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On the origins of dark matter

by Brad Setser
January 13, 2006

Stephen "Current accounts almost always don't matter" Jen is intrigued by Ricardo Hausmann and Fredrico Struzenegger's discovery of dark matter.   Lots of others are too.   Michael Mandel for one. See Claus Vistesen for a wrap-up of the initial flurry.

Jen's and Mandel's interest is no surprise.  Dark matter supports Jen's over-arching dollar bullishness in the face of large deficits, even if it doesn't generate the $1 trillion or so in cold hard cash the US needs to finance its (expected) 2006 current account deficit.   Though in fairness, Jen currently expects the dollar to weaken against Asia — just for cyclical reasons, not structural ones like the US current account deficit. And the discovery of dark matter supports Mandel's belief that the current account deficit is dated concept — rising external liabilities are fine so long domestic assets are rising.   Dark matter suggests that the United States' (net) external liabilities, correctly measured, aren't really rising. 

I digress.   This post is about the origins of dark matter, not its adoption by those who think current account don't matter – or at least do not matter quite as much as I do.  I have a bit of skin in this game: Hausmann and Sturzenegger frame their argument (which has now been updated) in part as a response to the arguments Dr. Roubini and I have made in the past.  

So my apologies for a lengthy, data-rich, link-heavy post that tries to synthesize a lot of material. The Lex column of the FT covers some of the same ground in far fewer words.  

Both Higgins, Klitgaard and Tille of the New York Federal Reserve and the CBO also have examined why the US earns more on its overseas assets than its pays on its external assets.  They, like me, just didn't have the genius required to spin the fact that foreign investment in the US earns next to nothing (judging from the balance of payments data) as a good thing.  Or the temerity to argue that the US can finance its current account deficit by borrowing against the imputed assets ("dark matter") created by low foreign returns on investments in the US!

Dark matter, as defined by Hausmann and Sturzenegger, is the gap between the assets implied by the fact that the US receives more on its international investments than it pays on its external debt (the investment income line in the balance of payments is positive, or at least was) and the United States' formal debt position.

In 2004, according to Hausmann and Sturzenegger, the US got $30 billion more on its overseas investments than it paid on its external debts, which implies $600 billion of assets (with a 5% return).   Yet formally the US had $2.5 trillion in (net) external debt, which implies (with a 5% return) net payments of $125 billion.   Voila.  $3.1 trillion in dark matter.

Actually, the revised data on investment income suggests the gap was a bit bigger – more like $35 billion.  Hausmann and Sturzenegger may have underestimated the stock of dark matter ever so slightly.  No matter.

In 2005, the income line will probably be slightly negative, at least if I am right about the fourth quarter.  But in the grand scheme of things, it will remain pretty close to zero.  The net investment position of the US also will deteriorate, to north of $3 trillion.  Let's say $3.2 trillion.  I am assuming about $100 billion in capital gains on US equities abroad.   That implies the US should have an income deficit of $160 billion.   It didn't.  Or in Hausmann and Sturzenegger's terms, the amount of dark matter on the US balance sheet rose slightly, to $3.2 trillion.

Stubborn long-term dollar bears – at least those who have looked closely that the balance of payments data – were quite aware that the US does not (yet) make net payments of interest to the world. For that matter, we stubborn bears also have noted the fact that the US net international investment has deteriorated far less than would be expected by large ongoing current account deficits.  

We just are not convinced that the current, positive investment income balance is:

  • Likely to last.  US interest rates are not going to stay as low as they were in 2002, 2003 and 2004.  And foreigners hold a decent chunk of US debt, particularly US Treasuries.   Payments on US debt are rising.  See Menzie Chinn.
  • Real, rather than an artifact of tax arbitrage and transfer pricing. US firms have an incentive to report profits in low tax countries (at least if they finance themselves with equity, not debt, see the CBO). European firms seem to have an incentive to minimize their reported US profits.  I'll put it this way. US firms like to report their profits in low-tax European countries (Ireland, among others).   And European firms seem to like to report their profits from their US operations in low-tax European countries too.

