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The Pulse of Capitalism

Issue Number 04-1, April 2004

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International Comparisons
Business Activity Indicators
Financial Indicators - United States
Selected International Transactions - United States

United States International Investment Position

The last issue of the Pulse included selected data on the U.S. international investment position. This position has deteriorated steadily over a period of years, and economic observers should watch it closely.

The international investment position can be likened to an individual who lists his financial assets and financial liabilities, ending up with a net balance either positive or negative. The U.S. net investment position does this for the nation as a whole. It is compiled by the Bureau of Economic Analysis and published each year as of the end of the previous year (July, 2003 most recent). The Bureau uses two different ways to measure the item Direct Investment - current cost and market value. In this discussion direct investment will always be presented on the basis of current cost. The Bureau's table includes 43 different items; an abbreviated version is as follows:

International investment position of the United States
  • U.S. owned assets abroad
    • U.S. official reserve assets
      • Gold
      • Special drawing rights (a form of money used to settle claims among governments)
      • Reserve position in the International Monetary Fund
      • Foreign currencies
    • U.S. Government other than official reserve assets
      • U.S. credits and other long-term assets
      • U.S. foreign currency holdings and U.S. short term assets
    • U.S. private assets
      • Direct investment abroad
      • Foreign securities
      • U.S. claims on unaffiliated foreigners reported by U.S. non-banking concerns
      • U.S. claims reported by U.S. banks, not included elsewhere
  • Foreign-owned assets in the United States
    • Foreign official assets in the United States
      • U.S. Government securities
        • U.S. Treasury securities
        • Other
      • Other U.S. Government liabilities
      • U.S. liabilities reported by U.S. banks, not included elsewhere
      • Other foreign official assets
    • Other foreign assets
      • Direct investment in the United States
      • U.S. Treasury Securities
      • U.S. securities other than U.S. Treasury Securities
        • Corporate and other bonds
        • Corporate stocks
      • U.S. currency
      • U.S. liabilities to unaffiliated foreigners reported by U.S. non-banking concerns
      • U.S. liabilities reported by U.S. banks, not included elsewhere
Source: Survey of Current Business, July, 2003 (Additional material: Federal Reserve Bulletin, May, 2003)

These asset and liability classes respond to a variety of factors. Official assets are affected by world political considerations more than domestic economic ones. Bank and non-bank claims are volatile and temporary; they represent funds largely in a state of transition from one use to another; quarterly data may fluctuate considerably but not have much significance. Changes in direct investment and in holdings of stocks and bonds, however, reflect economic trends and investment flows, particularly those in the private sector. They can be viewed as a sensitive indicator of confidence in the U.S. economy, much like market valuation changes in stocks and bonds, and can cause wide swings in the investment position.

The past two decades

As already mentioned, the U.S. net investment position has trended downward since 1985, as shown in the graph. The decline accelerated since 1995 when the net position reached $-.5 trillion. By 1999 we had reached $-.8 trillion, and since then we have been in freefall to $-2.4 trillion in 2002. The changes affecting 2002 can be summarized as follows:

(in $millions) 2001 Financial Flows Valuation Adjustments 2002
Net Internat'l Investment Pos'n -1,979,906 -527,998 120,693 -2,387,211
  U.S. owned assets abroad 6,187,410 178,985 -177,204 6,189,191
  Foreign owned assets in U.S. 8,167,316 706,983 -297,897 8,576,402

The major factor affecting the net investment position was the difference in investment flows - over $.5 trillion more flowed into the United States than flowed out of it - and this difference had persisted for many years. Where have these financial flows been invested? This question can be answered by listing the main asset classes as follows:

Position in 2002
Asset Classes ($ millions) U.S. assets abroad Foreign assets in U.S.
Official assets other than official reserve assets 85,686 1,132,530
    Direct investment 1,751,852 1,504,428
    Portfolio investment (stocks & bonds) 1,846,976 3,364,745
    Claims reported by U.S. non-banks 890,961
    Claims reported by U.S. banks 1,455,114
    Liabilities reported by U.S. non-banks
    Liabilities reported by U.S. banks

