Lesson 16: International Investment

Those of you with post-kindergarten training may or may not know that governments keep international trade statistics. Even some of our current presidential candidates know that.  These statistics are found in something called the Balance of Payments Accounts and are found at bea.gov . 

While there are two equally groovy parts to the BOP figures most politicians only know about one part of it, the Current Account. The Current Account is on the top and we wouldn’t expect those people to actually read all the way down to the bottom, right? They are busy people. Also the history of the world and the solar system has emphasized the Current Account so it would be unfair to criticize our politicians for only knowing about the Current Account.

This Current Account is where we publish statistics that have to do with exports and imports of goods and services. We sell Chevys to China and they sell rice and replicas of the Great Wall to us. It’s a cool deal. Some of our political leaders have noticed that our dear country almost always has a deficit in our Current Account. And that burns them. After all – the word “deficit” is not a nice word. If your teacher said you had deficits in your behavior, you would feel injured and probably never get a PhD in science or classical studies. This deficit in Current Account means that we are buying more stuff from other countries than they are buying from us. This is especially true of China and since we have a very long list of other issues with China, our politicians complain and sometimes cry that this deficit with China is worse than Dengue Fever and needs to be stopped.

I have written thousands of posts (I exaggerate all the time) which explain why Current Account deficits are not necessarily bad things and I don’t won’t to repeat all that minutia here. I see the Tuna is already starting to nod off.

This post is about the other part of the BOP Accounts – the part at the bottom that most people ignore. It is the part that our politicians don’t have a clue about. So you should feel very special that I am doing this for you today and send either money or JD to thank me.

The second part of the BOP account is called the Financial and Capital Account (F&C Account). What a name! Can you imagine being in the first grade and having a name like that? No wonder no one looks at this account. But this account is the coolest kid on the block and has a lot to tell us.

The F&C Account records all the financial trades between countries. We don’t usually call these import and exports – instead we talk about outflows and inflows. If China invests in America we call that an investment inflow. We like it when foreigners open up US bank accounts and when they buy our bonds, stocks, and companies. All of those financial inflows are recorded in our F&C Account. At the same time, we also like it when US citizens invest abroad. We usually call that diversification. You don’t want all your eggs in one basket and you don’t want all your investments in US bonds, stocks, etc.

When foreigners invest in America we call that an inflow. When US citizens invest abroad we call that a financial outflow. Globalization means that citizens around the world have become increasingly interested in investments both at home and abroad. 

So as a public service and hopefully for money and booze I will acquaint you with some of the financial flow numbers. Below I will refer to some numbers from a close cousin of the F&C Account called the International Investment Account or IIA (the F&C Account focuses on the one period flows between countries while the IIA reports the resulting total ownership positions). 

As it turns out, there are some looming risks associated with the IIA account that we should be worrying about. Unfortunately our leaders are playing with their bellybuttons and/or are unaware of these trends.

I went to the bea.gov web site and downloaded a spreadsheet of IIA information from 2000 to 2015. Here is some of the information from that download:

                                         2000   2007   2015

US Ownership of F. Assets   7.6    20.7    23.3   

F. Ownership of US Assets   9.2    22.0    30.6
Data is trillions of US dollars
F. stands for Foreign

This little table tells you the following:

·       Globalization of financial markets was very evident in the new century with foreign ownership more than tripling from 2000 to 2015.

·       Most of that increase came between 2000 and 2007.

·       Then the activity slowed – especially with respect to US ownership of foreign assets. After growing by $13.1 trillion in the first period, it grew by $2.6 trillion between 2007 and 2015.

·       Foreign ownership of US assets slowed as well but it still increased by almost $9 trillion between 2007 and 2015.

·       If we focus on the 2007 to 2015 time period we see a much wider gulf – foreigners owned $7.3 trillion more of us than we owned of them. Nearly all of that gap can be explained by what is called portfolio investment (in bonds and stocks). That gap was $1.6 trillion in 2000; $1.3 trillion in 2007; and then $7.3 trillion in 2015.

What’s going on? Why are foreigners so interested in our financial markets?

First, since the financial crisis, the US has done better economically than other countries. A relatively stronger economic profile means more confidence in our financial products. Think Greece, China, and Venezuela.  

Second, think US government deficits and debt that have supplied a lot of investment opportunities to both residents and foreigners. Foreigners gobbled up our huge pile of new government bonds!

Third, while foreign companies did increase their acquiring and merging with in US companies, most of the gap mentioned above came from investments in private bonds, government bonds, and equities.

Fourth, notice that despite the gap, US citizens have shown a strong and growing appetite for foreign bonds and stocks. Despite a financial crisis foreigners continued to buy US assets and Americans continued to buy foreign assets.

What do we make of all this? When the gap is favoring US assets, this implies two important things. First, people need dollars to buy US assets so this has strengthened the dollar. Second, when foreigners buy our assets this pushes our asset prices up and interest rates down. With the huge increases in national debt and the needs of firms to finance their investment projects, this asset demand from foreigners prevented our interest rates from rising/stocks falling and thus helped to keep the US economy growing.  

And this is what concerns me. What happens when things turnaround? What happens when other major countries strengthen and their assets look more desirable to global investors? What happens when our government increases its debt even more as foreigners desert US financial markets? Financial globalization made the US wealthier when the rest of the world was weak and uncertain. Financial globalization will have the opposite impact if the US grows weaker relative to Europe, Japan, China, and other countries. Our politicians have complained loudly about the Current Account Deficit. Just wait to see what happens when buckets of money leave the US to be invested elsewhere. Then we will be clamoring about deficits -- deficits in the F&C Account!