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Schmitt-Grohe, Uribe, Woodford, “International Macroeconomics” Slides for Chapter 1: Global Imbalances

Slides for Chapter 1

Global Imbalances

Columbia University

March 3, 2020

1


Motivation

Countries trade a lot with one another, and the United States is no

exception. This fact elicits a number of questions, such as

• How big are international transactions in goods, services, and fi-

nancial assets for the United States and other countries?

• Does the United States have a trade deficit or a trade surplus

with the rest of the world? What about China, Europe, and Latin

America?

• Is the United States an external debtor or an external creditor?

• How have the trade balance and the international asset position

of the United States and other countries evolved over time?

This chapter addresses these and other related questions.

2


Overview

The main focus of the present chapter is descriptive. In later chap-

ters, we will ask more positive questions such as

• Why are exports of goods and services larger or smaller than im-

ports of goods and services?

• Why do countries borrow from abroad?

• Can countries borrow forever?

• What determines the size of a country’s external debt?

3


The Geography of External Debt

Take a look at the heat map in slide 5. It displays with colors

the accumulated current accounts between 1980 and 2017. We

will define it more precisely, but roughly speaking, a country’s e

current account is the difference between exports and imports of

gods and services plus the difference between international receipts

and payment of interest, dividends, profits, etc. The map shows that

the country with the biggest accumulated current account deficit

(brightest red) is the United States. The countries that have been

financing these deficits (deepest green) are Japan, China, Germany,

and oil and gas exporting countries (members of OPEC, Russia, and

Norway).

Overall, the picture is one of unbalanced accumulated international

trade, with some countries running protracted current account deficits

and others running protracted surpluses. If all countries were in bal-

ance, the map would look pastel white. Instead, it looks mostly ei-

ther flaming red or dark green, reflecting large global imbalances.

4


Cumulative Current Account Balances Around the World

1980-2017, in billions of U.S. dollars

Notes. The map shows for each country the sum of current account balances in billions of U.S. dollars between 1980 and 2017. The data source is Philip R. Lane andGian Maria Milesi-Ferretti (2017), “International Financial Integration in the Aftermath of the Global Financial Crisis,” IMF Working Paper 17/115. Data for formerSoviet Union countries start in 1992. Countries for which no data are available appear in gray. Country names are displayed for the countries with the top 10 largestcumulated current account surpluses and deficits.

5


The International Transactions Accounts

In the United States, international transactions are recorded by the

Bureau of Economic Analysis (www.bea.gov) in the International

Transactions Accounts (ITA), also known as the Balance of Pay-

ments.

The balance of payments has three components:

1. current account

2. financial account

3. capital account (quantitatively unimportant)

In the following slides we will introduce each component.

6


The current account is the sum of three accounts:

current account = trade balance +

income balance +

net unilateral transfers

7


1. The Current Accounta. The Trade Balance

An important figure produced in the ITA is the Trade Balance,

which measures the difference between exports of goods and services

and imports of goods and services:

Merchandise Trade Balance = Exports of Goods − Imports of Goods

Service Balance = Exports of Services − Import of Services

Trade Balance = Goods Balance + Service Balance

Examples of traded goods: textiles, oil, cars, and wheat.

Examples of traded services: education, medical care, and consult-

ing.

8


The U.S. Trade Balance in 2016

Exports of goods and services: $2.2 trillion

Imports of goods and services: $2.7 trillion

Trade balance = $2.2-$2.7 = -$0.5 trillion

Is $0.5 trillion a big or small number?

Let’s relate it to the size of the U.S. economy. In 2016, GDP was

$18.6 trillion. Letting TB denote the trade balance, we have

TB2016

GDP2016= −

0.5

18.6= −0.027

or the 2016 trade deficit was 2.7 percent of GDP. Now is this a

small or a big number? Shortly, we will see how the accumulation of

trade deficits of this magnitude has turned the United States from

a creditor to the world’s largest debtor.

9


The U.S. Trade Balance Over Time

Is the size of the trade deficit in 2018 typical for the United States?