The primary constituent of foreign official assets in the U.S. is U.S. government securities, commonly acquired as a result of purchasing U.S. dollars in order to support the home currency. U.S. direct investment abroad continues to exceed foreign direct investment in the U.S., but the difference has been shrinking. In portfolio investment, however, foreign holdings of U.S. stocks and bonds greatly exceed U.S. holdings of foreign stocks and bonds. Foreign activity in this area could potentially have great influence in U.S. markets. U.S. currency circulating abroad constitutes an interest-free loan to the Treasury since the Federal Reserve holds an offsetting amount of Treasury bonds on which most of the interest is returned to the Treasury. Claims and liabilities by U. S. non-banks and banks are almost offsetting.

Ownership of portfolio investment

U.S. investment: More than half of U.S. investment in foreign stocks is concentrated in Western Europe led by the United Kingdom, France, and Nether-lands. Other major holdings are in Japan, Bermuda, and Canada. U.S. holdings of foreign bonds are largest in Canada, the United Kingdom, Germany, and Japan.

Foreign investment: Foreign investment in U.S. stocks is concentrated in Western Europe, especially the United Kingdom, Germany, and Netherlands. Canada and Japan are also major investors. Foreign official and private holdings of U.S. Treasury securities are highest in Japan, China, and Hong Kong. Foreign holdings of U.S. corporate and agency bonds are highest in the United Kingdom (almost half), Japan, and Germany.

The current account

We compared the net investment position to an individual listing his assets and liabilities to find whether he was a net creditor or debtor. In the same way the current account can be compared to an individual listing his income and expenditures for a given year to determine whether he lived within his income or exceeded it. Like the net investment position, the current account has been negative for most of the past two decades. The balance for 2002 consisted of the following:

Balance on trade in goods $-482,872 million
Balance on trade in services 64,834 million
Balance on income - 3,970 million
Unilateral current transfers (gifts) - 58,853 million
Current account -480,861 million

The negative balance on goods exceeds the current account imbalance as the remaining items roughly offset each other. It is worth noting, however, that the balance on income was negative for the first time.

It is tempting to regard the negative net investment position as simply the consequence of our negative current account through the years. Under this assumption foreigners acquire U.S. dollars through trade and choose to invest them in U.S. assets. This raises the question of why don't these foreign investors invest their money at home for the benefit of their own people? Apparently they either do not find any promising opportunities at home or they do not consider their funds secure at home. In either case it underlines the fragility of world economic conditions.

If we look at the broad distribution of the U.S. current account deficit, we find that the 2002 deficit of $-481 billion was offset by a Japanese surplus of about $100 billion, a European Union surplus of about $50 billion, an Asian emerging market surplus of about $120 billion, and a statistical discrepancy (unexplained) of about $150 billion. This distribution does not agree particularly well with foreign ownership of U.S. portfolio investment. The United Kingdom is the leading single country investor in U.S. stocks and corporate bonds and agency bonds but has a large current account deficit of its own. Japan, however, is the largest investor in U.S. Treasury securities and also runs the world's largest current account surplus. These discrepancies underline the complexity of world financial flows.

The U.S. current account deficit is undoubtedly a significant contributor to the U.S. international investment deficit, but if we look for a mathematical relationship, we do not find one as shown in the following graph:

The graph shows that, on a yearly basis, there is little relationship between the current account balance and the yearly change in the net investment position. In some years they move in opposite directions and in others the movement of one greatly exceeds that of the other. In the 1980s the current account deficit consistently exceeded the yearly change in net investment, but since then the comparison is very mixed. Nevertheless, the cumulative amount of current account deficits since 1990 is $-2,455.1 billion compared with a cumulative increase in the negative net investment position of $-2,127.0 billion.

