The 2 puzzles of US economy

It has been a while since I got to read speeches from Central Banks explaining basic concepts/research issues. Most of the recent speeches have been explaining stateof financial markets,  inflation, their action etc. I can’t blame them for the same as times are such. Earlier speeches explaining concepts/research were very common, now rare.

I came across one such rare speech by Randall Krozner, Fed Governor. His speech focuses on the linkages the US economy has with the World Economy. He looks at 2 main linkages – trade and finance. Read the speech for details.

I will focus on the 2 puzzles he raises:

  1. the income received by U.S. residents on their foreign investments has consistently exceeded that received by foreigners on their holdings in the United States. This difference totaled $90 billion in 2007. So, at first blush, it might appear that the rest of the world pays the United States for the privilege of lending to it.
  2.  Why does it seem that the United States can borrow without a corresponding increase in its debt? To be more specific, over the past six years, the United States has run current account deficits that add up to over $3.8 trillion ….. Over the same period, U.S. net liabilities increased by only $600 billion, which is $3.2 trillion less than the cumulated current account deficits.

For both the puzzles, the answer is the same:

Most U.S. liabilities are debt securities, which realize small capital gains, while a large fraction of U.S. claims on the rest of the world are equity securities, which realize much larger capital gains. The result is a net difference in the capital gains rate slightly in favor of U.S. investors. When this rate differential is applied to the enormous gross claims and liabilities positions, however, it generates a sizable adjustment to the net investment position.

So, the differences in portfolio explains the two puzzles. The foreigners invest in debt securities (in search of safer haven) and US invests in equity securities (have a higehr risk profile, invest in emerging market equities etc). This leads to the differences in incoem earned (Puzzle 1) and a lower external debt (Puzzle 2).

How much is the interest rate differential?

Taking into account the differences in returns and the differences in the composition of assets, the total return on U.S. claims turns out to be about 2 percentage points per year higher than the return that the United States pays on its liabilities to the rest of the world.

Is US unique in this aspect?

As also was the case with the first puzzle, the United States is not unique in regard to this second puzzle. For several other countries, including the United Kingdom, Canada, Australia, and New Zealand, the international investment positions have for extended periods diverged from the value suggested by historical current account balances, in a manner similar to that of the United States. The divergence can go the other way as well–Switzerland and Japan currently report net investment positions substantially less positive than those suggested by their persistent current account surpluses.

One should expecially see the graphs Krozner points towards the end. They explain the 2 puzzles rather well. Excellent speech.

One Response to “The 2 puzzles of US economy”

  1. Business blog » Blog Archive » The 2 puzzles of US economy Says:

    […] Read the rest of this great post here […]

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