The world's greatest debtor nation?

The World's Greatest Debtor Nation? ROBERT EISNER and PAUL J. PIEPER ABSTRACT The widely repeated assertion that the United States has become "the world's greatest debtor nation" is based on reports of its "net international investment position." This position relates not exclusively to debt but rather to the difference between net United States claims to foreign assets and net foreign claims to United States assets. Major portions are equities and direct investment, the latter valued at "book" or original cost. Estimates of the current value of direct investment, either market value on the basis of share prices or replacement cost, effect huge asymmetric adjustments. As United States direct investment abroad is generally much older, it has appreciated much more than foreign direct investment in the United States. With adjustments as well for the market value of gold and for bad debts, it is estimated that the United States net international investment position was more or less in balance at the end of 1987 and in only relatively small deficit at the end of 1988.

"The United States has become the world's greatest debtor nation." This statement has been repeated so often by pundits, politicians, and economists as to become an article of faith. For better or for worse, simply enough, the statement is not true. Indeed, not only is the United States hardly the world's greatest debtor nation; in literal terms, it is not a "debtor nation" at all.

THE OFFICIAL INTERNATIONAL INVESTMENT POSITION OF THE UNITED STATES The basis for the assertion that the United States has become the world's greatest debtor nation is, presumably, periodic releases of the Bureau of Economic Analysis (BEA) of the United States Department of Commerce and associated articles and tables published in the Survey of Current Business (June issues), or perhaps press reports on those releases. These data, however, as the BEA explains (see Bame 1985), indicate not net debt but rather the "international investment position of the United States. ''~ As shown in Table 1, an abbreviated presentation for selected years of the last two decades, what the BEA reports are values in dollars of United States assets abroad and of foreign assets in the United States. The bottom line is the "net international investment Robert Eisner • NorthwesternUniversity,Evanston,Illinois60208, and Paul J. Pieper • Universityof Illinois at Chicago, Chicago, Illinois 60680. North American Review of Economies & Finance, 1(1):9-32

ISSN 1042-752X

Copyright© 1990 by JAI Press, Inc. All rights of reproduction in any form reserved.

EISNER AND PIEPER

10 TABLE1.

Official U . S . International I n v e s t m e n t Position, Selected Years (billions of dollars) 19~

19~

1~0

165.4

295.1

607. I

949.7

1253.7

U.S. official reserve assets Gold Other~

14.5 11.1 3.4

16.2 11.6 4.6

26.8 11.2 15.6

43.2 I1.1 32.1

47.8 11.1 36.7

U.S. govt. assets abroad b

32. I

4 I. 8

63.8

87.6

85.5

U.S. private assets abroad Direct investment Foreign securities U.S. bank claims Other,

118.8 75.5 20.9 13.8 8.5

237.1 124.1 34.9 59.8 18.3

516:6 215.4 62.7 203.9 34.7

818.9 230.3 ! 12.2 447.4 29.0

1120.4 326.9 156.8 603.8 32.9

106.9

220.9

500.8

1061. I

1786.2

U.S. assets abroad

Foreign assets in the U.S.

19~

1~8

Foreign official assets

26.2

86.9

176. I

202.7

322.1

Foreign private assets Direct investment U.S. securities U.S. bank liabilities Other,

80.8 13.3 36.0 22.7 8.8

134.0 27.7 49.9 42.5 13.9

324.8 83.0 90.2 121.1 30.4

858.4 184.6 289.8 354.5 29.5

1464.1 328.9 490.2 609.5 35.5

58.5

74.2

106.3

- 111.4

-532.5

Net international investmentposition of the United States

aConsistsof foreigncurrency,specialdrawingrights, and the reservepositionin the InternationalMonetaryFund. bPrimarilyU.S. governmentloans. cPrimarilytradecredit and loansby nonbankingconcerns.

position of the United States," the difference between the sum of the values of all United States assets abroad and the sum of the value of all foreign assets in the United States, measured in dollars. It is important to note that a major portion of "United States assets abroad" involves claims in foreign currencies, while virtually all of the "foreign assets in the United States" entail claims in dollars. Thus, the usual vision of a debtor nation forced to run export surpluses if it is to service its foreign debt in dollars or other alien currency does not apply to the United States. The obligations are in dollars, and if foreigners want payment of interest or principal in their own or any other currencies they have to find their own countrymen, or others with these other currencies, to take over their dollar holdings. Further, both United States and foreign, are in the nature of equity, not debt. In no sense then can the reported net investment position be called "net debt." The BEA has been reporting the net international investment position of the United States on a consistent basis since 1970. As may be seen in Table 2, that net position moved from an initial positive figure of $58.5 billion to plus $140.9 billion at the end of 1981. It then declined to minus $111.4 billion by the end of 1985, to minus $267.8 billion at the end of 1986, to minus $378.3 billion (revised by the BEA from the $368.2

The World's Greatest Debtor Nation?

TABLE 2.

11

U.S. Net International Investment Position by Type of Asset, 1970-1988 (billions of dollars)

Year

Reserve assets"

U.S. govt. assets ~

Direct investment

Stocks and bonds ~

Bank claims

1970 1971 1972 1973 1974

Other

-3.2 -32.2 -39.9 -39.9 - 42.8

30.4 32.9 34.7 36.4 35.6

62.2 68.8 75.0 80.8 84.9

- 15.1 - 18.0 -24.5 -19.6 - 8.3

- 15.5 -6.4 -9.0 -11.8 - 14.0

-0.3 0.4 0.7 2.1 3.1

58.5 45.5 37.0 47.9 58.5

1975 1976 1977 1978 1979

-50.2 -59.6 -93.3 - 118.3 -97.6

37.6 37.1 39.3 41.5 45.7

96.4 106.0 I 11.4 120.3 133.4

- 15.0 - 17.8 -9.4 -9.1 - 16.0

1.0 10.4 14.4 29.8 16.2

4.4 7.4 10.3 12.1 12.8

74.2 83.6 72.7 76.1 94.5

1980 1981 1982 1983 1984

- 105.6 - 110.6 -116.5 - 121.0 - 123.3

50.4 55.6 60.9 65.3 69.9

132.3 119.6 83.1 70. I 46.9

-27.6 -30.4 -43.4 -64.3 -96.6

52.4 101.4 151.6 130.6 107.4

4.2 5.2 1.1 8.2 - 1.0

106.3 140.9 136.7 89.0 3.3

1985 1986 1987 1988

-117.0 - 147.5 - 190.4 -228.6

71.8 71.6 73.0 71.3

45.6 39.4 36.2 -2.0

-177.6 -268.5 -275.9 -333.5

66.1 27.8 -23.8 -37.1

-0.4 9.5 1.8 -2.6

-111.4 -267.8 -378.3 -532.5

Total

aU.S. official reserve assets less foreign official reserve assets in the U.S. bU.S. government loans less all U.S. government liabilities to foreigners other than Treasury securities. Treasury securities held by foreign governments are listed under reserve assets; Treasury securities held by other foreigners are included under stocks and bonds. "U. S. private holdings of stocks and bonds (both government and corporate) less foreign private holdings of U.S. stocks and bonds.

billion first reported) at the end of 1987, and finally to minus $532.5 billion at the end of 1988. It was the original 1987 figure that initially brought the deafening chorus of "world's greatest debtor nation" complaints. A breakdown of the components of the net investment position by type of assets indicates that the big movement to large negative numbers has been in the categories of official assets and "United States securities," or stocks and bonds. The former, corresponding chiefly to the huge increase in foreign official reserves or foreign central bank holdings of dollars (essentially special Treasury obligations), moved from $26.2 billion in 1970 to $322.1 billion in 1988, as shown in Table 1, "Foreign official assets." The United States official reserves remained relatively modest, including a virtually constant $11 billion component of gold, viewed presumably as convertible to foreign currencies and hence an offset to foreign holdings of dollars. The major positive categories were private United States direct investment, holdings of foreign securities, and United States bank claims. The big story we have to tell is that direct investment is measured at cost and not current value. Reasonable estimates for current values of United States direct investment abroad and foreign investment in the United States, along with current values of gold, make all the difference.