International Comparisons
Canada Germany Japan United Kingdom United States
GDP (% chg. one year ago)
    2001 (Q4)
0.9 -0.1 -1.9 1.6 0.5
    2002 (Q4)
3.9 0.5 2.8 2.2 2.9
    2003 (Q4)
1.6 0.2 3.4 2.8 4.3
Industrial Production (1997=100)
115.0 111.2 92.7 102.5 111.5
117.3 109.9 91.7 99.7 110.9
117.5 110.5 94.6 99.0 111.1
Retail Sales (volume chg. at annual rate)
5.7 -4.1 -4.4 5.7 6.5
1.4 -3.2 -3.0 6.4 4.9
    2003 @ Nov
2.1 @ -2.5 0.4 4.0 7.4
Consumer prices (1995=100)
169.1 144.8 120.1 203.6 177.1
172.9 146.7 119.0 207.0 179.9
177.7 148.3 118.7 213.0 184.0
Unemployment Rates
    2001 (Dec)
8.0 9.5 5.5 3.2 5.6
    2002 (Dec)
7.5 10.1 5.3 5.1 6.0
    2003 (Dec)
7.4 10.4 4.9 4.9 5.7
Interest Rates (3 months)
2.10 3.34 * --- 3.99 1.69
2.67 2.94 * --- 3.84 1.19
2.59 2.15 * * --- 3.74 .90
Stock Indices (ending)
7,688.41 5,160.10 10,542.62 5,217.40 10,021.50
6,614.54 2,892.63 8,578.95 3,940.40 8,341.63
8,220.89 3,965.16 10,676.64 4,476.90 10,453.92
Current Acc't Bal's ($bn) latest 12 months
18.9 10.2 91.2 -25.1 -393.7
11.0 50.4 115.0 -13.1 -480.9
18.5 56.3 136.0 -30.8 -541.8
Foreign Exchange Rates
1.55 0.90 * 121.57 1.44 125.91
1.57 0.95 * 125.22 1.50 126.75
1.40 1.13* * 115.94 1.63 119.28
Currency units per U.S. $
UK pound in U.S. $s
U.S. dollar: index of dollar against major trading partners, January 1997=100
* Euro area (US$/Euro)
Sources: Economist, Economic Indicators,
F.R. Bulletin, Survey of Current Business

The U.S. and Japan registered the best GDP performance in 2003 while Canada and Germany showed declines and Britain a small increase. Japan had the strongest gain in industrial production with minor changes up or down in the other four countries. Retail sales grew strongly in the U.S.

Consumer prices rose rather strongly in the U.S., Canada, and the U.K, while falling again in Japan, and rising a little in Germany. Improved production led to reduced unemployment rates except in Germany.

Short term interest rates fell in all countries except Japan which has a "zero interest rate" policy. This clearly indicates that economic activity remains weak. The stock indices, however, apparently indicate that growth will strengthen, with all five indices up significantly. The Canadian, Japanese, and U.S. indices exceeded both their 2001 and 2002 closing levels.

The Japanese current account surplus expanded to its best level in over six years, indicating a surge in exports that helped lift its economy. The U.S. deficit reached one half $trillion for the first time, equal to 4.9 percent of GDP. This external deficit along with the budget deficit led to a weakening of the U.S. dollar against the other four currencies in the table. The euro subsequently rose as high as $1.27 and the yen to 105 per dollar.

