman's collapse and the run for dollar denominated assets, and the appreciation of the dollar; subsequently the gradual depreciation of the dollar returned, but so far no Wile E. Coyote moment).

Some mainstream authors are also puzzled by the fact the US, in spite of having persistent CA deficits and a large and negative IIP, has consistently had a positive net investment income position. In other words, interest and profits resulting from holding foreign assets has exceeded the payments of income to owners of US assets. Hausmann and Sturzenegger argued creatively (let's call it that) that the reason for this 'paradox' is that the CA does not measure well the net international investment position, since insurance and liquidity services go unaccounted. Their adjusted measure to add those invisible services, which they refer to as 'dark matter'* would explain the paradox, and why the US IIP is sustainable after all.

Note, however, that once one takes into account that the US holds the reserve/vehicle currency much of the discussion about the dangers of the CA deficits, the sustainability of IIP and the paradox of the positive net investment income position sort of vanishes. US debts are in dollars, which implies that there is no possibility of default in a fiat system. Chartalism holds in the open economy too.

The US does not need to export to obtain dollars, and how it uses the accumulation of financial claims on the US by foreigners is not crucial for sustainability. Holding the key currency does NOT come without consequences, but those are not the ones often suggested by the mainstream. Certainly given US policy choices there has been a loss of industrial jobs in the Rust Belt, yet as noted in another post, not with a significant loss in terms of technological advantage for US corporations. The consequence, thus, of the hegemonic position of the dollar, together with other policy choices (e.g. financial deregulation, lower taxes for the wealthy, deregulation of labor markets, etc.) has been one that affected the balance between labor and capital domestically.

Also, there is no need for dark matter, or other neologisms, to understand why the US has positive net investment income flows. By definition, the key currency is the risk free asset, and hence investments denominated in other currencies must pay a risk premium. Yes, sure BOP accounts are imperfect, like NIPA or any other measure of the economy. But there is no need to revamp the BOP accounts to get that the US CA deficit and the negative IIP are not really unsustainable.

* Hausmann has a flair for coining terms for ideas or problems that were well known by heterodox authors, and to incorporate them inconspicuously in the mainstream discourse. He refers to the notion that developing countries cannot borrow long term in their own currency as "the original sin." Note that the original sin is exactly the notion suggested by Prebisch, Kaldor, Thirlwall and others, that argue that since these countries cannot borrow internationally, and must pay with exports in the long run, then the CA becomes a constraint for economic growth.

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