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February 14, 1986

The Largest Debtor Nation
During 1985, the United States became a net
international debtor for the first time since
World War I. At the present rate of net capital
inflow and foreign debt accumulation, U.s. net
international indebtedness should reach $150 billion by the end of this year - well above the
amounts owed by such well"known debtor
nations as Brazil and Mexico. With continuing
annual net capital inflows, further deep declines
in the U.S. international investment position
beyond 1986 can be expected.
Because of its implications for the u.s. and
world economies, this development has created
considerable concern. Some of the factors
underlying the recent trend in the U.S. investment position are reviewed in this Letter. The
Letter also discusses the welfare and policy
implications both at home and abroad of
increasing U.s. indebtedness. It concludes that
whether the emergence of the United States as a
net international debtor is cause for concern
depends on how the incoming funds are spent
and on how rapidly U.S. debt is rising in relation
to what foreigners have available to invest.
International investment position
The net international investment position is a
balance sheet measure of the difference between
a country's accumulated stocks of foreign assets
and liabilities. U.s. foreign assets consist of claims
on foreigners held by the u.s. government as
well as foreign direct and portfolio investment
assets held by u.s. firms and residents. u.s. foreign liabilities include the liabilities of the U.S.
government to foreigners, and also direct investment and portfolio investments of foreigners in
this country. While the distinction between
direct and portfolio investment is sometimes
arbitrary, the former generally refers to investments by firms in existing or newly acquired foreign affiliates, and the latter, to investments in
foreign corporate bonds, stocks, and other
securities where there is no effective control by
the investor over the use of the funds invested.

Foreign assets and liabilities change from year to

year as the result of both international capital
flows and valuation changes. Capital outflows
arising from the acquisition of foreign assets
(lending) improve the net international investment position, while capital inflows arising from
the issuance of liabilities to foreigners (borrowing) worsen the position. Valuation adjustments
are made each year to reflect fluctuations in
securities prices and exchange rates.
The trend
The United States has been a net international
creditor for most of this century. Its net international investment position improved steadily following World War I from $6 billion in 1919 to
$147 billion in 1982. Initially, the improvement
was due to increases in U.s. government assets
abroad associated with foreign credits and
loans; in the 1950s and 1960s, it was due to the
growth offoreign direct investment by u.s.
firms; and, in the late 1970s, to the rapid rise in
U.s. foreign bank loans.

The long-term rise in the u.s. net investment
position reversed dramatically after 1982. From
the peak level of $147 billion in 1982, the U.S.
net investment position deteriorated so severely
in the following three years that, in 1985, the
United States became a net international debtor
in the amount of about $50 billion.
How did this turnabout occur so rapidly? In general terms, the deterioration in the investment
position is the resultof massive net capital
inflows associated with the liquidation of u.s.
foreign assets and the accumulation of foreign
debt in the u.s. capital account. These inflows
are the counterpart of the current account deficits that have also risen sharply since 1982. The
current account measures trade in goods and
services (and transfers), and deficits in that
account imply that the United States has been
able to spend substantially more on goods and
services than it has produced. Since international payments flows must balance, the difference has matched the net inflow of funds in
the capital account.

The chart illustrates recent changes in the net
u.s. international position, disaggregated by net
u.s. government assets, direct investment, and
portfolio investment. All three net investment
categories have deteriorated since 1982. The net
direct investment position fell some $25 billion
between 1982 and 1985 as U.S. direct investment abroad slowed and foreign direct investment in this country surged. The net portfolio
and u.s. government positions declined even
more significantly, by approximately $125 billion
and $50 billion, respectively, as bank lending
abroad dropped sharply and foreign purchases of
us. Treasury securities and us. private securities
increased substantially.
The decline in bank lending can be attributed to
several factors: sluggish loan demand in Europe,
particularly in 1983 and 1984; a desire by banks
to limit their overseas exposure as a reaction to
the debt repayment problems of borrowing
countries; and declining credit demand by oilimporting developing countries due to a falling
price for oil. Factors inducing the foreign purchase of u.s. securities included the high rates
of return generated by u.s. government budget
deficits, and, to a lesser extent, the view that the
U.s. political climate provided a "safe haven"
for investments.

How serious is it?
While the downward swing in the u.s. investment position is clear, the magnitude of this
swing has been exaggerated to some extent. Net
U.s. bank lending was inflated by roughly $20
billion between 1981 and 1982 as the result of
the establishment of International Banking Facilities which allowed foreign bank loans to be
shifted from offshore banking affiliates to the
books of banking offices in the United States. In
addition, net bank loans were reduced greatly in
1983 and 1984 essentially because of a contraction in interbank lending prompted by stronger
domestic capital requirements.
There are also reasons to question the accuracy
of the reported figures. On the one hand, U.s.
assets abroad are certainly understated because
direct investment assets and u.s. official gold
holdings are carried at book rather than market
value. On the other hand, there is reason to
believe that u.s. liabilities are understated as
well, first because of book valuation of foreign

direct investment liabilities, and second because
of unreported capital inflows.
Estimates of adjustments to the reported figures,
particularly for direct investment, that take these
considerations into account improve the current
u.s. international investment position (on balance) by roughly $200 billion. They imply that
the United States may still be a net creditor at
this time. Nevertheless, at the current rate of
debt accumulation, there is little doubt that even
with this adjusted investment position figure, the
United States will soon turn into a net debtor.