12

EISNER AND PIEPER

THE INTERNATIONAL INVESTMENT POSITION AT CURRENT VALUES One of the better known and more important aphorisms in economics is, "Bygones are bygones." What is relevant to economic activity and well-being is not the original purchase price of an asset or what was originally put into a company. What must matter, to an economy and to economic analysis, is the current value of assets and liabilities, what they are worth to their holders or what they can be bought and sold for in the market. The original cost of acquisitions, however, is the more usual stuff of accounting, and it is this cost that is recorded in the case of direct investment, both that of the United States abroad and of the rest of the world in the United States. The BEA reports the value, in dollars, of all United States investments abroad. Hence for direct investment as well as for other assets, changes in exchange rates will alter dollar values of United States holdings abroad from their original dollar costs. But the B E A - - i n accordance with general accounting practice, it should be acknowledged--does not adjust direct investment for changes in own-currency values. Thus the exchange rate gains and losses are calculated only on the original values of investments, and both the own-currency changes in value and, in the case of United States nondollar investment, the exchange rate gains or losses on those own-currency changes in value are not included. By way of illustration, suppose IBM invested $10 million dollars in Japan in 1984 when the dollar was worth 250 yen. Assuming that all of IBM's Japanese affiliate's assets and liabilities are denominated in yen and that there was no reinvestment of earnings, with the dollar in 1988 at about 125 yen, the original 2.5 billion yen investment was, at original cost, now worth $20 million. That $10 million capital gain was reported by the BEA and turned up in the value of United States direct investment in Japan. But suppose further that the 2.5 billion yen IBM affiliate in Japan in 1988 was worth 5.0 billion yen, which current exchange rates translated into $40 million. Neither the gain in value in yen of the Japanese investment nor the exchange gain on that gain was included. The BEA carried the IBM direct investment at $20 million rather than the actual current value of $40 million. One might suppose that the failure to report such capital gains or to include the stock of direct investment at current value would operate equally in its effects on United States investment abroad and on foreign investment in the United States. In fact, two important factors make this not the case. First, the appreciation of own-currency prices and values has generally been greater in the rest of the world than in the United States. Second, as may be noted in Table 3, United States direct investment in the rest of the world is older, while foreign direct investment in the United States has, on average, been more recent. The mean age of United States direct investment at the end of 1988 was 11.9 years, but that of foreign direct investment in the United States only 5.1 years. In terms of cumulative flows, 59.2 percent of United States direct investment took place before 1980; 82.8 percent of foreign direct investment in the United States took place from 1980 on. The combination of these factors effects a much greater upward revaluation of United States direct investment abroad than of foreign investment in the United States. The consequence for the United States net international investment position is then considerably compounded in the years 1985 to 1987 by the fall in the dollar, more than one-third on a (not entirely relevant) trade-weighted basis. The very substantial appreciation of the value of United States direct investment measured in foreign currencies contributed to a further gain in values in dollars as a consequence of the increase in value of each unit

The World's Greatest Debtor Nation ?

TABLE 3.

Period

13

Direct Investment Capital Outflows, by Various Periods Total direct investment capital outflows (billions of dollars)----~ U.S. to Foreign Foreign to U.S.

1950-59 ~ 1960-69 1970-74 1975-79 1980-84 1985-88

31.1 42.2 43.4 79.4 29.3 106.1

6.3 5.1 10.3 30.5 93.2 158.4

Mean age (years) Median age (years)

11.9

5.1

10.3

3.6

Percentage of total capital outflows, ~ 1950-1988 U.S. to Foreign Foreign to U.S.

9.4 12.7 13.1 24.0 8.8 32.0

2.1 1.7 3.4 10.0 30.7 52.1

"Includes the 1950 stock of direct investment.

of foreign currency. As foreign direct investment in the United States is in dollars, there is no offsetting increase in foreign claims on the United States. 2 We have undertaken to adjust measures of the value of direct investment to reflect both the appreciation in terms of own currencies and the further exchange-rate effects on that appreciation. 3 As shown in the following pages, we have done so in fairly detailed fashion on a country-by-country basis and have put together year-by-year aggregates going back to 1950. The critical issue is how to estimate current values of the stocks of direct investment. We have addressed this by two methods: a market price valuation based on share or equity prices and a replacement cost valuation based on price indices of capital goods or, failing that, of gross domestic product. By either method, we will note, we find adjustment of the value of direct investment to current price goes far toward wiping out the "net debtor" position of the United States.

Market Value Adjustment For the market price adjustment we have utilized share price indices, in dollars, constructed by Morgan Stanley International. Changes in per-share market values reflect, however, not only revaluations of existing assets but also retained earnings. We developed series on retained earnings as a ratio of market price from Morgan Stanley International series of price-earning ratios and dividend yields. These series were applied in order to isolate changes in the market values of companies, aside from changes that may be ascribed to retained or reinvested earnings. Such a series on net changes in value of companies enables us to estimate changes in the value of stocks of direct investment by adding new flows to the revalued existing stocks. Essentially, then, writing Av as the relative change in value of a unit of the stock of direct investment, we have: K, = (I + Av,)* K,_ / + 1,,

(1)

where K denotes the end-of-year stock and I the net flow of direct investment. Beginning

14

EISNER AND PIEPER

with the assumption that initially, in 1950, market value equals book value, we develop recursively the subsequent market-value series for each country. 4 There is, it must be said, one critical assumption underlying this method: Changes in the market values of United States direct investment are similar to changes in market values of shares as indicated by stock market transactions. One may of course doubt, in view of the rash of takeovers and bidding wars for American companies, with stock quotations suddenly moving widely from those on the usual daily transactions, whether prices on traded shares ever give a reliable measure of value of a firm's equity. A further complication for us is the question of whether aggregate share price indices, reflecting stocks in large numbers of domestic companies, offer a reasonable measure of the values of the companies or shares of companies in which United States firms have made direct investment. A hypothesis of equal ignorance may help sustain the assumption that on balance this method neither overestimates nor underestimates the market value of United States direct investment abroad. That said, however, it must be admitted that, accurate or not, our market-value estimates based on share prices mirror the sometimes extreme fluctuations in stock markets over the world. Table 4 reveals that, despite some year-to-year fluctuations, the market value of United States direct investment in the rest of the world, as estimated from share price indices, was consistently greater than book values after their assumed equality in 1950. By 1980 the difference had reached a magnitude of $81.6 billion. That difference dipped as the United States economy drifted into recession, falling to $32.0 billion at the end of 1982. It then soared to $313 billion by the end of 1987 and to a high of $422 billion by the end of 1988. We estimated the market value of United States direct investment at this point as some 2.3 times the book value carried by BEA. The breakdown of these estimates for 1987 and 1988 by country, shown in Tables 5A and 5B, is revealing. Some 29 percent of the difference between market and book values is accounted for by Japan. Another 14 percent of the difference in 1987 and 18 percent in 1988 is attributable to developing countries in Asia, 9 and then 8 percent to Latin America, and 12 and then 8 percent to the United Kingdom. The figures for Japan are suggestive of another phenomenon of some interest that has generally escaped attention, the existence of an offset in changing capital values to the current account deficits and corresponding capital surpluses that have seemed to dominate political discussion. It suggests that much of what countries may gain in trade surpluses and consequent acquisition of foreign assets, they may lose in the market values of their international investment position. The United States nominal current-account deficits may be offset by increasing dollar values of United States investment in the countries with which the deficit is greatest.

Replacement Cost Adjustment Our replacement-cost method of getting at current values is essentially similar to the market-value method. Instead of using changes in share price indices to arrive at Av in equation 1, we use investment-goods price indices (usually the fixed-investment implicitprice deflator) or, where it is not available, the gross domestic product implicit-price deflator, sometimes supplemented, to extrapolate for missing years, by consumer price indices. Replacement costs related to investment-price deflators are used in the United States to prepare estimates of current capital stocks and capital consumption. Replacementcost capital estimates thus offer the advantage of historical experience. They also show

The World's Greatest Debtor Nation?

