Views of the Economy
Economist's View: Paul Krugman: The Phantom Menace

Bad News on the International Finance Numbers

Daniel Gros writes in the FT: / Comment & analysis / Comment - Discrepancies in US accounts hide black hole: By Daniel Gros: The global financial system seems to have a black hole at its centre. Over the last two decades, US residents have sold a total of about $5,500bn worth of IOUs to foreigners, yet the officially recorded net investment position of the US has deteriorated only by a little more than half of this amount ($2,800bn). The US capital market seems to have acted like a black hole for investors from the rest of world in which $2,700bn vanished from sight -- or at least from the official statistics.

How can $2,700bn disappear?

It is often argued that the US can simply make large capital gains on its gross positions because its assets are denominated in foreign currency and its liabilities in dollars. However, the available data indicate that over the last two decades this factor has netted the US at most $300bn-$400bn. This still leaves a loss of well over $2,000bn to be explained.

The explanation comes in two tranches of about $1,000bn each.

The first source of accounting revenues for the US derives from an anomaly in the item "reinvested earnings" on foreign direct investment in the US balance of payments... foreign companies systematically report abnormally low profits for their US operations to avoid US corporate income taxes.... [T]he country's current account deficit would thus be about 1 per cent of gross domestic product larger than officially reported.

The underreporting of the current account deficit implies that US indebtedness is also underestimated... about $1,000bn.

A second source of gains comes from very large residuals... in... statistics on the evolution of the net US international investment position... also... about $1,000bn over the past two decades....

The discrepancy arises for a simple reason: the current account data are based on actual flows of payments recorded in the balance of payments. By contrast, the data on the US international investment position are based on surveys of depository institutions, which year after year tend to lose sight of US assets held by foreigners, especially portfolio investment and real estate....

[I]t is likely that the true US net external debtor position is around $4,000bn (about 40 per cent of GDP) rather than the $2,500bn reported officially for end-2004... both the current account deficit and the net debtor position of the US are even worse than officially reported. This can only mean that the need for a substantial depreciation of the dollar and/or a period of sub-par growth is even bigger than generally accepted...