From the United States' point of view, the net
capital inflows and increased U.S. liabilities to
foreigners have augmented the pool of savings
available to finance private business investment
and the federal budget deficit. Without such an
inflow, U.s. interest rates would have been
higher, the budget deficit would have crowded
out investment much more severely, and recent
economic growth would have been dampened,
if not completely eliminated. In the longer run,
however, the increased liabilities to foreigners
will result in greater interest and dividend payments to foreigners and a corresponding drain
on U.s. economic resources. Net U.s. income
receipts have generally fallen in recent years as
payments have risen in association with the
declining net investment position.
Whether the initial capital inflows from abroad
impart longer term benefits on the u.s. depends
on whether the funds generate investment in
ways that increase output and employment for
domestic residents more than they cost in terms
of interest paid out. It is difficult to tell the extent
to which these funds themselves have been
invested or have served to free up u.s. domestic
savings for investment. U.S. domestic real
investment was relatively strong in 1983 and
1984 but has since leveled off. If incoming funds
result in consumption or other "non-productive"
expenditures, there are no long-term benefits,
only costs in the form of the interest payments
that reduce the income available for future
domestic consumption and investment.
The net welfare effect of the capital inflows
depends on the balance between increased current consumption and reduced future consump-

U.S. Net International Investment Position
$ Billions



100 f--

·100 - . Total Net Investment Position
U.S. Government Assets
Direct Investment
EE Portfolio Investment

·200 ' - - _ - ' -_ _I'--_ _I'--_-'-_---.J_ _--L_ _

tion. Reducing the build-up of debt is
appropriate if the discounted value of lost future
consumption is high and if it is deemed undesirable to compel future generations to bear all the
costs of sustaining current consumption levels.
Another possible concern is that the buildup of
U.S. foreign debt will increase the vulnerability
of the U.s. economy. to foreign economic shocks
and further constrain policymakers who must
respond to these shocks. Many fear that the
United States will become overly sensitive to
changes in risk perceptions by foreigners who
hold assets in this country. A sudden loss in confidence in U.S. creditworthiness, it is argued,
could cause a sharp fall in the dollar, a recession
in the United States, and a global financial crisis
as the Federal Reserve Board is forced to raise
interest rates to support the dollar.
The likelihood of such a shift in the asset preferences of foreigners depends on the implications
of the build-up of u.s. debt from the point of
view of the rest of the world. Clearly, the U.S.
capital inflows and trade deficits helped to end
the recession in the world economy several
years ago by stimulating economies abroad. In
addition, the U.S. trade deficits helped developing countries generate the exports with which to
service their own debts. However, the capital
inflows have also siphoned off funds that could
have been invested abroad.

Until now, the willingness offoreign investors to
invest in U.s. assets has merely been a rational
response to the greater returns expected in the
u.s. relative to investments in other countries.
Assuming U.S. real interest rates remain at their
current levels, whether foreigners will continue
to accumulate U.S. assets depends on their perceptions of U.S. creditworthiness and on their
own rate of savings.
The United States likely will be able to service
its repayment obligations as long as the U.S.
economy continues to prosper and grow. In
addition, because u.s. debts are primarily
denominated in dollars, the burden of repaying
these debts is much less than that of countries
that borrow in terms of currencies not their own
and who consequently bear exchange risk.
Nevertheless, even if creditworthiness concerns
are not warranted, one must ask what proportion
of their savings foreigners are willing to continue
to invest in U.s. assets. One estimate is that
global net savings outside of the United States
and the rise in foreign wealth amount to $1
trillion annually. The allocation of 10 percent of
this pool of savings to additional U.s. assets
each year would be sufficient to finance continuing current account deficits of $100 billion.
Since the United States accounts for roughly a
quarter of gross world product, the willingness
of foreigners to allocate their savings in this
manner, while historically unprecedented, is not
If the magnitude of U.S. foreign capital inflows
causes u.s. assets to become a steadily increasing proportion offoreign portfolios, however,
foreigners will ultimately reach a limit to their
willingness to accumulate U.S. debt. Under such
a circumstance, it would be essential to reduce
U.S. capital inflows and the corresponding current account deficits to limit the proportion of
u.s. liabilities in foreign portfolios. A decline in
the value of the dollar would contribute towards
the achievement of this goal.

Reuven Glick, Economist

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974·224b.





!!omoH O!UJOj!l0)







~uew~Jodea LpJOeSe~
(Dollar amounts in millions)

Selected Assets and Liabilities
Large Commercial Banks
Loans, Leases and Investments 1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
U.S. Treasury and Agency Securities 2
Other 5ecu rities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances4
Total Non-Transaction Balances 6
Money Market Deposit
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS

Two Week Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+ )jDeficiency (-)
Net free reserves (+ )jNet borrowed( -)



Change from 1/23/85


- 372
- 435





- 1.9


- 4.5




Period ended


Period ended





1 Includes loss reserves, unearned income, excludes interbank loans

Excludes trading account securities

3 Excludes U.S. government and depository institution deposits and cash items
4 AT5, NOW, Super NOW and savings accounts with telephone transfers

S Includes borrowing via FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7 Annualized percent change