Thursday, July 05, 2007

Counter-intuitive fact regarding US net international investment position

Brad Setser says:
A paper that Dr. Roubini and I wrote in 2004 – a paper that incidentally is still by far the most popular thing I have ever helped to write – made this argument. We recognized even then that US had one big advantage than most emerging economies lacked: its liabilities are denominated in dollars, while many of its assets are denominated in foreign currencies (mostly the euro and loonie). That means that falls in the dollar improve the United States external position. The falling dollar increases the value of many US external assets without changing the value of (most) US external liabilities.
In the linked article Setser expands considerably on the subject of the US's net international investment position, but the main point of the post is that, contrary to Setser's predictions, "the US net international investment position has actually improved since the end of 2004." The prime reasons for that being due to the decrease in the dollar's value, and also due to the fact that
"Foreign equity markets – in terms of their own currency -- dramatically outperformed US equity markets – in dollar terms -- in both 2005 and 2006...

The implied return (in local currency terms) on US holdings of foreign stocks (portfolio equity) was 22.1% in 2005 and 18.4% in 2006. Throw in currency moves, which cut a bit over 7% off US returns in 2005 but added about 5.5% in 2006, and the gain -- in dollar terms -- on US holdings of foreign stocks in dollar terms was around 15% in 2005 and 24% in 2006.

That tops the 3.1% return foreigners got (in dollar terms) on US stocks in 2006, and their 13.2% return in 2006.

US equity investors abroad did about 12% better than foreign equity investors in the US in 2005 and about 11% better in 2006. They make it hard to argue (credibly) that the US can finance large deficits because the US is such a good place for investment ..."
The question of why foreign investment in the US has performed relatively poorly compared to the reverse is a complex one...perhaps US investment managers are more sophisticated than their foreign counterparts. Two examples of investment trends in the US that drew a lot of foreign capital in recent years are the dot-com boom and the recent residential housing boom. In both instances, I believe a significant amount of capital that drove over-investment in these sectors came from foreign sources who likely failed to perform enough investigation of their investments before forking over their cash.

1 comment:

CV said...

Hi Scott,

Nice that you picked up on this ... This is Brad Setser at his best in my opinio; very nice work. Especially since it is an important point about the relative clout of the US economy in a global context.