TABLE 4.

15

Total U.S. Direct Investment Abroad, 1950-1988 (billions of dollars) Direct investment ~ Market Replacement value value

<--Ratio to book value o f ~ Market Replacement value value

Year

Book value

1950 1951 1952 1953 1954

11.785 12.979 14.721 16.253 17.631

11.789 14.669 16.882 17.907 23.865

11.789 13.890 16.429 18.148 19.389

1.000 1.130 1.147 1.102 1.354

1.000 1.070 1.116 1.117 1.100

1955 1956 1957 1958 1959

19.395 22.505 25.394 27.409 29.827

30.039 33.742 32.076 41.973 50.315

21.673 26.112 29.868 32.591 35.704

1.549 1.499 1.263 1.531 1.687

1.117 1.160 1.176 1.189 1.197

1960 1961 1962 1963 1964

31.865 34.717 37.276 40.736 44.480

51.811 62.385 57.347 66.572 76.474

38.620 41.610 44.595 49.705 52.585

1.626 1.797 1.538 1.634 1.719

1.212 1.199 1.196 1.220 1.182

1965 1966 1967 1968 1969

49.474 51.792 56.560 61.907 68.093

81.732 75.822 90.322 110.823 109.134

59.793 66.990 72.430 79.882 90.504

1.652 1.464 1.597 1.790 1.603

1.209 1.293 1.281 1.290 1.329

1970 1971 1972 1973 1974

75.480 82.760 89.878 101.313 i10.078

109.150 127.901 170.525 155.190 111.525

105.765 124.659 143.957 186.297 229.909

1.446 1.545 !.897 1.532 1.013

1.401 1.506 1.602 1.839 2.089

1975 1976 1977 1978 1979

124.050 136.809 145.990 162.727 187.858

149.894 160.790 167.842 204.666 249.052

256.351 281.933 321.700 381.064 455.004

1.208 1.175 1.150 1.258 1.326

2.066 2.061 2.204 2.342 2.422

1980 1981 1982 1983 1984

215.375 228.348 207.752 207.203 211.480

296.970 256.034 239.765 290.343 283.650

521.709 521.960 493.357 469.930 446.920

1.379 1.121 1.154 1.401 1.341

2.422 2.286 2.375 2.268 2.113

1985 1986 1987 1988

229.748 259.562 307.983 326.900

404.310 563.212 621.001 748.894

502.031 587.705 706.780 747.144

1.760 2.170 2.016 2.291

2.185 2.264 2.295 2.285

a greater year-to-year stability, as rates of inflation are generally highly autocorrelated. Replacement-cost estimates suffer deficiencies, though, in at least two major respects. First, the current value of many firms or of their direct investments may have little to do with the replacement cost of the bricks and mortar and machinery that went into them. Much may not be worth replacing or would be replaced, if market conditions indicated, with quite different asset mixes. Second, values of firms and their direct investments may

EISNER AND PIEPER

16

TABLE 5A. Book Value, Market Value, and Replacement Cost of U.S. Direct Investment by Country, 1987 (billions of dollars)

Region

Developed countries Australia Belgium Canada France Germany Italy Japan Netherlands Norway Switzerland United Kingdom Other Developed

Book value

Direct investment ~ Market Replacement value value

Market minus book

Replacement minus book

232.690 11.143 7.544 58.377 11.771 24.792 9.008 14.671 14.361 3.844 19.518 42.031 15.630

450.403 13.103 21.741 73.881 21.540 34.553 20.910 105.172 16.636 3.720 27. 148 79.272 32.727

526.093 24.646 16.814 108.723 29.135 58. 160 22.945 27.052 28.710 7.725 45.579 108.987 47.616

217.713 1.960 14.197 15.504 9.769 9.761 11.902 90.502 2.275 - 0.124 7.630 37.241 17.097

293.403 13.503 9.270 50.346 17.364 33.368 13.937 12.381 14.349 3.88 I 26.061 66.956 31.986

70.678 44.907 4.488 4.589 16.694

146.368 73.622 6.513 5.114 61.118

142.259 96.827 13.060 5.607 26.766

75.690 28.715 2.025 0.525 44.424

71.582 51.920 8.572 1.018 10.072

4.617

24.230

38.428

19.612

33.811

Total U.S. Direct investment

307.983

621.001

706.780

313.018

398.797

Foreign Direct investment in U.S.

271.788

309.338

269.131

37.550

- 2.657

Net U.S. Direct investment position

36.195

311.663

437.648

275.468

401.453

Developing Countries Latin America Africa Middle East Asia Internationala

alncludes direct investment not categorized by country.

have relatively little to do with the price of their fixed calSital. Much more goes into the value of a firm than its physical a s s e t s - - t h e skills of its management and workers, its technology and stock of investment in research and development, its location, and its market position. Even, with respect to fixed capital, movements of aggregate indices may differ substantially from those of the prices or values particular to the capital goods relating to the direct investment with which we are concerned. Despite these deficiencies, replacement cost estimates, so familiar in series on tangible wealth, would seem to warrant major, if not prime, focus in producing estimates of current values of direct investment. Our estimates of the aggregate of United States direct investment abroad, evaluated on the basis of capital-goods replacement costs are also shown, for the years 1950 to 1988, in Table 4. Again assumed equal to book value in 1950, they diverged in an upward direction at a fairly steady pace until 1980, at which point the replacement-cost estimates exceeded book values by 142 percent or $306.3 billion. The relative differences then declined with the great increase in the value of the d o l l a r - - o r decline in the relative values of foreign currencies--through 1984. By the end of 1987, however, after the significant dollar decline, the value of United States direct investment in the rest of the

17

The World's Greatest Debtor Nation ?

TABLE 5B. Book Value, Market Value, and Replacement Cost of U.S. Direct Investment by Country, 1988 (billions of dollars)

Region

Book value

Direct investment ~ Market Replacement value value

Market minus book

Replacement minus book

Developed countries Australia Belgium Canada France Germany Italy Japan Netherlands Norway Switzerland United Kingdom Other Developed

245.498 13.058 7.980 61.244 12.495 21.673 9.075 16.868 15.367 3.834 18.672 47.991 17.241

530.376 17.473 32.406 82.492 28.769 36.960 22.347 141. 142 18.408 5.083 25.857 81.131 38.307

541.879 32.368 15.832 125.779 27.830 50.326 22. 162 28.234 29.634 7.761 38.659 116.241 47.052

284.878 4.415 24.426 21.248 16.274 15.287 13.272 124.274 3.041 I. 249 7. 185 33.140 21.066

296.381 19.310 7.852 64.535 15.335 28.653 13.087 11.366 14.267 3.927 19.987 68.250 29.811

Developing countries Latin America Africa Middle East Asia

76.836 49.284 4.602 4.090 18.860

190.823 84.307 6.264 4.718 95.534

166.657 ! 16.398 14.870 5.260 30. 129

113.987 35.023 I. 662 0.628 76.674

89.821 67.114 10.268 1.170 I 1.269

4.565

27.695

38.609

23.130

34.044

Total U.S. direct investment

326.900

748.894

747.144

421.994

420.244

Foreign direct investment in U.S.

328.851

389. 121

337.704

60.270

8.853

Net U.S. direct investment position

- 1.951

359.773

409.440

361.724

411.391

International"

alncludesdirect investmentwhichis not categorizedby country.

world, by our replacement-cost method, came to $706.8 billion dollars, an excess of $398.8 billion over the BEA book-value estimate of $308.0 billion. This $398.8 billion, it may be noted, more than balances the entire $378.3 billion book-value deficiency in our international accounts reported by the BEA. The replacement-cost estimate of United States direct investment at the end of 1987 was 129 percent greater than the reported book-value figure. At the end of 1988 our estimated replacement value of direct investment, of $747.1 billion, was almost identical with the market-value estimate of $748.9 billion, some 2.3 times the book value of $326.9 billion. The distribution of revaluations by the replacement-cost method differs considerably from that derived from the market-value adjustments based on share prices, as may be noted in Tables 5A and 5B. Developed countries as a whole, in 1987, accounted for $293.4 billion or 73.6 percent of the $398.8 total by the replacement-cost method, as opposed to $217.7 billion or 70.0 percent of the lesser market-value total. Japan here contributed a much lesser amount, only $12.4 billion, with the largest revaluations accounted for by the United Kingdom at $67.0 billion, Canada at $50.3 billion, Germany at $33.4 billion, and Switzerland at $26.1 billion. These four countries showed revaluations or excesses

18

EISNER AND PIEPER

of current value over book by the replacement-cost method that totalled $176.8 billion, or 44 percent of the total. Figures for 1988 were fairly similar, with this four-country group summing to $181.4 billion, or 43 percent of the total of $420.2 billion.