Look at the graphs in slides 11 and 12, showing the trade balance

since 1960, both in nominal terms and as a fraction of GDP.

The trade balance was practically nil between 1960 and the early

1980s. Since then, trade deficits grew steadily, reaching almost 6

percent of GDP just before the beginning of the Great Recession of

2007-2009. That recession was associated with an improvement in

the trade balance to around 3 percent, which has persisted to the

present.

10


The U.S. Trade Balance Over Time: 1960-2016

(in billions of dollars)

1960 1970 1980 1990 2000 2010−800

−700

−600

−500

−400

−300

−200

−100

0

100

Year

Bill

ions o

f dolla

rs

Data Source: BEA, bea.gov, ITA, Table 1.1. (December 19, 2017 release).

11


The U.S. Trade Balance as a Share of GDP: 1960-2016(in percent of GDP)

1960 1970 1980 1990 2000 2010−6

−5

−4

−3

−2

−1

0

1

2

Year

Perc

ent of G

DP

Data Source: BEA, bea.gov. TB data: ITA, Table 1.1. (December 19, 2017 release). GDP data:NIPA Table 1.1.5. (December 21, 2017 release).

12


The Income Balance

Another item of the Balance of Payments is the Income Balance,

which measures the difference between incomes received from the

rest of the world and incomes paid to the rest of the world. These net

income payments are recorded separately for capital and labor. Net

income from capital is called Net Investment Income and consists

of payments such as dividends, interest, and profits. Net income

from labor is called Net International Payments to Employees

and records earnings of U.S. residents temporarily employed abroad

and compensation payments to foreigners temporarily working in the

U.S. So we have that

Income Balance = Net Investment Income

+ Net International Payments To Employees

13


Net Unilateral Transfers

A third item in the Balance of Payments is Net Unilateral Trans-

fers, which keeps record of the difference between gifts received

from the rest of the world and gifts given to the rest of the world.

These gifts can involve private agents or governments:

Net Unilateral Transfers = Private Remittances

+ Government Transfers

14


The Current Account

The Current Account is the sum of the Trade Balance, the Income

Balance, and Net Unilateral Transfers:

Current Account = Trade Balance +

Income Balance +

Net Unilateral Transfers

The current account is an important concept because if the current

account is negative, all other things equal, the net external debt

of the country goes up, and if the current account is positive, the

external debt falls.

The table in slide 16 displays the values of the different components

of the Balance of Payments in the United States in 2016.

15


The Current Account of the United States in 2018

Billions PercentageItem of dollars of GDP

Current Account -488.5 -2.4Trade Balance -622.1 -3.0Balance on Goods -891.3 -4.3Balance on Services 269.2 1.3Income Balance 244.3 1.2Net Investment Income 258.1 1.3Compensation of Employees -13.8 -0.1Net Unilateral Transfers -110.7 -0.5Private Transfers -94.4 -0.5U.S. Government Transfers -16.2 -0.1

Data Source: Authors’ calculations based on data from ITA Tables 1.1 and 5.1. and NIPA Table1.1.5. of the Bureau of Economic Analysis.

16


Observations on the U.S. 2016 Balance of Payments

• In 2018, the United States ran a large current account deficit.

• The bulk of the current account deficit is accounted for by a large

trade balance deficit. The United States imports mostly low-tech

manufactured goods (textiles, electronics, etc.) and exports human-

capital-intensive services (higher education, R&D, health care, pro-

fessional consulting). Thus, the United States typically runs a trade

deficit in goods and a trade surplus in services.

• Net investment income is positive, which means that investments

of U.S. residents in foreign assets paid more in interest, dividends,

profits, than the investments of foreign residents in U.S. assets. Net

International Payments to Employees was negative but small.

• Net Unilateral Transfers were negative, which means that the

United States gave more gifts to the rest of the world than it re-

ceived. These gifts are mostly remittances of immigrants in the U.S.

to relatives living abroad.

17


In the United States, the Trade Balance and theCurrent Account Move in Tandem Over Time

We saw in the previous table that for the year 2018, the bulk of the

U.S. current account is the trade balance. The figures in slides 19

and 20 show that this is indeed true pretty much all the time.