I want to take each point in turn.  But first, a few basic facts.  

At the end of 2004, the US had $10 trillion in external assets, and in 2004 it received 376.5 billion on those assets.  It had $12.5 trillion in liabilities, and paid $$340 billion on it.  That works out to an implied rate of return of 3.8% on US overseas assets, and an return of 2.7% on foreign assets in the US.  Store that away, and remember, that difference is in dollar returns – it doesn't account for exchange rate changes. 

In 2005, both US assets and US liabilities will increase.  Assets (including valuation changes) could rise to roughly $10.6 trillion, and liabilities to $13.9 trillion.  I estimate that the US is likely to get about $455 billion on its assets, and pay $460 billion on its liabilities.  If , that works out to a return of 4.3% on US assets, and payments of 3.3% on US liabilities. 

Let's disaggregate the data on assets and liabilities to better match the categories that appear in the current account data.   The dollar value of US equity investment abroad has surged since 2002, so the US now has more equity investment – including FDI – abroad than foreigners have equity investment in the US.  American portfolio holdings of foreign stock exceed foreign holdings of US stock. 

However, the positive net US equity position is offset by a big net debt position.   By my calculations, the US has lent about $4.15 trillion to the world at the end of 2004, but the world has lent $7.9 trillion to the US.   This shows up clearly if you look at the US net investment position, disaggregated by different categories.   The recent rise in the value of US equity investment abroad has been offset – as we know – by a rise in private holdings of US debt securities (net of US holdings of foreign securities), and by a rise in official claims on the US (net of US reserves and other foreign assets of the US government).

image

According to the available evidence, the US generally not only borrows in the dollars, but also generally lends to the rest of the world in dollars.  US holdings of euro, yen and even high-yielding Brazilian real denominate bonds are relatively small.  That means the net US debt position doesn't vary with currency moves, and the US basically gets a dollar interest rate on the money it has lent to the rest of the world. 

It also means that we can dismiss one of the explanations Hausmann and Sturzenegger put forward for dark matter, namely the United States capacity to borrow abroad cheaply to finance the purchase of high-yielding emerging market debt.

That happens, but not on a big scale.  US has lent about $4.15 trillion to the world.  The EMBI – the leading index of dollar-denominated emerging market bonds – has a market cap $290 billion, and not all those bonds are held by Americans.  The disaggregated survey data from the US Treasury tell the same story.  The US holds lots of British, Canadian, Japanese, European and Cayman bonds – and not so many Mexican and Brazilian bonds.  The Cayman bonds are presumably issued by US firms that have moved offshore. 

That brings me to a key point.  Dark matter doesn't stem from particularly high reported returns on US investment abroad.  It stems from unusually low returns on foreign investment in the US.   Steve Kyle is right: dark matter looks more like dark anti-matter.

Pictures often can tell a story better than words.

Dark Matter stems in part from low US policy rates

I have summed up "government payments" and "other payments" recorded in the income line of the US current account.   And compared what the US pays on its debts (and any dividends paid to foreign portfolio investment in US stocks) to what the US gets on its lending to the rest of the world (and any dividends the US gets on its investment in foreign stocks).  

image

A couple of things stand out.  First, in 2004 the US paid out a bit LESS than it paid out in 2000.   Thank you Alan Greenspan.  Rising debt was offset by falling US rates. 

The aggregate payments the US receives on the money it loans out to the rest of the world (setting 2001 aside) generally have moved in line with US payments.   Indeed, the relative returns on US lending to the world and foreign lending to the US are quite similar.  That is consistent with the data showing that most US lending to foreigners is in dollars (or with foreign rates moving in line with US rates).  
 image

One point of clarification. This data includes payments and holdings on "portfolio" equity, largely because stripping dividends out of the data is more trouble than its worth.  To see the data with dividends on portfolio equity merged with payments on FDI, see Higgins, Klitgaard and Tille

The problem going forward.?  Simple.  US rates are rising.   So too are US interest payments.   See Robert Scott of the EPI.  That's only fair.  Foreign investors have accepted very low yields for a while.  They earned their reward ….

