Net foreign assets and liabilities 1970-2013
by William Baunton
Fri 21 Nov 2014
What the chart shows: The net foreign assets, measured as a percent of GDP, of Spain, Italy, US, France and UK from 1970 to 2013.
Why it is important: The external balance sheet of a country is an important dimension of global imbalances, possibly still more so than current accounts. The issue has been highlighted by the IMF in its latest World Economic Outlook in October. Economies with large net liability positions are more susceptible to disruptive external financial market conditions. Both in the global financial crisis, and in the subsequent euro area upheaval, large debtor economies showed greater vulnerability to sovereign debt problems and experienced ‘sudden stops’ when market sentiment changed.
The volume of net foreign assets is usually a slow moving variable, as it shows an imbalance in stocks, rather than in flows, as measured by current accounts. This is underlined by the relatively small changes in the list of top debtor and creditor economies between 2006 and 2013. The notable changes are the rise of France to among the Big Six debtors (in net dollar terms) in 2013, and the improvement in the UK’s position from the third biggest net debtor in 2006 to outside the Top 10 in 2013. France’s net foreign liability position has deteriorated from a mere 1.3% in 2006 of GDP to 20.6% in 2013.
Imbalances in global flows peaked as long ago as 2006. Yet global stock imbalances have continued to grow. This shows that the trend of international financial integration has not reversed, as some might have expected following the global financial crisis. In fact the narrowing of flow imbalances has not produced a narrowing of stock imbalances. A combination of prolonged low inflation and stagnant growth, seen currently in the euro area, contributes to a rising debt-to-GDP ratio via the ‘snowball effect’. Government borrowing costs increase, leading to austerity measures which in turn depress growth, causing higher government spending.
If capital flows had indeed reversed, which has not the case, then by definition stock imbalances would have decreased; in fact this has not happened, since capital markets and official lenders are plugging the gaps. Valuation effects can play an important role, too. In the case of the UK, the main cause of its substantial fall in net foreign liabilities, from 30.6% of GDP in 2006 to a mere 5.0% in 2013, stemmed from significant valuation effects. These can cause marked changes in asset positions, regardless of flows, and make an important contribution to an economy’s international investment position (IIP). Among the most important component of valuation changes are fluctuations in currencies, and in equity and bond prices. Since the gross assets in question can be many times the size of national GDP, relatively small changes in relative currency valuations, and capital gains or losses on the value of assets held at home and abroad, can have substantial effects on net foreign assets.
The UK’s net liability position has improved, since the value of assets held abroad by UK investors has risen (in sterling terms) substantially more than the value of assets in the UK held by foreign investors – partly because sterling has devalued in the 2006-13 period.
In a similar way, but with the opposite effect, the US net liability position has deteriorated sharply, from 14.2% of GDP in 2006 to 34.0% in 2013, since the value of assets invested by foreigners in the US over that period has appreciated by more than the value of investments abroad by US residents (partly because of the relatively strong performance of the dollar and of US financial markets). The high relative attractiveness of the US as a home for investments from all over the world explains the apparently paradoxical consequence of the last few years: even though the US debtor position has greatly deteriorated, America’s status as the No 1 reserve currency base has been further solidified.
The continued predominance of the dollar may well be tested in coming years, because the international economy as a whole faces challenging times. The IMF predicts stock imbalances will rise from the current level of 40% of world GDP to 45% by 2019, enforcing the need for increased international focus on this issue and a coordinated effort to curtail this trend.