18


The U.S. Trade Balance and Current Account, 1960-2018

(in billions of dollars)

1960 1970 1980 1990 2000 2010−900

−800

−700

−600

−500

−400

−300

−200

−100

0

100

Year

Bill

ion

s o

f d

olla

rs

TB

CA

Data Sources: BEA, bea.gov, ITA, Table 1.1. (December 19, 2017 release).

19


The U.S. Trade Balance and Current Account, 1960-2018

(in percent of GDP)

1960 1970 1980 1990 2000 2010 2020−6

−5

−4

−3

−2

−1

0

1

2P

erc

ent of G

DP

Year

TB/GDP

CA/GDP

20


The Trade Balance and the Current Account Also Often Move

in Tandem Across Countries

The following figure shows the current account (vertical axis) and

the trade balance (horizontal axis) as percentages of GDP for 88

countries in 2016. Each dot is one country.

The fact that most dots lie close to the 45-degree line indicates that

the trade balance and the current account comove closely across

countries. Countries with large trade balances tend to be countries

with large current account balances, and countries with small trade

balances tend to have small current account balances.

21


Trade Balances and Current Account Balances Across Coun-

tries in 2016

−10 −8 −6 −4 −2 0 2 4 6 8 10−10

−8

−6

−4

−2

0

2

4

6

8

10

China

MexicoIndonesia

Guatemala

Germany

USA

45o

100 × TB/GDP

100 ×

CA

/GD

P

Notes. TB denotes the trade balance andCA denotes the current account balance.The data source is World DevelopmentIndicators (WDI). There are 88 countriesincluded in the figure. Countries in theWDI database with trade balances or cur-rent account balances in excess of ± 10percent of GDP were excluded.

22


The previous figure also shows that the current account and the

trade balance need not both have the same sign (as it is the case in

the United States) and that the current account can be either larger

or smaller than the trade balance. Any sign pattern is possible, as

shown in the following table.

23


Trade Balance and Current Account as Percentages of GDP

in 2016 for Selected Countries

Country TB/GDP CA/GDP

China 2.2 1.8Germany 8.0 8.3Guatemala -7.8 1.5United States -2.7 -2.4Mexico -1.8 -2.2Indonesia 0.8 -1.8

Notes. TB denotes trade balance and CA denotes current account. Data Source. World Development Indicators, available online at databank.worldbank.org.

24


CA = TB + Income Balance + Net Unilateral Transfers

Germany:CA

GDP > TBGDP > 0 because Income Balance > 0. Germany is a net

creditor, so it receives interest income from the rest of the world.

Indonesia:TBGDP > 0 > CA

GDP because Income Balance < 0. Indonesia is a net

debtor, so it makes interest payments to the rest of the world.

Guatemala:TBGDP

< 0 < CAGDP

because Net Unilateral Transfers > 0. Guata-

malans working in the United States and elsewhere are sending

money home, resulting in Personal Remittances of about 10% of

GDP.

25


Who Trades With The United States?

The next figure shows that a sizable fraction of the U.S. merchandise

trade deficit is accounted for by its trade with China.

The fraction of the U.S. merchandise trade deficit accounted for by

deficits with China has increased steadily since China’s accession to

the WTO in 2001 from about 20 percent in the 1990s to close to

50 percent by 2016.

26


Figure 1.4: The U.S. Merchandise Trade Balance with China

1960 1970 1980 1990 2000 2010 2020−900

−800

−700

−600

−500

−400

−300

−200

−100

0

100

Year

Bill

ions o

f dolla

rs

Total

with China

Notes. The data source for the U.S. merchandise trade balance is U.S. International Transactions, Table 1.1. The data source for the bilateral merchandise tradebalance between the United States and China is the OECD, http://stats.oecd.org for the period 1990 to 2002 and U.S. International Transactions, Table 1.3 for theperiod 2003 to 2016. The vertical line marks the year 2001 when China became a member of the World Trade Organization.

27


The World Map of Current Account Balances

If the United States is running a large current account deficit, some

other countries must be running current account surpluses. Why?