Foreign Direct Investment in the United States We have not yet told all of the story. For one thing, we must undertake analogous adjustments for foreign direct investment in the United States. Actually, the adjustments are not quite analogous because, as indicated before, foreign direct investment in the United States entails claims in dollars and hence its value in dollars is not affected by exchange-rate movements. In terms of magnitude, for the reasons we have discussed--that foreign investment in the United States is relatively recent and rates of appreciation less--as well as the lack of the exchange-rate factor, the adjustments for foreign direct investment in the United States have been relatively minor. Up to the mid-1970s, the book value of foreign direct investment in the United States was never large enough for the adjustment to make much difference. Assumed equal to book value in 1950, the aggregate market value (share-price method), while higher than book over the intervening years, fell below book in 1974, as shown in Table 6, and was above book thereafter for consecutive years only from 1985 to 1988. The excess of market value over book attained $48.8 billion in 1986 and $60.3 billion in 1988. Replacement-cost estimates of foreign direct investment in the United States never exceeded book value by more than trivial amounts. For 1987 we put replacement-cost at $2.7 billion or 1 percent less than book and for 1988 only $8.9 billion or 2.7 percent above book. Netting the adjustments,to current value of United States and foreign direct investment (see Table 7), we find, by the market-value or share-price method, an improvement in the net international investment position of the United States at the end of 1987, in terms of direct investment alone, that amounts to $275 billion, as may be seen in Table 8. By the replacement-cost method, the net adjustments come to $401 billion, very close in amount to the presumed overall "net debt" at that time. 5 By 1988, the adjustments, while larger, were not quite sufficient to offset fully the negative official international investment position of the United States.

The Value of Gold It may seem hard to believe, but gold is carried in United States accounts, and in the BEA reports on the investment position of the United States, at its entirely nominal value of $42.22 per ounce, although its current market price is approximately nine times that figure. This discrepancy suggests an upward adjustment of about $90 billion to bring the valuation of United States Treasury gold, taken as $11.1 billion in the BEA reports, to its current market value. 6

The Value of Bank Loans to Third World Countries The BEA reports all United States bank loans at their face value. We have received from Salomon Brothers secondary market prices of bank loans to 36 less-developed countries for the period 1985 to the present. For each country we multiplied the Salomon Brothers price index by the total amount of bank loans outstanding. At the end of 1988

The World's Greatest Debtor Nation?

TABLE 6.

Year

19

Total Foreign Direct Investment in the U.S., 1950-1988 (billions of dollars)

Book value

Direct investment ~ Market Replacement value value

~-Ratio to book value o f ~ Market Replacement value value

1950 1951 1952 1953 1954

3.391 3.658 3.945 4.251 4.633

3.391 4.081 4.651 4.545 6.511

3.391 3.746 3.980 4.340 4.591

1.000 1.116 1.179 1.069 1.405

1.000 1.024 1.009 1.021 0.991

1955 1956 1957 1958 1959

5.076 5.459 5.710 6.115 6.604

8.563 8.870 7.728 10.309 11.594

5.270 5.912 5.886 6.046 6.695

1.687 1.625 1.353 1.686 1.755

1.038 1.083 1.031 0.989 1.013

1960 1961 1962 1963 1964

6.910 7.392 7.612 7. 944 8. 363

11.178 14.244 12.433 14.639 16. 542

6.918 7.212 7.762 7. 880 8.324

1.618 1.927 1.633 I. 843 1.978

1.001 0.976 1.020 0.992 O.995

1965 1966 1967 1968 1969

8.797 9.054 9. 923 10.815 11.818

18.041 15. 872 18. 904 21.414 18.967

8.906 9.484 9.952 11.145 12.518

2.051 1.753 1. 905 1.980 1.605

1.012 ! .047 1.003 1.030 1.059

1970 1971 1972 1973 1974

13.270 13.914 14.868 20.556 25.144

19.668 21.572 25.920 22.589 18.894

13.566 14.132 15.171 18.416 28.310

1.482 1.550 1.743 1.099 0.751

1.022 1.016 1.020 0.896 1.126

1975 1976 1977 1978 1979

27.662 30.770 34.595 42.471 54.462

26.439 34.479 32.127 38.132 50.244

29.895 33.409 35.902 44.535 58.451

0.956 1.120 0.929 0.898 0.923

1.081 1.086 1.038 1.049 1.073

1980 1981 1982 1983 1984

83.046 108.714 124.677 137.061 164.583

76.428 88.571 111.408 137.627 156.952

76.776 117.449 126.549 135.551 163.606

0.920 0.815 0.894 1.004 0.954

0.924 1.080 1.015 0.989 0.994

1985 1986 1987 1988

184.615 220.414 271.788 328.851

213.283 269.205 309.338 389.121

185.152 224.052 269.131 337.704

1.155 1.221 1.138 1.183

1.003 !.016 0.990 i.027

20

EISNER AND PIEPER

TABLE 7.

Net U.S. Direct Investment Position, 1950-1988 (billions of dollars) Net investment position ~ Market Replacement value value

Market minus book

Replacement minus book

Year

Book value

1950 1951 1952 1953 1954

8.394 9.321 10.776 12.002 12.998

8.398 10.588 12.230 13.362 17.354

8.398 10.144 12.449 13.808 14.797

0.004 1.267 1.454 1.360 4.356

0.004 0.823 1.673 1.806 1.799

1955 1956 1957 1958 1959

14.319 17.046 19.684 21.294 23.223

21.476 24.872 24.348 31.664 38.722

16.404 20.200 23.982 26.545 29.009

7.157 7.826 4.664 10.370 15.499

2.085 3.153 4.297 5.251 5.786

1960 1961 1962 1963 1964

24.955 27.325 29.664 32.792 36.117

40.633 48.141 44.914 51.933 59.932

31.702 34.398 36.833 41.826 44.261

15.678 20.816 15.250 19.141 23.815

6.747 7.073 7.169 9.034 8.144

1965 1966 1967 1968 1969

40.677 42.738 46.637 51.092 56.275

63.691 59.949 71.418 89.409 90.167

50.887 57.506 62.478 68.737 77.987

23.014 17.211 24.781 38.317 33.892

10.210 14.768 15.841 17.645 21.712

1970 1971 1972 1973 1974

62.210 68.846 75.010 80.757 84.934

89.482 106.329 144.605 132.601 92.631

92.198 110.527 128.786 167.881 201.598

27.272 37.483 69.595 51.844 7.697

29.988 41.681 53.776 87.124 116.664

1975 1976 1977 1978 1979

96.388 106.039 111.395 120.256 133.396

123.456 126.312 135.715 166.534 198.808

226.456 248.524 285.797 336.529 396.553

27.068 20.273 24.320 46.278 65.412

130.068 142.485 174.402 216.273 263.157

1980 1981 1982 1983 1984

132.329 119.634 83.075 70.142 46.897

220.542 167.463 128.357 152.715 126.698

444.934 404.511 366.808 334.380 283.315

88.213 47.829 45.282 82.574 79.801

312.605 287.877 283.733 264.238 236.418

1985 1986 1987 1988

45.133 39.148 36.195 - 1.951

191.027 294.008 311.663 359.773

316.879 363.653 437.648 409.440

145.894 254.860 275.468 361.724

271.746 324.505 401.453 411.391

The World's Greatest Debtor Nation?

TABLE 8.