Given that the US tends to both borrow from and lent to the rest of the world in dollars – and given that it has borrowed far more than it has lent – rising dollar interest rates tend to increase the (net) US interest bill – and reduce the total stock of dark matter.

Dark matter stems for low returns on foreign direct investment in the US

That brings me to the second source of "dark" matter — the gap between the return that foreign direct investors report on their US income and the return that US firms report on their direct investment abroad.  In 2004, the US received $128 billion more than it paid out.

 image

The US has effectively financed some high yielding investment abroad with low-yielding US debt.   But that is not the primary source of dark matter.  The market value of US direct investment abroad only exceeded the market value of foreign investment in the US by $600 billion — not nearly enough to generate an income surplus of $128 billion.

The real source of dark matter is that a dollar of US investment abroad yields a far higher return than a dollar of foreign investment in the US.  Look at this graph, which shows the reported return on US FDI abroad and the reported return on foreign investment in the US.

 image

There returns were calculated relative the market value of foreign direct investment, but the story doesn't change much if you use book value (current cost in the balance of payments data).  The average returns on US investment abroad over the past five years rises from 6.5% to 8.9%; the average return on foreign investment in the US rises from 2.3% to 3.7%.   The discrepancy remains.

The gap doesn't stem from the fact that US firms tend to invest in particularly risky countries, like say Bolivia.   Most US foreign direct investment is in Europe, Canada and Japan. And most foreign direct investment in the US comes from Europe, Canada and Japan.   Certainly not from China.   Dark matter is a US-European thing, not a US-emerging markets thing – even if it was discovered by two distinguished Latin American economist.

The second key point: the reported return on foreign direct investment in the US have not been all that spectacular, to say the least.  Actual returns averaged 2.3% between 2000 and 2004.  So much for the argument that the US is the world's greatest place to invest.

The fact that dark matter comes from the incredibly low reported return on foreign direct investment in the US, not from great US returns on its overseas investment also casts doubt on Hausmann and Sturzenegger's claim that dark matter comes from superior US know-how.  

You know the story. Disney takes out a low interest loan to build Eurodisney.   But then its skill turns a field outside Paris into the Magic kingdom, and a money machine.  The profits on Eurodisney lead the price of Disney's US stock to soar.  But that doesn't get captured in the formal measurement of the net international investment position.

I actually am not so sure about that.  Technically, I think the loan would appear as a foreign liability of a US resident (the Disney corporation), and Disneyland Paris as the offsetting asset.  The payments on the loan should appear in the income balance of the US (as US debt payments).  And Disneyland Paris' profits should appear in the income balance too, as the profits on US investment abroad.   Call it the gains of intermediation – Disney issues low yielding debt abroad to build a high-yielding asset abroad.  So if everything is valued correctly and measured correctly, the large profits Disney earns abroad that support the high valuation of Disney's US stock should appear in the balance payments.  That of course is a big if.

But there is another reason why Hausmann and Sturzenegger's story doesn't make all that much sense to me.  European firms know a thing or two about luxury retailing.   LVMH.   Cheap chic too. Zara and H&M.  French champagne is just better – that has to generate some dark matter.  German firms have a reputation for top of the line engineering.  BMW.  Japanese firms for quality and fuel-efficiency.  Toyota.  Not all corporate know-how is concentrated in the US.

Hat tips: Old Vet, Steve Kyle, PGL and Kash over at Angry Bear.  

So all things being equal, one would expect some of the same factors that generate dark matter for the US to work in reverse.  Toyota and BMW take out dollar loans to finance the construction of US assembly plants, and then make Eurodisney sized profits on their reputation for quality.  Hausmann and Sturzenegger's argument only works if say Toyota and BMW really earn very little on their US operations, while Ford and GM earn a lot in Europe. Somehow, I doubt it.