Because it must be the case that:

CAUS + CAROW = 0,

where ROW stands for rest of the world.

So who is running big current account surpluses? Look again at the

heat map in slide 5.

28


The Net International Investment Position (NIIP )

A country’s Net International Investment Position (NIIP ) is the dif-

ference between its foreign asset position (A) and its foreign liability

position (L)

NIIP = A − L

If the NIIP is negative, then the country has an external debt, and

if the NIIP is positive, the country is a net creditor of the rest of

the world.

29


• Look at the figure in slide 31 . It shows the U.S. current account

(CA) for the period 1960 to 2018 and the U.S. net international

investment position (NIIP) for the period 1976 to 2018, both in

percent of GDP.

• The NIIP was positive at the beginning of the sample (1976).

• The large CA deficits of the 1980s brought the NIIP to negative

territory.

• Even larger CA deficits occurred during the 1990s, and the United

States ended that decade as the world’s largest external debtor.

• The CA deficits continued to increase until the onset of the Global

Financial Crisis (GFC) in 2007, reaching 6% of GDP.

• During the GFC, the CA deficits became smaller, but still sizable

at around 2.5% of GDP.

• By the end of 2018, the NIIP stood at -9.6 trillion dollars or -47

percent of GDP.

• A natural question (addressed in Chap. 2) is whether the U.S. CA

deficits are sustainable over time.

30


The U.S. Current Account and Net InternationalInvestment Position

1960 1970 1980 1990 2000 2010 2020−60

−40

−20

0

20

Year

NII

P,

pe

rce

nt

of

GD

P

1960 1970 1980 1990 2000 2010 2020−6

−4

−2

0

2

CA

, p

erc

en

t o

f G

DP

NIIP/GDP

CA/GDP

Notes. CA, NIIP , and GDP stand for current account, net international investment position, andgross domestic product, respectively. The sample period for CA is 1960 to 2018 and for NIIP1976 to 2018.

31


The Net International Investment Position (NIIP ) changes for two

reasons

∆NIIP = CA + valuation changes

where

CA= The Current Account

Valuation Changes= changes in the market value of the country’s

foreign asset and liability positions (due to currency appreciations or

depreciations, changes in stock prices, etc.)

32


We already looked at the U.S. current account data (slides 19 and

20). We saw that the current account has been in deficit since the

early 1980s. These current account deficits certainly contributed to

the deterioration of the NIIP .

Next let’s look at the second component, Valuation Changes.

The following example illustrates how valuation changes can have

significant effects on the size and even the sign of the NIIP.

33


Example

• International assets (A): 25 shares in Italian carmaker Fiat. The

price of each share is 2 euros. The exchange rate is 2 dollars per

euro. Then

A = 25 × 2 × 2 = 100 dollars.

• International liabilities (L): 80 U.S. bonds held by foreigners. Price

1 dollar per unit. Then

L = 80 × 1 = 80

• NIIP = A − L = 100− 80 = 20

• Depreciation of the euro: Now the exchange rate is 1 dollar per

euro. Then,

• A = 25 × 2 × 1 = 50

• L unchanged (sinse U.S. bods denominated in dollars)

• NIIP = A − L = 50 − 80 = −30.

• Conclusion: Just because of a change in the exchange rate, the

country went from being a creditor to being a debtor of the rest of

the world.

34


Example (cont.)

Suppose that the price of the Fiat share jumps to 7 euros. Then

• A = 25 × 7 × 1 = 175

• L unchanged.

• NIIP = A − L = 175 − 80 = 95 • A change in stockprices has an

effect on the country’s NIIP. In this example, the country went from

being a net debtor to being a net creditor.

• Conclusion: The above hypothetical examples illustrate how

a country’s net international investment position can display large

swings because of movements in asset prices or exchange rates. This

is indeed the case in actual data as well, as we’ll see next.

35


The Importance of Valuation Changes

Look at the figure in slide 37, which plots realized valuation changes

since 1976. It shows that

• Valuation changes can be large. We have observed valuations

changes as large as ±15 percent of GDP.

