Evolution of US NIIP

The United States is getting deeper into debt - but not in the way we think The United States is a debtor towards the rest of the world by a substantial amount of more than $14’000 billion at the end of 2020 (65% of GDP),1 according to statistics published last week. If the trade deficit of the last 40 years plays an important role in explaining this situation, the rapid deterioration of the last 5 years is due to the evolution of the financial markets, in particular the stock markets. How has the US debt evolved? The \"net international investment position\" statistics give us the value of US assets abroad, as well as the assets of foreign investors in the US. The difference between the two is the net position. These figures cover all categories of investments (direct investments by multinationals, stocks, bonds, bank positions). The figure below shows the evolution of this position since 1980 (red line). If the United States was then a creditor to the rest of the world, this situation changed rapidly and it has become a debtor since the end of the 1980s. The dynamics have notably accelerated since 2015, with the net position rising from 41% to 65% of GDP. Net international investment position (% GDP) 20% 10% 0% 1980 1985 1990 1995 2000 2005 2010 2015 2020 -10% -20% -30% -40% -50% -60% -70% Net international position Cumulated current account balance At first glance, this is not surprising: the United States has been running a current account deficit for the past 40 years, which has led it to live on credit and thus increase its liabilities. But this 1 Relative to 2019 GDP. Considering 2020 GDP would artificially inflate the figure due to the temporary sharp drop in GDP.

is by far not the only reason. The blue line shows the value of the net position if we add up the current account deficits since 1980. The line goes down, not surprisingly, and currently reaches a value (54%) quite close to the net position. But we see large gaps between the two lines, especially since 2000. Between 2000 and 2007 the blue line fell sharply, as the current account deficit was high, while the red line rose. In 2007 the gap between the two represented one third of GDP. Between 2007 and 2015, the gap narrowed somewhat (10% of GDP in 2015), mainly because the red line fell more rapidly. Since then, the blue line has remained stable, with the current account deficit offset by GDP growth, while the red line has fallen sharply. Why these differences? Simply because the current account deficit is not the only factor. One also has to take into account fluctuations in stock and bond market prices, as well as in the exchange rate. They affect the value of assets, and thus the net position, without any transactions taking place. For example, since U.S. assets are largely denominated in foreign currencies, while liabilities are denominated in dollars, a strengthening of the dollar leads to a decrease in the net position because it reduces the dollar value of assets denominated in euros or yen. The figure below illustrates these valuation effects. The black line shows the change in the net position. This is broken down into financial flows (the current account balance, green bars), valuation effects due to changes in the price of securities (blue bars), and those due to exchange rate movements (red bars). Sources of changes in the net international position (% GDP) 15% 10% 5% 0% -5% -10% -15% -20% -25% 2005 2010 2015 2020 2000 Financial flows Valuation from asset prices Valuation from exchange rate Other Total change

We see that valuation effects are important. Prior to 2007, the US made gains due to strong stock markets and a weakening dollar. Since then, market movements have led to losses. This is due to the better performance of the U.S. market relative to others, resulting in larger valuation gains on U.S. liabilities than on assets. The strengthening of the dollar between 2013 and 2015 was a source of losses, but its weakness since then has generated gains, especially in 2020. Profound changes in portfolio structure Let's focus on the evolution since 2015, which saw a sharp decline in the net position. This examination shows a strong heterogeneity across asset classes, as shown in the figure below. Over these years, the total decline in the net position represents 35% of the annual GDP (first column), mainly due to losses in value because of exchange rates (blue bar). The weakening of the dollar led to gains (red bars). Sources of changes since 2015 (% GDP 2019) 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% -40% Total FDI + stocks Bonds (total) Treasury Other (incl. bonds Banks) Financial flows Valuation from asset prices Valuation from exchange rate Other Total change This change is seen primarily in the categories of direct investment (holdings of multinationals in their subsidiaries) and equity investment, both of which are represented by the second column. While the net position in bonds, including Treasury bonds, and in bank positions also declined (last three bars), this reflects only the flows of purchases of U.S. securities by foreign investors (green bars).

How can we explain the sharp losses in value of direct investment and equity positions? The better performance of U.S. markets than foreign ones plays a role, but it does not explain everything. Another factor is a major change in the structure of the U.S. net position. The figure below shows the net position by category. Until 2015, the U.S. was somewhat in the position of a leveraged investment fund, combining a debtor position in bonds (blue line) and a creditor position in direct investments and equities (red line). Since equities offer a higher return than bonds, this helped to offset some of the trade deficit. In addition, when stock markets were rising around the world, the U.S. enjoyed value gains because of its creditor position. Net international position by category (% GDP) 30% 20% 10% 0% 1985 1990 1995 2000 2005 2010 2015 2020 1980 -10% -20% -30% -40% -50% FDI + stocks Bonds (total) Treasury bonds Other (incl. Banks) The situation has changed dramatically since then. While the debtor position in bonds has remained stable (with investment from abroad being offset by GDP growth), the position in direct investment and equities has deteriorated sharply, and has become a sizable negative position. A global stock market recovery will therefore now result in losses for the US.