2.8: International Investment Position

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Learning objectives

1. Learn how to define and interpret a country’s international investment position.
2. Understand how the international investment position is updated from year to year.

A country’s international investment position (IIP) is like a balance sheet in that it shows the total holdings of foreign assets by domestic residents and the total holdings of domestic assets by foreign residents at a point in time. In the International Monetary Fund’s (IMF) financial statistics, these are listed as domestic assets (foreign assets held by domestic residents) and domestic liabilities (domestic assets owned by foreign residents). The financial account balance, whose counterpart is the current account balance, is more like an income statement that shows the changes in asset holdings during the past year. In other words, the financial account balance consists of flow variables since it records changes in the country’s asset holdings during the year, while the international asset position of a country consists of stock variables since it records the total value of assets at a point in time.

A country’s net international asset position may be in surplus, deficit, or balance. If in surplus, then the value of foreign assets (debt and equity) held by domestic residents exceeds the value of domestic assets held by foreigners. Alternatively, we could say that domestic assets exceed domestic liabilities. This country would then be referred to as a creditor country. If the reverse is true, so that domestic liabilities to foreigners exceed domestic assets, then the country would be called a debtor country.

Asset holdings may consist of either debt obligations or equity claims. Debt consists of IOUs (i.e., I owe you) in which two parties sign a contract agreeing to an initial transfer of money from the lender to the borrower followed by a repayment according to an agreed schedule. The debt contract establishes an obligation for the borrower to repay principal and interest in the future. Equity claims represent ownership shares in potentially productive assets. Equity holdings do not establish obligations between parties, at least not in the form of guaranteed repayments. Once ownership in an asset is transferred from seller to buyer, all advantages and disadvantages of the asset are transferred as well.

Debt and equity obligations always pose several risks. The first risk with debt obligations is the risk of possible default (either total or partial). To the lender, default risk means that the IOU will not be repaid at all, that it will be repaid only in part, or that it is repaid over a much longer period of time than originally contracted. The risk of default to the borrower is that future borrowing will likely become unavailable. The advantage of default to the borrower, of course, is that not all the borrowed money is repaid. The second risk posed by debt is that the real value of the repayments may be different than expected. This can arise because of unexpected inflation or unexpected currency changes. Consider inflation first. If inflation is higher than expected, then the real value of debt repayment (if the nominal interest rate is fixed) will be lower than originally expected. This will be an advantage to the borrower, who repays less in real terms, and a disadvantage to the lender, who receives less in real terms. If inflation turns out to be less than expected, then the advantages are reversed. Next, consider currency fluctuations. Suppose a domestic resident, who receives income in the domestic currency, borrows foreign currency in the international market. If the domestic currency depreciates, then the value of the repayments in domestic currency terms will rise even though the foreign currency repayment value remains the same. Thus currency depreciations can be harmful to borrowers of foreign currency. A similar problem can arise for a lender. Suppose a domestic resident purchases foreign currency and then lends it to a foreign resident (note that this is the equivalent of saving money abroad). If the domestic currency appreciates, then foreign savings, once cashed in, will purchase fewer domestic goods and the lender will lose.

The risk of equity purchases arises whenever the asset’s rate of return is less than expected. This can happen for a number of different reasons. First, if the equity purchases are direct investment in a business, then the return on that investment will depend on how well the business performs. If the market is vibrant and management is good, then the investment will be profitable. Otherwise, the rate of return on the investment could be negative. All the risk, however, is borne by the investor. The same holds true for stock purchases. Returns on stocks may be positive or negative, but it is the purchaser who bears full responsibility for the return on the investment. Equity purchases can suffer from exchange rate risk as well. When foreign equities are purchased, their rate of return in terms of domestic currency will depend on the currency value. If the foreign currency in which assets are denominated falls substantially in value, then the value of those assets falls along with it.

The U.S. International Investment Position

The United States is the largest debtor nation in the world. This means that its international investment position is in deficit and the monetary value of that deficit is larger than that of any other country in the world. The data for the U.S. international investment position in 2008 are available in this U.S. BEA international investment position spreadsheet.The data for the U.S. international investment position are available from the Bureau of Economic Analysis, International Economic Accounts, International Investment Position, at www.bea.gov/international/xls/intinv08_t1.xls. At market values the preliminary estimate for 2008 is that the U.S. was in debt to the rest of the world in the amount of $3.469 trillion. (Refer to cell I22 in spreadsheet.) Excluding financial derivatives that refer to interest rate and foreign exchange contracts, the United States was in debt in the amount −$3.628 trillion (cell I24).