• large valuation changes are a recent phenomenon. Until the year

2003, the typical valuation change was ±3 percent of GDP.

• the United States experienced valuation gains more often than

valuation losses, 24 versus 16 times.

36


Figure 1.6: Valuation Changes as Share of GDP, 1977-2016

1975 1980 1985 1990 1995 2000 2005 2010 2015 2020−15

−10

−5

0

5

10

15

Year

Pe

rce

nt

of

GD

P

37


Valuation Changes Before and After theGlobal Financial Crisis (2007 to 2012)

• From 2002 to 2007, the U.S. cummulative CA deficit was 3.9

trillion (32% of GD)).

• Yet, the NIIP improved by 80 billion.

• This means that valuation changes during this period amounted

to more than 4 trillion. This is how:

(1) The dollar depreciated by 20%. This cause large positive val-

uation changes because U.S. assets are mostly in foreign currency,

whereas its liabilities are mostly in dollars.

(2) the stock markets in foreign countries significantly outperformed

the U.S. stock market: cummulative return from 2002 to 2007,

190% aborad and 90% in the United States. As a result, the U.S.

net equity position went from virtually nothing to 3 trillion.

• This came to a sudden stop in 2008 (look at the figure in slide 37):

that year, valuation changes were -15% of GDP, mostly from an

enormous drop in foreign stock markets.

38


Observations on the figure

Points above the 45-degree line correspond to years with positive

valuation changes and points below the 45-degree line to negative

valuation changes. 24 observations are above the 45-degree line and

16 are below.

If valuation changes were quantitatively unimportant, most observa-

tions should lie in a narrow corridor around the 45-degree line. The

graph shows that this is not the case. On the contrary, deviations

from the 45-degree line are both frequent and large. The largest

valuation changes (positive or negative) occurred after 2000 (red

dots).

39


A Hypothetical NIIP Without Valuation Changes

The figure in slide 41 answers this question. It plots the actual

U.S. NIIP and a hypothetical NIIP constructed by removing valu-

ation changes from the actual NIIP .

To construct the hypothetical NIIP for a given year, start with the

NIIP of the initial year, NIIP1976, and add all of the CA balances

from 1977 until the year of interest. For example, for 2016, the

hypothetical NIIP is given by

hypothetical NIIP2016 = NIIP1976+CA1977+CA1978+· · ·+CA2016

The figure in slide 41 plots the actual and hypothetical net interna-

tional investment positions over the period 1976 to 2018 in percent

of GDP.

40


Figure 1.8: Actual and Hypothetical U.S. NIIPs: 1976 to 2016

1975 1980 1985 1990 1995 2000 2005 2010 2015 2020−12

−10

−8

−6

−4

−2

0

2

Year

Trilli

ons o

f dolla

rs

Actual NIIP

Hypothetical NIIP

Notes. The hypothetical NIIP for a given year is computed as the sum of the NIIP in 1976 and the cumulative sum of current account balances from 1977 to theyear in question. Source. Own calculations based on data from the Bureau of Economic Analysis.

41


Observations on the Hypothetical NIIP

• Until 2002, the actual and hypothetical NIIP were not significantly

different from each other ⇒ valuation changes were not sizable.

• In 2002 the hypothetical NIIP s starts to at a much faster pace

than the actual NIIP⇒ large positive valuation changes.

• Without this lucky strike, the NIIP in 2007 would have been -46%

of GDP instead of the actual -9 percent.

• The reversal of fortune in the GFC broght the actual and hypo-

thetical NIIP almost as close to each other as before 2002.

42


One reason why have valuation changes become so large is

that Gross Positions Have Exploded since the 2000s

Take a look at the figure in the next slide

Why?

• Suppose in country x A = L = 1 and in country y A = L = 1000.

• Suppose GDP is 100 in both countries.

• Then, in both countries NIIP = 0% of GDP.

• Suppose the value of assets increases by 1% in both countries.

• This causes the NIIP to go from 0 to 0.1 in country x, and from

0 to 100 in country y. Thus, the NIIP increases by 0.1% of GDP in

country x and by 100% of GDP in country y.