Business Activity Indicators - United States
2001 2002 2003
Industrial Production (1992=100) 111.5 110.9 111.1 *
    Capacity Utilization Rate (% total industry)
77.4 75.6 74.8
Manufacturers' New Orders (billions of $s) 322.9 316.7 329.2 #
New Construction Expenditures (billions of $s) 852.6 860.9 898.7 *
Real Gross Priv. Dom. Invest. (chained[1996]$s) 1,590.6 1,572.0 1,638.9
Business Sales - Mfg. & Trade (billions of $s) 818.8 823.3 858.8 #
Business Inventories (ending) (billions of $s) 1,145.7 1,169.3 1,191.7
Retail Sales (billions of $s) 262.8 270.5 285.2 #
Retail Inventories (ending) (billions of $s) 405.6 436.1 458.1
Per Cap. Personal Consump. Expend.'s (chained [1996] $s) 24,196 24,773 25,295 *
Nonagricultural Employment (millions) 131.8 130.3 129.9 #
    Goods Prod. (millions)
23.9 22.6 21.8 #
    Services Prod. (millions)
108.0 107.8 108.1 #
# Monthly average Source: Economic Indicators

Real GDP rose 3.1 percent in 2003 after rising 2.2 percent in 2002. The increase resulted mainly from an increase in nonresidential investment and in exports, partly offset by a decrease in inventories and a small downturn in consumer spending.

Industrial production accelerated in the last four months of 2003, particularly in durable goods. The capacity utilization rate declined slightly for the second successive year. Manufacturers' new orders also picked up beginning in September led by durable goods. New construction was strong throughout the year, easily reaching a new high. This strength was confined to residential and government expenditures as nonresidential building reached a six year low.

Real private investment increased in 2003 to the highest level since 2000; business investment in equipment and software as well as residential investment was responsible for the increase.

Business sales turned downin 2001 but turned up in 2002, and the upturn accelerated in 2003. Retail sales did not experience any decline over the past decade and accelerated more in 2003 than in the two preceding years. Business and retail inventory sales ratios are lower than they were in the late nineties.

Real per capita consumption expenditures also expanded every year over the past decade, and the 2003 increase was little changed from that in 2002.

Employment continues to be the weak point of the economy. Total employment fell 410,000 in 2003 after falling 1,485,000 in 2002. Goods producing employment again fell in 2003, but services picked up a bit, led by education and health. In January and February 2004, total employment increased 118,000, far below the gains registered in the late nineties.

Financial Indicators - United States
2001 2002 2003
National Income (billions of $s) 8,981.4 9,290.8 9,681.5 *
    Percent change
2.1 3.4 4.2
Per Cap. Disp. Personal Income (chained [1996]$s) 25,653 26,355 26,761
Avg. Real Gross Wkly Earnings (1982=100) 275.38 278.83 278.75
Gross Saving " 1,658.1 1,539.3 1,463.3 *
    Personal "
127.2 183.2 165.6
    Business "
1,463.0 1,599.5 1,717.6
    Government (all)"
67.9 -243.4 -419.9
Commodity Price Index (1995=100) 65.4 74.7 89.0
Producer Price Index (1982=100) 140.7 138.9 143.3
Corp. Profits (with i.v.a.&c.c.a.) (billions of $s) 770.4 904.2 1,061.2
Interest Rates - 10 year Treas. 5.02 4.61 4.01
Money Supply - M3 (ending) " 8,012.2 8,540.6 8,813.6
    Percent change
12.8 6.6 3.2
Commercial Bank Credit (ending) " 5,438.8 5,895.4 6,254.7
Consumer Credit (ending) " 1,822.2 1,902.7 2,001.8
Credit Market Debt (ending) " 29,408.8 31,699.2 34,449.2
    Household Sector "
7,722.4 8,498.1 9,401.2
    Total bankruptcy filings (thousands)
1,491.7 1,576.1 1,659.6
Sources: Economist, Economic Indicators, F.R. Bulletin, F.R. Flow of Funds, Administrative Office of the U.S. Courts

National income grew more in 2003 than in 2002 with the two strongest sectors being Compensation of employees and Corporate profits, both of which benefited from tax reductions.

Real per capita income grew 1.5 percent in 2003 after growing 2.7 percent in 2002 despite additional tax cuts. Real weekly earnings declined eight cents after rising $3.45 in 2002; consumer price inflation accelerated in 2003.

