The United States as a Global Financial Intermediary and Insurer

Alexander Monge-Naranjo of St Louis Fed in St Louis Fed Eco Synopses:

Over long periods, American investors have obtained rates of return from their foreign assets that exceed the rates of return on foreign holdings of U.S. assets. The first column of the table shows estimates from Gourinchas, Rey, and Govillot (2017), who find that from 1952 to 2015, American investors obtained a 5.8 percent rate of return on their foreign investments, while foreign investors obtained only 3.3 percent on their U.S. assets. Hence, U.S. investors could earn positive net income while holding a lower level of assets abroad than foreigners hold in the United States. Indeed, back-of-the envelope calculations suggest large leverage ratios (liabilities-to-asset) ratios, on the order of 1.75, could be sustainable for the United States. More elaborate estimates find lower numbers, but all of them are well above 1.¹ 

The table also shows that U.S. investors hold foreign assets that are riskier than U.S. foreign liabilities: Returns to the former have a higher standard deviation than returns to the latter, 15.2 percent versus 11.8 percent. This finding is consistent with the fact that U.S. liabilities are largely in the form of equity and foreign direct investment (FDI), while much of the U.S. foreign liabilities are in the form of bonds and bank deposits, which have more stable market values. These asymmetries explain the differences in average returns and risks (standard deviations). 

These portfolio asymmetries have implications for the global allocation of risk. Indeed, Gourinchas, Rey, and Govillot (2017) argue that the United States is working as a global insurer. That is, in exchange for collecting positive net returns during normal times, the United States transfers resources to the rest of the world during global downturns and crises. Collecting positive returns in normal times and paying out during bad times is what an insurance company does. During global crises the market value of most assets, including U.S.-owned foreign equity and FDI, falls relative to the value of U.S. Treasury bonds. Moreover, during global crises, investments “fly to quality,” typically leading to an appreciation of the U.S. dollar. As a result, during a crisis the value of the U.S. international investment position (IIP) falls; that is, the amount of U.S. resources owned by foreigners increases.