43


Figure 1.7: U.S.-Owned Assets Abroad and Foreign-Owned Assets in the U.S.

1975 1980 1985 1990 1995 2000 2005 2010 2015 20200

20

40

60

80

100

120

140

160

180

200

Perc

ent of U

.S. G

DP

Year

U.S.−owned assets abroad

Foreign−owned assets in the United States

44


1.7 The Negative-NIIP-Positive-NII Paradox

45


Suppose you had a negative balance on your credit card. Would you

expect to receive interest payments from your credit card company

or to have to make payments to your credit card company? Probably

the latter.

Well, that is not what happens with the United States. Look at the

next figure. Even though the U.S. is the largest external debtor in

the world, it receives investment income from the rest of the world.

At the end of 2016, the U.S. net international investment position

stood at $-8.3 trillion, and its net investment income was $+0.2

trillion.

How can this paradoxical situation happen? Here are two suggested

explanations: Dark Matter and Return Differentials. After the

next figure, we will spell them out.

46


Positive Net Investment Income And Negative NIIP: A Paradox?

Figure 1.9: Net Investment Income and the Net International Investment Position,

United States 1976 to 2016

1975 1980 1985 1990 1995 2000 2005 2010 2015 2020−500

−400

−300

−200

−100

0

100

200

300

US

Ne

t In

ve

stm

en

t In

co

me

, $

bn

1975 1980 1985 1990 1995 2000 2005 2010 2015 2020−10000

−8000

−6000

−4000

−2000

0

2000

4000

6000

US

NII

P,

$b

n

NII (left)

NIIP (right)

Data Source: BEA, bea.gov, ITA, Table 1.1., (December 19, 2017 release).

47


What is plotted?

Solid (blue) line: Net Investment Income (NII), which are income

receipts on U.S. owned assets abroad minus income payments on

foreign-owned assets in the United States. [left scale, $bn]

Broken (red) line: Net International Investment Position (NIIP ),

which represents net foreign wealth of the United States. [right

scale, $bn]

Sample: 1976 to 2016.

Data Source: Bureau of Economic Analysis. NIIP : Table 1. International In-vestment Position of the United States at the End of the Period. NII: U.S. Inter-national Transactions Accounts Data, Table 1. U.S. International Transactions,Lines 13 and 30.

48


1.7.1 Explaining the NII-NIIP Paradox: (I) Dark Matter

The Dark Matter hypothesis maintains that in reality the U.S. net

international investment position is positive, but that the Bureau of

Economic Analysis fails to account for all of it.

Assuming this theory is valid, how much dark matter is there in the

NIIP? Let’s make a simple calculation. First some notation:

TNIIP = the ‘true’ net international investment position.

NIIP = the observed net international investment position (-9.6

trillion in 2018).

NII = net investment income (258.1 billion in 2018, see the table in

slide 16).

49


Net investment income is the return on the True Net International

Investment Position. So, letting r denote the interest rate, we have

NII = rTNIIP

Let’s take a value of r of 5% per year. Then solving for TNIIP we

have

TNIIP = NII/r =0.2581

0.05= 5.2 trillion dollars

Dark matter is simply the difference between the true and the recorded

NIIP s, or

Dark Matter = TNIIP - NIIP = 5.2−(−9.6) = 14.8 trillion dollars!in2018

50


So, according to the dark-matter theory, the U.S. doesn’t owe $9.6

trillion to the rest of the world. On the contrary, the rest of the

world owes $15.2 trillion to the United States.

$14.8 trillion of dark matter seems like a big figure to go unnoticed

by the BEA (and the IRS!).

51


1.7.2 Explaining the NII-NIIP Paradox (II): Return Differentials

This second explanation is motivated by the observation that the

gross international asset position of the U.S. is mostly composed

of risky but high-return assets, such as foreign stocks, whereas its

gross international liability position is composed of safer low-return

assets, such as U.S. government bonds (e.g., T-bills).

Let A continue to denote the U.S. international asset position and

L its international liability position. Then NIIP = A − L. Let rA be

the return on A, and rL the return on L.