Year

21

Official and Adjusted U.S. Net International Investment Position, 1970-1988 (billions of dollars)

Official international investment position

Revaluations on ~ direct investment ~ ReplaceMarket ment value cost

Revaluations on gold

Revaluations on Third World loans

Adjusted U.S. international ~ investment position "~ ReplaceMarket ment value cost

1970 1971 1972 1973 1974

58.5 45.5 37.0 47.9 58.7

27.3 37.5 69.6 51.8 7.7

30.0 41.7 53.8 87.1 116.7

.9 2.6 7.6 19.5 42.1

------

86.6 85.6 114.2 119.2 108.5

89.3 89.8 98.4 154.5 217.5

1975 1976 1977 1978 1979

74.2 83.6 72.7 76.1 94.5

27. I 20.3 24.3 46.3 65.4

130.1 142.5 174.4 216.3 263.2

27.1 25.6 34.2 50.9 124.4

------

128.4 129.4 131.3 173.3 284.3

231.4 251.6 281.3 343.3 482.0

1980 1981 1982 1983 1984

106.3 140.9 136.7 89.0 3.3

88.2 47.8 45.3 82.6 79.8

312.6 284.9 283.7 264.2 236.4

144.7 93.8 110.4 88.4 69.2

------

339.2 282.6 292.4 260.0 152.3

563.6 519.6 530.9 441.7 308.9

-111.4 - 267.8 -378.3 -532.5

145.9 254.9 275.5 361.7

271.7 324.5 401.4 411.4

74.8 91.5 116.5 96.4

-30.1 - 29.8 -43.4 -42.7

79.1 48.8 -29.7 - 1 1 7 .1

204.9 118.4 96.2 -67.4

1985 1986 1987 1988

the total market value of United States third-world bank loans was $41.1 billion, or about 49 percent of their face value. Adjusting for the value of third-world bank loans would decrease the United States net international position by $43.4 billion.

PUTTING IT ALL TOGETHER: THE INTERNATIONAL INVESTMENT POSITION OF THE UNITED STATES We have added, to the B E A reports of the international investment position of the United States, our adjustments or revaluations on direct investment and on gold and, for the last few years, for the bad debt of less-developed countries held by United States banks. Our adjustments, shown in Table 8, using either market values or replacement-cost for direct investment, generally improve the net position of the United States. The official position, as reported by the BEA, reached a peak of 140.9 billion dollars in 1981 and was positive through the end of 1984. The adjusted series both peaked in 1980, at $339.2 billion and $563.6 billion for the market-value and replacement-cost estimates, respectively. From the end of 1981 to the end of 1987, by official measure, the net international investment position of the United States declined by more than half a trillion dollars or, precisely, $519.2 billion, to reach that much-heralded "debtor status" of minus $378.3 billion. Over the same period, the current value estimates reflecting market-value or

22

EISNER AND PIEPER

share-price estimates for direct investment, which had reached a peak of $339.2 billion in 1980, declined $312.3 billion, ending at an only trivially negative $29.7 billion. On a replacement-cost basis, the United States net international investment position at the end of 1987, despite a very large decline of $423 billion from 1981 and of $467 billion from 1980, remained at a positive figure of $96.2 billion. By the end of 1988, however, the adjusted net positions by both methods were negative, but only small fractions of the negative amount of the official net investment position. There are other adjustments to make. One, possibly important, would be made for errors and omissions or statistical discrepancies in the official accounts, which totalled $202 billion from the beginning of 1975 to the end of 1987 (but turned to a negative $10.6 billion in 1988). 7 Some of this sum very likely relates to overstatement of the current account deficit, due in part to understatement of exports, particularly of United States firms (for tax reasons) to their foreign subsidiaries. A further overstatement of the current account deficit is to be found in the understatement of income from United States investment abroad, particularly from portfolio investment as a result of the understatement of the market value of assets abroad .8 There is some reason to believe that in part the errors and omissions relate to unrecorded foreign claims on United States assets, including those connected with the drug trade. To this extent, correct accounts would indicate a lower net investment position for the United States. A full look behind these entries would require a search for hidden United States assets abroad as well as discovering the extent to which unrecorded foreign claims abroad, such as black-market dollars, may have been used to pay for unrecorded United States exports. 9 With the major adjustments we have made, for the values of direct investment and of gold, the picture is clear, and different from that usually portrayed. The net international investment position of the United States has declined by substantial amounts with the large current account deficits of recent years. That decline has not been so great as indicated in official accounts, however, because of the offset of appreciation in the value of United States direct investment abroad and the major exchange gains, with the falling dollar, on that appreciation. This last finding suggests an important offset to current account deficits and their associated capital-account surpluses. If exchange rates are really allowed to float freely, current account deficits may be expected to generate exchange rate declines. In the case of the United States, the fall in the dollar--or rise in the value of foreign currency--will generate major increases in the value of investment in the rest of the world, indeed of all investment, not only direct investment. The current market value of the foreign-currency-denominated portion of those assets may be taken, for illustration in round numbers, to be about one trillion dollars? ° A 20 percent fall in the value of the dollar, suggested by some as in order, would mean a 25 percent increase in the value of foreign currency, which would raise the dollar value of United States investment in the rest of the world, and hence its net international investment position, by $250 billion, enough to offset almost two years of current account deficits even if they continued at current rates. If current account deficits did continue, the dollar would be likely to decline, thus generating further gains in the value of United States investment in the rest of the world. The alleged calamitous increase in United States indebtedness to foreigners generated by current account deficits--this "living beyond one's means" and "passing a burden on to future generations"--may thus have a built-in corrective. As the United States goes further "into debt," the value of its assets abroad rises. We can therefore answer the doomsayers

The WorM's Greatest Debtor Nation ?

23

who warn with ever-increasing shrillness of the future costs of our "twin deficits" and alleged "consumption binge." In yet another way they have not seen, there may be a free lunch after a l l - - o r at least one significantly subsidized.~ As we said at the beginning, the United States is certainly not the world's greatest debtor nation. In terms of current values of United States and foreign claims, it is barely a debtor nation at all.

APPENDIX: SOURCES AND METHODS We estimate the replacement-cost of the end-of-year stock of direct investment by revaluing the existing stock on the basis of current changes in per-unit dollar values and adding the flow of new investment adjusted to end-of-year prices. ~2 Algebraically, this may be expressed as: K(i,t) = K ( i , t -

1) * P D R ( i , t ) / P D k ( i , t - 1) + l(i,t)*PR(i,t)/pR(i,t),

(A1)

t = 1951 to 1988 where K ( i , t ) is the stock of direct investment of country i for year t; P D R is an end-of-year, dollar price index for investment goods; P~ and pR are, respectively, end-of-year and average annual investment price indices in terms of foreign currency; and I is net investment in dollars. Dollar price indices were calculated generally as: P D ( i , t ) = P ( i , t ) * E ( i , 1980) / P(i, 1980)*E(i,t),

(A2)

where E is the end-of-year exchange rate, expressed as units of currency per United States dollar.~3 The capital flows were reported in end-of-year dollars and hence need no exchangerate adjustment. The process was initialized by assuming that both the market value and the replacement cost of the stock of direct investment in each country at the end of 1950 equalled its book value, B:

(A3)

K(i, 1950) = B(i, 1950).

In estimating the market value of the stock of direct investment, we used indices for share-prices instead of investment goods. However, conventional share-price indexes reflect both changes in the market evaluation of existing capital and retained earnings. As retained earnings are included in the flow of new investment reported by the BEA, application of equation AI with share-price indexes would involve double counting. To avoid this, we adjusted net investment by subtracting the product of the existing stock of capital and the ratio re of retained earnings to price of companies included in the stock-price index. Then, K(i,t) = K ( i , t -

1 ) * P D M ( i , t ) / P D M ( i , t - 1) + [l(i,t) -

* PM(i,t)/pM(i,t) , t = 1951 to 1988

re(i,t)*K(i,t-

1)]

(A4)

24

EISNER AND PIEPER

Application of equations A1 and A4 requires 1950 book values and investment flows, stocks of investment, share-price indexes, and rates of retained earnings for 1950 and all subsequent years. Our sources and the details of our improvisations and approximations for missing data for some countries and for some years are explained below.