Ok, in some sectors, US firms can exploit de facto monopolies (Microsoft for PC operating systems), duopolies (Intel and AMD for CPUs), unique know-how (Google's skill matching eyeballs to ads) or skill using IT to manage inventories in big boxes (Walmart).  Maybe high US margins in these sector's offset juicy foreign margins in sectors where US firms are not world beaters.   Maybe.

There are other potential explanations for low profits on investment in the US.  In recession years -or years when the euro and yen are unusually strong — foreign firms operating in the US may temporarily accept low margins to maintain market share.  That may explain why foreign firms did so badly in 2002 and even 2003.  And foreign firms may have overbid for no profit US companies at the height of the tech bubble.  But established European firms should have been doing very well in 2000, when the US economy was booming and the euro and yen are weak. 

It seems strange that, in good times as well as bad, the reported return on foreign direct investment in the US is quite low.  So low that most foreign firms would have been better off just putting their money in Treasuries. 

image

Note. The reported return on holding US debt in 2000 and 2001 may seem a bit high, but my numbers parallel those of William Cline of the IIE.  No funny business.

What else might explain the difference between US profits abroad and foreign profits in the US, other than superior US know-how? 

Easy.  Tax avoidance and transfer pricing. 

The US theoretically taxes an American firm's global profits, not just the profits from its US operations.  In practice, however, US corporate taxes can be avoided so long as a US firm doesn't formally repatriate its profits.  Or, for that matter, if the company waits until the US passes a tax holiday to encourage repatriation.  

The EU doesn't have a harmonized corporate tax.   That means US firms — at least those that finance themselves with equity not debt, hat tip Menzie Chinn — have an incentive to show their European profits in low tax jurisdictions in Europe.  Perhaps some of their global profits too.

An example: Microsoft, for some reason, books lots of profits in Ireland.  Glenn Simpson in the November Wall Street Journal:

The four-year-old subsidiary, Round Island One Ltd., has a thin roster of employees but controls more than $16 billion in Microsoft assets. Virtually unknown in Ireland, on paper it has quickly become one of the country's biggest companies, with gross profits of nearly $9 billion in 2004.

Ireland's citizens may not have heard of Round Island One, but they benefit greatly from its presence. Last year the unit handed the government of this small country of four million citizens more than $300 million in taxes.

The citizens of other nations where Microsoft sells its products are less fortunate. Round Island One provides a structure for Microsoft to radically reduce its corporate taxes in much of Europe, and similarly shields billions of dollars from U.S. taxation.

No Wall Street Journal subscription?  This Irish blog covers the key points of Simpson's article.

Another example: Ever wonder why Pfizer's effective US tax rate was 8.2% in 2003 — not 35%?  Ever wonder why Pfizer makes Lipitor in Ireland?  Finfacts/ Ireland Business News (emphasis added)

In October 2004, the Financial Times said that from 1994 to 2003, foreign profits of the six largest US pharmaceuticals companies went from 38 per cent of their overall income to more than 65 per cent. At the same time, the taxes paid on those profits fell from a rate of 31 per cent to 17.5 per cent, just half the US corporate tax rate.

In the case of the drug companies, the growing share of profits booked abroad – most of it in low-tax jurisdictions – does not reflect any significant shift in where those companies do business. Even as their overseas share of profits nearly doubled over the past decade, their overseas sales grew from just 40 to 43 per cent.

The net result:  European firms AND American firms both want to show profits from their global operations outside the US, whether in low-tax European jurisdictions or the Caribbean. 

That doesn't necessarily mean the US current account deficit is mismeasured: as Philip Lane noted in the comments of an earlier post, firms can increase their "overseas" profits is by understating the value of their exports to their subsidiaries abroad.  That just shifts US external revenues from the export line to the income line of the balance of payments. 

I don't have proof that tax arbitrage explains the large gap in reported rates of return.  It was easier to find information of US firms avoiding US (and other) taxes by routing US profits through Europe than the strategies that European firms use to avoid US (and other) taxes.  To paraphrase a Deutsche Bank research report, it is hard to find empirical support for the argument that tax arbitrage accounts for the gap in returns, but easy to find anecdotal evidence.  In this case, I believe the anecdotes. 