The question is how large does the interest rate differential on assets

and liabilities, rA − rL, have to be to explain the paradox.

Start by noting that the NII must equal the difference between in-

vestment income and investment payments, that is,

NII = rAA − rLL.

52


Now let’s put some numbers. In 2018, the U.S. gross international

asset position was $25.3 trillion, and its gross international liability

position was $34.8 trillion. In addition, the average real rate of

return on U.S. T-bills, which we will use as a proxy for rL, was low,

2.25% per year. (Data from the FRB.) Finally, as we mentioned

earlier, NII was $258.1 billion. Thus, we set A = 25.3, L = 34.8,

NII = 0.2581, and rL = 0.0225.

We wish to find the value of rA that solves the paradox. To this

end, solve the above equation for rA

rA =NII + rLL

A=

0.2581 + 0.0225× 34.8

25.3= 0.0412

That is, rA = 4.12%, or an interest rate differential between the

U.S. foreign assets and liabilities of rA − rL = 1.9% per year. This

doesn’t look like an exorbitant premium.

53


Why is it that a relatively small interest rate differential suffices to

explain the NII-NIIP paradox?

Recall that gross asset and liability positions of the U.S. have become

very large relative to the net position (A = 25.3, L = 34.8). Hence

just a relatively small rate of return differentials can lead to a positive

NII even though the NIIP is negative.

54


The Flip Side of the Paradox

If the return-differential hypothesis is correct, then some country or

group of countries in the rest of the world must experience a flip

version of the paradox, that is, negative net investment income and

a positive net international investment position.

A natural candidate is China. This country holds large amounts of

U.S. government bonds, which are safe, earn low return. At the

same time, the rest of the world invest in more risky but higher

assets in China, such as stocks (FDI).

The next figure shows that this is indeed the case. Since 2000,

with the exception of the Great Contraction years (2007 and 2008),

China has displayed a positive NIIP and a negative NII.

55


Figure 1.10: Net Investment Income and the Net International Investment

Position, China 1982 to 2015

1980 1985 1990 1995 2000 2005 2010 2015 2020−100

−50

0

50

100

150

200

250C

hin

a N

et In

vestm

ent In

com

e, $bn

1980 1985 1990 1995 2000 2005 2010 2015 2020−1000

−500

0

500

1000

1500

2000

2500

Chin

a N

IIP

, $bn

NII (left)

NIIP (right)

Data Source: NIIP is from Lane and Milesi-Ferretti (2017) and NII is from imf.data.org.

56


Summing Up• The current account (CA) keeps record of a country’s net exports

of goods and services and net international income receipts.

• The CA has three components, the trade balance (TB), the in-

come balance, and net unilateral transfers.

• For most countries, including the United States, the TB is the

largest component of the CA.

• In the United States, the TB and the CA move closely together

over time.

• The United States have been running large CA deficits since the

early 1980s.

• CA deficits deteriorate a country’s net international investment

position NIIP, which is the difference between a country’s interna-

tional asset position and its international liability position.

• Due to its large CA deficits, the United States turned from being

a net external creditor to being the world’s largest debtor.

• A second source of changes in a country’s NIIP position is val-

uation changes, originating from changes in exchange rates and in

57

the price of the financial instruments that compose a country’s as-

set and liability positions. In the United States, valuation changes

became large in the early 2000s, reaching values as high as plus or

minus 15 percent of GDP in a single year.

• Paradoxically, the United States has a negative NIIP and posi-

tive net investment income (NII). Two stories aim to explain the

NIIP − NII paradox: the dark matter hypothesis and the rate-

of-return-differential hypothesis. The NIIP − NII paradox in the

United States must have a flipped paradox in the rest of the world.

We documented that China has had a positive NIIP and negative

NII since the 2000.

• Global Imbalances: Worldwide, the distribution of external debts

and credits is not even. Some countries, like the United States, are

large debtors and some, like China, are large creditors.

slides for chapter 1 global imbalances - columbia universitymu2166/uim/slides_bop.pdf ·...

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