Note that this valuation is the U.S. “net” investment position, meaning that it is the difference between the sum total value of foreign assets owned by U.S. residents (U.S. assets abroad) minus U.S. assets owned by foreigners (foreign-owned assets in the United States). The first of these, U.S. assets abroad, represents our purchases of foreign equities and money we have lent to foreigners. The total value stood at $19.888 trillion in 2008 using market value methods (cell I26). The second, foreign-owned assets in the United States, represents foreign purchases of U.S. equities and money foreigners have lent to us or, equivalently, that we have borrowed. The total in 2008 stood at$23.357 trillion (cell I50).

The size of the U.S. debt position causes worry for some. Thirty years ago the United States had a sizable creditor position. However, as a result of trade deficits run throughout the 1980s and 1990s, the United States quickly turned from a net creditor to a net debtor. The changeover occurred in 1989. In the early 1990s, the size of this debt position was not too large compared to the size of the economy; however, by the late 1990s and early 2000s, the debt ballooned. In 2008, the U.S. debt position stood at 24.6 percent of GDP, which interestingly is down slightly from 24.9 percent of GDP in 2002 despite annual current account deficits since then. The reason for these changes is changes in the valuations of assets, as reflected in stock market prices, real estate price changes, and changes in the exchange rate.

Notice in the 2008 BEA IIP spreadsheet that the investment position is derived from the 2007 position in the following way. First, the current account deficit caused an addition to U.S. external debt of $505 billion (cell D22). Changes in asset prices both here and abroad further increased U.S. external debt by$720 billion (cell E22). This could be because either real estate prices abroad fell by more than in the United States or security prices abroad fell by more than in the United States. Next, there was another increase of $583 billion in external U.S. debt because of changes in exchange rates. In this case, an appreciation of the U.S. dollar increased the values of foreign-held U.S. assets and reduced the value of U.S.-held foreign assets. Finally, U.S. external debt decreased by$479 billion due to other factors that don’t neatly fit into the first two categories. (See footnote 2 in the BEA IIP spreadsheet.)

For several reasons, the debt is not a cause for great worry, although it is growing quickly. First, despite its large numerical size, the U.S. international debt position is still less than 25 percent of its annual GDP. Although this is large enough to be worrisome, especially with a trend toward a future increase, it is not nearly as large as some other countries have experienced in the past. In Argentina and Brazil, international debt positions exceeded 60 percent of their GDPs. For some less-developed countries, international debt at times has exceeded 100 percent of their annual GDP.

A second important point is that much of our international obligations are denominated in our own home currency. This means that when international debts (principal + interest) are paid to foreigners, they will be paid in U.S. currency rather than foreign currency. This relieves the U.S. from the requirement to sell products abroad to acquire sufficient foreign currency to repay its debts. Many other countries that have experienced international debt crises have had great problems financing interest and principal repayments especially when bad economic times make it difficult to maintain foreign sales.

Finally, it is worth noting that, despite the name applied to it, our international “debt” position does not correspond entirely to “debt” in the term’s common usage. Recall that debt commonly refers to obligations that must be repaid with interest in the future. Although a sizable share of our outstanding obligations is in the form of debt, another component is in equities. That means some of the money “owed” to foreigners is simply the value of their shares of stock in U.S. companies. These equities either will make money or will not be based on the success of the business, but they do not require a formal obligation for repayment in the future.

key Takeaways

• The IIP measures the difference between the total value of domestic holdings of foreign assets and the value of foreign assets held in the domestic country. If the IIP is negative, we say the country is a debtor country. If the IIP is positive, we say the country is a creditor country.
• Asset holdings include both debt and equities. Debt involves an obligation to repay principal and interest, whereas equities involve either profit or loss to the foreign asset holder.
• The U.S. IIP stands at \$3.5 trillion in 2008, making the United States the largest debtor nation in the world.

Exercise

1. Jeopardy Questions. As in the popular television game show, you are given an answer to a question and you must respond with the question. For example, if the answer is “a tax on imports,” then the correct question is “What is a tariff?”

• A complete record of a country’s holdings of foreign assets and foreigners’ holdings of domestic assets at a point in time.
• The term describing a country whose total domestic assets held abroad exceed total domestic liabilities held by foreigners.
• The term describing a country whose total domestic liabilities held by foreigners exceed total domestic assets held abroad.
• The name for the type of asset that establishes an obligation for the borrower to repay principal and interest in the future.
• The name for the type of asset that represents ownership shares in potentially productive assets.