Book Values and Investment Flows We generally take the book values of investment flows and the stocks of foreign investment directly from United States Department of Commerce compilations (1982 and 1986a) for the years 1950 to 1981 and, for the years 1982 to 1987, from the subsequent August issues of the Survey of Current Business (U.S. Department of Commerce, 1983, 1,984, 1985, 1986b, 1987, 1988). In later years the BEA has included capital gains on the book value of direct investment due to exchange-rate changes as part of capital outflows. As exchange-rate capital gains are already captured by our dollar-price indexes, we excluded these capital gains from capital outflows to avoid double counting for the 1979-1987 period on the basis of unpublished BEA data. Prior to 1979, companies followed a different accounting procedure and, consequently, exchange-rate capital gains were generally not included in BEA measures of capital outflows. For a number of countries, BEA direct-investment and capital-outflow figures prior to 1966 were lumped together in "other" categories. In those cases we assumed that the individual country's stock of direct investment was the same proportion of the total for countries in its category as in 1966. Thus, for each country i in an "other" category, prior to 1966, B(i,t) = B(t) * B(i, 1966)/B(1966), t = 1951 to 1965

(A5)

where B(t) and B(1966) = total stocks in the category. The flow of direct investment for the years prior to 1966 was similarly calculated on the basis of the 1966 stock proportions: l(i,t) = l(t) * B(i,1966)/B(1966), t = 1951 to 1965

(A6)

These extrapolations were necessary for (1) Hong Kong, Malaysia, Singapore, South Korea, Taiwan, and Thailand, which prior to 1966 were aggregated along with other unspecified countries in the "other Asia and Pacific" category; (2) Austria, Finland, Greece, Portugal, and Turkey, which were part of "other Europe"; and (3) Ecuador, Egypt, and Israel, which were in the "other South America," "other Africa," and Middle East categories respectively.

Share-Price Indexes We used four main sources for the share-price indexes used in our market value calculations: (1) unpublished data from Morgan-Stanley International, available for most major industrial countries in the 1975-88 period; (2) OECD Main Economic Indicators, used for most OECD countries in the 1955-75 period; (3) IMF Financial Statistics Yearbook, used primarily for the early 1950s; and (4) Moody's International Manual. When more than one source was used for a country, the indexes were spliced together. December values were used for the end-of-year indexes, with the exception of Korea and Taiwan, where annual averages were used. The sources for the individual countries were as follows:

The World's Greatest Debtor Nation ?

Australia Austria Belgium Canada Denmark Finland France Germany Hong Kong India Ireland Israel Italy Japan Netherlands New Zealand Norway Singapore/Malaysia South Africa South Korea Spain Sweden Switzerland Taiwan United Kingdom United States

25

IMF 1957-63, OECD 1963-75, Morgan-Stanley 1975-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 IMF 1950-55, OECD 1955-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 Moody's 1966-1975, Morgan-Stanley 1975-88 IMF 1960-88 IMF 1950-55, OECD 1955-88 IMF 1960-86 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 Moody's 1950-75, Morgan-Stanley 1975-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 OECD 1960-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 Morgan-Stanley 1970-88 IMF 1950-60, Moody's 1960-88 Moody's 1975-88 IMF 1952-55, OECD 1955-75, Morgan-Stanley 1975-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 Moody's 1968-88 IMF 1950-55, OECD 1955-75, Morgan-Stanley 1975-88 S&P 500 index, 1950-75, Morgan-Stanley 1975-88

The market value of direct investment in other developed countries (Greece, Portugal, Turkey, and other Europe) was calculated on the basis of a composite share-price index, in dollar terms, of all developed countries with share-price indexes. The composite share-price index was also used to extrapolate back to 1950 those developed-country indexes (Australia, New Zealand, and Spain) beginning at a later date. The composite index was calculated as: PDAVM(t) = PDAVM(t -

1) * ~ [ w ( i , t ) * P D M ( i , t ) / p D M ( i , t - 1)] , t = 1951 to 1988 (A7)

where w is a weight and i is summed over all developed countries in year t for which dollarprice indexes were available. The weights were proportional to the previous end-of-year market value of direct investment: w(i,t) = K(i,t-

1) / E K ( i , t -

1)

(A8)

The process was initialized by setting P D A V ( 1 9 5 0 ) equal to one. The composite deflator was thus calculated as a chain index, using previous-year stocks as weights. The flows of direct investment, where individual country indexes were not available, were similarly adjusted by a composite foreign-price index. This was calculated in accordance with equation A7, except that foreign-price indexes were used in place of dollar-price indexes.

26

EISNER AND PIEPER

Share-price indexes in developing countries were extrapolated back to 1950 on the basis of the United States share-price index, which was also applied to all countries in Latin America. As direct investment in Africa and Indonesia was primarily petroleum related, the S&P index for integrated international oil companies, taken from Standard & Poor's Analyst's Handbook, was applied to this category. The market value of direct investment in the Philippines, Thailand, and the "other Asia" category was estimated on the basis of a composite share-price index for Asian countries, using beginning-of-year market values as weights. Finally, as there were often large negative capital outflows in the non-Israeli Middle East and the other Western Hemisphere categories, the market value of direct investment was set equal to the book value.

Retained Earnings We have received from Morgan-Stanley International, for the years 1975 to 1988, data on price-earnings ratios and dividend yields, both expressed as a fraction of end-of-year market value, for all developed countries, except Finland, Ireland, and New Zealand, and for Hong Kong and Singapore/Malaysia. The ratio of retained earnings to beginning-ofyear market value was calculated as re(i,t) = [1/PE(i,t) - DY(i,t)] * P(i,t)/P(i,t- 1), t = 1975 to 1988

(A9)

where PE is the price-earnings ratio and D Y is the dividend yield. A number of special assumptions were imposed for the years before 1975, when our data, particularly with regard to retained earnings, were less completeJ 4 Details of our procedure are as follows:

United States The earnings-price ratio and dividend yield for the S&P 500 were taken from the Economic Report o f the President.

Canada We multiplied the dividend yield in Canada by the United States ratio of retained earnings to dividend yields: re(CA,t) = DY(CA,t) * re(US, t)/DY(US,t), t = 1950 to 1974

(AI0)

United Kingdom Retained earnings ratios for the 1962-1974 period were taken from OECD Financial Statistics. Retained earnings ratios in the 1950-1961 period were estimated as: re(UK, t) = DY(UK, t) * rav,

(All)

where ray is the mean of re divided by the mean of D Y in the United Kingdom in the 19621972 period. Dividend yields in the 1950-1961 period were taken from the United Kingdom Annual Abstract o f Statistics. S o u t h Africa

Retained-earnings ratios for 1960-1978 were taken from Moody's International Manual.

The World's Greatest Debtor Nation?

27

Retained-earnings ratios in the 1950-1959 period were assumed to be equal to the mean of retained-earnings ratios in the 1960-1969 period. Similarly, retained-earnings ratios in the 1979-1988 period were assumed to be equal to the mean of retained-earnings ratios in the 1969-1978 period.

Belgium, France, Germany, Italy, Japan, the Netherlands, Sweden, and Switzerland Dividend yields for these countries were taken from the OECD's Financial Statistics for the years back to 1960, except for Switzerland, for which data were available only from 1966. Additional series for Germany back to 1953 were taken from Statistiches Jahresbuchfiir die Bundesrepublik Deutschland. The ratios of retained earnings to market value were calculated by multiplying each country's dividend yield by the ratio of retained earnings to dividend yields in the United Kingdom over the 1962-1972 period: re(i,t) = div(i,t) * rav,

(A12)

where ray is defined as before and t = 1953 to 1974 for Germany, 1966 to 1974 for Switzerland, and 1960 to 1974 for all other countries. For earlier years, retained-earnings ratios of market value were assumed to be the same as in the United Kingdom: re(i,t) = re(UK, t) , t = 1950 to 1959,

(AI3)

for all countries except Germany (1950 to 1952) and Switzerland (1950 to 1965).

