(December 11, 2012) – The United States manages to borrow more than it lends to rest of the world, while still bagging a net profit on its external position. But how?
Venerable economists including Milton Friedman have proposed that the solution might just be “a defect of the balance sheet figures.”
But two senior economists with the US Federal Reserve’s Board of Governors, Stephanie Curcuru and Charles Thomas, have ventured another answer: direct investment yields.
“A single asset class is responsible for the puzzle,” the authors assert in their study “The Return on US Direct Investment at Home and Abroad,” which was recently published as a discussion paper for the Fed’s Board of Governors. “Net income receipts in the BOP [balance of payments] owe entirely to a difference between the yields (income divided by the position) on direct investment claims and liabilities. The aggregate yield on US cross-border claims averaged 140 basis points per year higher than that paid on US cross-border liabilities from 1990 to 2010.”
The main driver of this spread, Curcuru and Thomas write, was foreign direct investment (FDI). The average yield received on US FDI claims abroad was 620 basis points per year higher than that paid on liabilities. In contrast, the authors continue, “for portfolio equity and debt the average yields on claims and liabilities were nearly identical. The overall yield advantage was enough to move the income balance in favor of US claims despite the large net liability position.”
Specifically, Curcuru and Thomas credit these America-favoring yields to compensation for taxes, risk, sunk costs, and age of investments/markets. The authors expect a spread of roughly 400 basis points between US direct investment abroad and foreign direct investments in the US to persist unless there is “a change in the underlying factors driving the difference—the perception of investment in the US as relatively safe and the relatively high US tax rate.”
The impending fiscal cliff may undermine the former condition, yet seems to all-but-guarantee the maintenance of second.
Read the entire paper here.