Gross saving again fell in 2003 as the government sector reached negative $419.9 billion. In the corporate sector, the capital consumption adjustment rose to $228.2 billion from $64.5 billion in 2001.

The commodity price index rose sharply in 2003 and early 2004 due to high oil prices and high metals prices resulting from strong demand in Asia. The weakening dollar is also a factor since most commodities are priced in U.S. dollars. The finished producer goods price index rose 4.4 points after falling in 2002. The strongest sector was nondurable goods while the weakest was durables.

Corporate profits rose more in 2003 than in 2002, primarily in the nonfinancial sector. The capital consumption adjustment lowered profits before tax by $228.2 billion. The ten year Treasury bond rate finished the year lower despite a spurt toward year end which carried through January and February 2004. The 4.01 rate was the lowest since 1963, reflecting the excess of funds relative to investment demand.

The 3.2 percent increase in the money supply in 2003 was the lowest since 1994. Nonfinancial debt growth, on the other hand, accelerated to 8.1 percent, the highest since 1994. This divergence is difficult to interpret. Commercial bank credit expanded less than in 2002 with the increase centered in securities and real estate. Commercial and industrial loans again declined. Consumer credit grew more than in 2002 but less than during 1999-2001.

Credit market debt expanded 8.7 percent, the fastest since 1998. Federal, home mortgage, and financial debt each grew 10 percent or more. Business debt grew only 3.9 percent. These increases provided the backdrop for the economic rebound in the second half of 2003. The question now is whether this growth can be sustained to maintain the recovery or whether it will create payment problems on the part of debtors that can not be met.

Total bankruptcy filings in 2003 increased 83,429 to a total of 1,659,562.

Selected International Transactions - United States
2001 2002 2003
Trade Balance on Goods & Services ($bns) -357.8 -418.0 -490.2
    Goods "
-427.2 -482.9 -549.4
    Services "
69.4 64.8 59.2
U.S. Owned Assets Abroad, net [inc/capital outflow(-)] " -349.9 -179.0 -277.7
Foreign Owned Assets in US, net [inc/capital inflow(+)] " 765.5 707.0 856.7
    Net change in US Int'l Inv. Pos'n "
415.6 528.0 579.0
Net change in Foreign Owned U.S Securities
    Treasury Securities & Cy Flows "
27.1 160.8 285.0
    Other U.S. Securities "
433.2 325.5 268.8
Sources: Economic Indicators, Survey of Current Business

The U.S. trade balance on goods and services deteriorated about the same amount in 2003 as in 2002 - roughly $70 billion. The deficit on goods increased to more than one half $trillion while the surplus on services declined $5 billion from 2002 and $10 billion from 2001. Exports rose 1.9 percent in 2003 after falling 2.4 percent in 2002. Imports rose 3.7 percent in 2003 after rising 3.3 percent in 2002.

U.S. owned assets abroad picked up almost $100 billion in 2003 after a sharp drop in 2002, but foreign owned assets in the U.S. increased $150 billion. As a result, the U.S. net investment position deteriorated over one half $trillion for the second successive year and is now approaching -$3 trillion.

There were two noteworthy developments in foreign owned U.S. securities. One was the large increase in purchases of U.S. Treasury issues. About half of these purchases were due to foreign official purchases as a result of their currency intervention operations while the other half was due to private purchases. Together, the purchases financed more than one half of the federal budget current deficit. The other noteworthy development was a further decline in foreign purchases of U.S. securities other than Treasuries to the lowest level in three years.

Copyright © Andrew Caughey, 2004

The Pulse of Capitalism is published quarterly. Comments may be sent to Pulse Publication, P.O. Box 140, Gibsonia, PA 15044. Telephone: (724) 443-2396
Material may be reprinted with acknowledgement of the source. Economic statistics are revised routinely and may, therefore, differ from one report to another.

Published April 2004

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