Australia, Austria, Denmark, Italy, Norway, and Spain Retained-earnings ratios were unavailable for these countries prior to 1975. Retainedearnings ratios for those years were assumed to be the same as those in the United Kingdom.

Finland, Ireland, and New Zealand Retained-earnings ratios of market value in the 1950-1974 period were assumed to be the same as in the United Kingdom. For the 1975-1988 period they were assumed equal to the Morgan-Stanley International average for Europe.

Developing countries The United States rate of retained-earnings was used for countries using the United States share-price index. Retained-earnings ratios for Hong Kong and Singapore were available from Morgan-Stanley for the 1975-1988 period. Prior to 1975, retained-earnings ratios in both countries were assumed to equal their 1975-1988 mean. Retained-earnings ratios in other countries (India, Israel, Korea, and Taiwan) were assumed to equal the average of the mean of Hong Kong and Singapore/Malaysia ratios for the 1975-1988 period. re(i,t) = [reav(HK) + reav(Sl)]/2,

where reav is the mean of re in the 1975-1988 period.

(A14)

28

EISNER AND PIEPER

Replacement Costs: Developed Countries A chain price index for nonresidential investment was used to estimate the replacement cost of direct investment in the United States. Implicit price deflators for investment, or gross fixed capital formation, for 21 other developed countries were taken or constructed from OECD (1982, 1989). j5 End-of-year stock deflators for all years except 1988 were calculated from the average annual (flow) deflators as:

PR(i,t) = [pg(i,t+ 1)/pR(i,t)]**0.5,

p(i, 1980) = 1.0

(A15)

The 1987 end-of-year deflator was extrapolated from the 1987 annual index:

PR(i, 1988) = pR(i, 1988) * [pR(i, 1988)/pR(i, 1987)]*'0.5

(A16)

The capital-formation deflator series begins in 1950 except for six countries--Italy, Japan, Belgium, Portugal, New Zealand, and Spain--for which the initial years were, respectively, 1951, 1952, 1953, 1953, 1954, and 1954. Deflators for those six countries were extrapolated back to 1950 from a composite or average dollar investment price index, P D A V R, for all of the developed countries combined. The composite index was formed using equation A7, except that dollar investment price indexes were used in place of share-price indexes and the weights were based on the replacement cost of direct investment, summed for all countries for which dollar-price indexes were available for that year. The dollar-price indexes for the six countries were then extrapolated backward as:

PDR(i,t) = PDR(i, iO) * PDAVR(i,t)/PDAVR(i, iO) , t = 1950 to i0 -

1

(A17)

where i0 is the initial year for which individual deflators were available for country i. As individual-country exchange rates for all countries were available back to 1950, the own-currency price end-of-year deflators could be estimated asl6:

PR(i,t) = PR(i, 1980) * pDR(i,t) * E(i,t)/E(i, 1980)

(AI 8)

The developed-country average dollar price deflator, P D A V R, was applied to the stock of direct investment for the "other Europe" and "international" categories. The flows of direct investment were similarly adjusted by a composite foreign-price index, calculated in accordance with equation A7, except that again foreign prices were used instead of dollar prices.

Replacement Costs: Developing Countries For developing countries we use gross domestic product price deflators, published by the International Monetary Fund (1989), because investment-price deflators were not available. The methodology for obtaining end-of-year prices is identical to that for the developed countries. For years for which individual-country deflators were not available, they were extrapolated back, on the basis of composite dollar-price deflators for the developing countries, from the earliest year those figures were available: 1950 1953

Columbia, Ecuador, Israel, Mexico, Panama, Philippines, Thailand, and Venezuela South Korea

The World's Greatest Debtor Nation? 1955 1959 1960 1963 1964 1967 1968 1970 1973

29

Nigeria Egypt India, Libya, Peru, and Singapore Brazil Liberia Indonesia Saudi Arabia Malaysia Chile

As price indexes were not available for Hong Kong and Taiwan, direct investment for these countries was included in the "other Asia and Pacific" category. Similarly, as a price index for Argentina was available for only a few years, Argentina's direct investment was grouped with the "other South America" category. Composite or average dollar-price deflators and own-currency price deflators were also calculated for five "other" categories for which aggregate data were presented: other South America, other Central America, other sub-Saharan Africa, other Saharan Africa, and other Asia and Pacific. These deflators were used where data were not available for individual countries, except in the case of the non-Israel Middle East, where the replacement value was assumed to equal the book value. The "other Western Hemisphere" category relates almost entirely to financial investment in Caribbean nations such as the Bahamas and Bermuda. As these countries generally have currencies that exchanged at par or at a fixed rate with the United States dollar, we used here the United States deflator for fixed nonresidential investment.

Gold The book-value figures for gold, based on the then-official price of $35 per ounce, were accepted prior to 1968. From 1968 on, the book values were multiplied by the ratio of market price to official price on the last trading day of the year. For the years from 1968 to 1980, market prices were taken from the Report of the Director of the Mint (United States Treasury, 1968-1980) and, for the years 1981 to 1988, from the Wall

Street Journal. Third World Bank Loans The value of United States bank loans to third world countries is from the Federal Reserve Board's Country Exposure Lending Survey. We. use the amount owed United States banks after adjustments for guarantees and external borrowings. Secondary market prices for third world country loans are unpublished data compiled by Salomon Brothers. Acknowledgments: The authors are grateful for the use of unpublished data from Morgan-Stanley International, research assistance by William E. Houlihan, Thomas P. Talerico, and Stacey M. Tevlin and helpful comments by R. David Belli, H. Robert Heller, Jeffrey D. Sachs, and Lois Stekler. They have also benefitted from the financial support of National Science Foundation grant SES-8707979.

NOTES l.

Responding to the contents of this paper, an earlier version of which was presented in

30

EISNER AND PIEPER

December 1988 to a joint session of the American Economic Association and the North American Economics and Finance Association, and to other comments, including those of the Working Group on Economic Statistics headed by the Chairman of the Council of Economic Advisors, the Bureau of Economic Analysis has now suspended presentation of this bottom line. It has explained in a press release for the media and in the Survey of Current Business (June 1990, p. 54) that this figure, based on "summations of components that reflected a mix of valuations.., does not provide a useful indicator of t h e . . , net position and of the total positions abroad and in the United States." It is " r e v i e w i n g . . . approaches to revaluing direct investment to reflect current-period prices and will present estimates using one or more of them. BEA will also revalue other components of the position to the extent that it is appropriate and feasible." 2. While a fall in the dollar does not alter the value in dollars of foreign investment in the United States, foreigners do of course suffer a loss in the value of their investment measured in their own currencies. 3. Similar efforts have now been reported by Ulan and Dewald (1989). 4. A detailed and rigorous account of our procedures is to be found in the Appendix. 5. Lois Stekler (1988: 28) offers estimates in the same range, suggesting that the net foreign direct investment position of the United States is "$300 billion larger than the net included by the Department of Commerce." She obtains this by "starting with the book value of direct investment assets in 1964, inflating each year by a weighted foreign price index adjusted for exchange rate changes, and adding the new capital outflow" and "using the same methodology" for foreign direct investment in the United States. Striking support for all of these estimates of much greater undervaluation of United States direct investment abroad than of foreign direct investment in the United States (also suggested by Stekler) is to be found in the relative rates of return on book value reported by the BEA. For the years 1983 to 1987, as reported in subsequent August issues of the Survey of Current Business (U.S. Department of Commerce, 1984, 1985, 1986b, 1987, and 1988, Tables 7 or 8), these were, in percentages, as follows (U.S. figures exclude exchange rate capital gains):

U.S. abroad Foreignin U.S.

1983

1984

1985

1986

1987

1983-1987

12.3 4.3

14.2 6.9

11.9 3.5

11.1 2.7

11.9 4.4

12.3 4.4

On the assumption that rates of return on market value should be equal, the greatly larger reported returns on book value imply that the excess of market over book must be vastly greater for United States direct investment, indeed, almost three times as great over the entire 1983-1987 period. It has been suggested that differences in risk could account for some difference in return on market values but it is hard to believe that risk premiums could be anywhere near that large. 6. Some may question the inclusion of United States Treasury gold as an asset in calculating the net international investment position of the United States. If we count gold, why not also include stockpiles of petroleum or wheat? One argument for counting gold is that it can be used as readily as central bank foreign-currency holdings in buying other assets or paying off liabilities. No question is raised about inclusion of these other central bank holdings. Has gold now become less of an asset than purely paper claims? The broader question of assets to be included helps to put the whole matter of the official measure of a nation's "international investment position" in a sharper and more narrowly focused light. Where, as in the case of the United States, relatively little of the foreign claims are in the form of foreign-currency debt, should that net investment position, even corrected to current value, be of much significance? Total tangible assets in the United States are on the order of $20 trillion. The present value of future income of all those currently alive--thus including intangible and human capital--may come to a total of $50 trillion. Even if the net international investment position of the United States were minus $532 billion, as BEA figures for the end of 1988 indicate, that total would be in the order of 1 percent of the nation's wealth.

The World's Greatest Debtor Nation?

31

Another way to get matters in perspective is to consider the real cost of even continuation of current-account deficits and capital-account surpluses of as much as $100 billion per year, without compensating capital gains, for another five years. That would add $500 billion to foreign net claims on the United States. At, say, a 4 percent real rate of interest, this would entail a drain of $20 billion on a national income that by then would be some $6 trillion. With a similar decline in the net investment position of the United States, Stekler (1988: 38) reports simulations with the Multicountry Model of the Federal Reserve Board, taking into account differential rates of return, that show a decline of $23 billion in annual net investment income. The probably worst-case scenario of continued trade deficits, without adjusting for differential rates of return or the effects of changing exchange rates on income flows, would then reduce our domestically available output by under V2 percent. An increase of a few tenths of a point in unemployment, which might result from austerity measures to reduce the trade deficit, would cost the economy considerably more. 7. Calculated from Economic" Report of the President, January 1989, Table B-102, p. 425, and, for the years 1986 to 1989, from Federal Reserve Bulletin, September 1989, Table 3.10, p. A55. 8. The errors and omissions or statistical discrepancy is discussed at some length by Stekler (1988: 4-26). 9. It should be recalled that the investment position of the United States relates to assets and liabilities of residents of the United States. A potentially major adjustment, which we have yet to make, relates to foreign assets brought in by new residents or immigrants. By BEA accounting convention these should be considered capital transfers and added to the stock of United States investment abroad. In fact, they are rarely so recorded although their amount, for a nation with so much net in-migration, may well be large. 10. The great bulk of United States bank claims abroad are in dollars and hence not subject to these exchange gains. With the market value of direct investment (see Table 3) in the neighborhood of $750 billion at the end of 1988 by our estimates, however (and climbing), and United States holdings of foreign equity coming to another $63 billion, there is enough more in assets that would gain with depreciation of the dollar to make our illustrative total of $1 trillion reasonable. 1 I. Jeffrey Sachs, in commenting on this argument, suggested that we were overlooking the loss from deteriorating terms of trade if the dollar were allowed to fall. The capital value of this loss, projected indefinitely into the future, would far outweigh the gain in the current dollar value of United States investments in foreign assets. If we are to broaden the issue in this way, however, unless we predetermine our conclusions with a number of special assumptions, we find ourselves in uncharted waters where the conclusions are far from obvious. For one thing, lower values of the dollar have not recently translated into proportionate deterioration in the terms of trade, as foreign sellers, in particular, have proved ready to cut their own-currency prices to maintain market share in the United States. (This need not result in commensurate reductions in the value of American investments in foreign firms, as not all of their sales are to the United States.) But second, and most important, there is no reason to view United States gross national product and expected future domestic incomes as constant. A more reasonable assumption would be that if the dollar is allowed to fall to market-determined levels consistent with an accommodating monetary policy, United States net exports and gross national product and income will increase. The net result, far from a loss that would outweigh the gains in value of our foreign assets, might well be an increase in the United States domestic wealth. A fall in the value of the dollar would also bring a not-insignificant increase in the dollar value of the annual flow of earnings from United States foreign investment. 12. The BEA measure of net investment includes retained earnings, which in turn are calculated on the basis of accounting profits. Errors in estimating profits will affect retained earnings and thus net investment. With positive rates of inflation, the use of historical cost depreciation would overstate profits and retained earnings. Working in the opposite direction, however, is the use of accelerated depreciation. In addition, firms receive a gain which is not included in profits when inflation reduces the real value of their liabilities. Lacking data on these offsetting items, we have accepted the BEA measure of net investment. 13. The investment-price deflators have as their base period the annual average of 1980.

32

EISNER AND PIEPER

Therefore, the end-of-period price indexes, P, will differ from unity. The dollar-price indexes, on the other hand, have the end of 1980 as their base period. 14. As most of the flow of direct investment as well as most of the movement in stock prices occurred after 1975, our estimates are not sensitive to our assumptions regarding rates of retained earnings before 1975. Setting the market value of direct investment equal to the book value in 1974 and applying our procedure only for those years for which we have direct measures of retained earnings results in only slightly lower market-value estimates than those reported in the paper• 15. A GDP deflator was used for South Africa, for which no investment-price index was available. GDP deflators were also used for the United Kingdom for the 1950-1952 period and for New Zealand for the 1954-1960 period• 16. The dollar-price indexes use the end of 1980 as their base period while the investment-price deflators use the 1980 annual average as a base period. The P(i, 1980) term (which differs from unity) is included in order to convert from an end-of-year to an annual-average base.

REFERENCES Bame, Jack• 1985• "A Note on the United States as a Net Debtor Nation," Survey of Current Business, 65(June): 28. Scholl, Russell B. 1989. "The International Investment Position of the United States in 1988," Survey of Current Business, 69(June): 41-49. Stekler, Lois, 1988. "Adequacy of International Transactions and Position Data for Policy Coordination." International Finance Discussion Papers, Number 337, Board of Governors of the Federal Reserve System, Washington, DC, November. Ulan, Michael, and Dewald, William G. 1989. "The U.S. Net International Investment Position." In Dollars, Deficits, and Trade, ed. James A. Dorn and William A. Niskanen. Boston: Kluwer Academic Publishers. Board of Governors of the Federal Reserve System, Federal Financial Institutions Examination Council, 1986-1989. Country Exposure Lending Survey. Central Statistical Office. 1952-1960. Annual Abstract of Statistics. London. Economic Report of the President, January 1987. 1987. Table B-99, U.S. International Transactions, 1946-86, p. 359. Washington, DC: GPO. Federal Reserve Bulletin• December 1987, 1988. Table 3.10, U.S. International Transactions, Summary, p. 53. Washington, DC: GPO. International Financial Statistics Yearbook. 1989. Washington, DC: GPO. Moody's Investors Service. 1988. Moody's International Manual. New York. Organization of Economic Cooperation and Development (OECD). 1966. Main Economic Indicators: Historical Statistics 1954-1966. Paris. - - . 1984. Main Economic Indicators: Historical Statistics 1964-1983. Paris. - - . 1988. Financial Statistics. Paris. Standard and Poors Corporation. 1988. Standard & Poor's Analyst's Handbook• New York. Statistiches Bundesamt. 1953-1960. Statistiches Jahrbuch fiir die Bundesrepublik Deutschland. Wiesbaden, West Germany. U.S. Department of Commerce. 1982. Selected Data on U.S. Direct In vestment A broad 1950-1976. Springfield, VA: National Technical Information Service. . 1986a. U.S. Direct Investment Abroad: Balance of Payments and Direct Investment Position Estimates, 1977-1981. Washington, DC: GPO. • 1983, 1984, 1985, 1986b, 1987, 1988, 1989. "U.S. Direct Investment A b r o a d . . . " and "'Foreign Direct Investment in the United States . . . . "Survey of Current Business, August issues• Washington, DC: GPO. U.S. Treasury Department, Bureau of the Mint. 1968-1980. Report of the Director of the Mint. Washington, DC: GPO.