Remember, lots of balance of payment data ultimately comes from tax data, of one kind (customs) or another (corporate income tax returns).  

Sum up the evidence, and my bottom line is simple. I suspect a lot of dark matter has its origins in what some have called one of the dark sides of globalization.  Corporate tax arbitrage.

58 Comments

  • Posted by Claus Vistesen

    This discussion seems to have caught the eye of someone else 😉

    http://www.economist.com/finance/displaystory.cfm?story_id=5408129

    ҠFor critical commentary see http://www.rgemonitor.com/blog/setser/113810

    CV

  • Posted by Eric Hansen

    I first read about the beliefs of Haussmann and Struzenegger in The Economist. This lead me to read your blog and your convoluted attempt to understand our current account deficit. Unfortunately, most of the things I have read in this blog are incorrect.

    Here are the parts that are incorrect:

    1. The US does not have any foreign liabilities. Zero. The world is not lending us any money. We are not borrowing money from the world.

    Millions of citizens, companies and countries outside the world convert their native currencies into dollars to purchase US assets, principally stocks, bonds, treasury bills and real estate. This is done either with their export earnings to the US or by converting their currencies into dollars in the foreign exchange markets.

    These conversions and purchases of assets are not liabilities. If a Japanese investor buys stock in Enron and loses his shirt, too bad. Nobody in the US owes that investor anything. The investor assumes 100% of the risk of buying that stock as well as any currency exchange gains or losses. The US is not liable to for anything.

    Incidentally, if China or Japan buys treasury bills, they are not loaning us money. Treasury bills are an asset just like real estate. They can be freely bought and sold in the market place and their value rises and falls depending on current interest rates. The US government promises to pay interest and principal in dollars only. It is up to Japan and China to figure a way to convert those dollars back into their own yen and yuan.

    2. The world does not owe the US any money. This is a blanket statement that must be qualified. The US does not lend money to the world with two exceptions: The World Bank and the International Money Fund. The US government provides a small amount of money to these two organizations (as do other countries) which do lend money to countries outside the US. These countries are liable for repayment to the World Bank and IMF, but they are not liable to pay the US. Our contribution to these two organizations is essentially a gift or foreign aid. There is little likelihood that we will ever be paid back nor is it required. The US has loaned money in the past to foreign countries (Lend-Lease during WWII is a good example), but we are not currently doing so now.

    Millions of American citizens and companies convert their dollars into foreign currencies and purchase stocks, bonds, companies, real estate abroad. We also build factories, buildings, EuroDisneys and other assets abroad. However, these are not loans. We certainly hope that our Foreign Direct Investment will turn a profit, but it is not a liability for the foreign country or their citizens. If I buy stock in the Japanese stock market and the company I buy goes bankrupt, I lose my shirt. Too bad.

    I will discuss further on why this distinction between owning foreign assets and loaning money abroad is important.

    3. Although tax advantages may have some effect on foreign investment, they are not always important. Much of the foreign investment in the United States is now done by governments. Japan and China’s central banks are the largest single owners of US treasury bills (about $1.6 trillion). Tax advantages are irrelevant to them because they do not pay taxes in this country or any other country.

    4. As to why we earn more on foreign investments than foreigners do in the US, the reason is simple. We usually invest in emerging markets and they typically grow faster than our mature economy. China’s economy is growing at 8-9% per year. Ours is growing at 3-4% per year. Naturally our percentage rate of earnings on assets in China exceed their earnings on assets in the US. As for why countries continue to invest in the US, the reason is low risk (safety), not high rates of return.

    5. Regarding the black hole, it does not exist and is not particularly relevant. You sight the figure that US citizens and corporations own $10 trillion in assets abroad and that foreign citizens and companies own $12.5 trillion in assets in the US. This implies that it is even possible to put a dollar figure on the millions of stocks, bonds, pieces of real estate, factories, buildings, stores, restaurants, trade names, copyrights and patents that we own in foreign countries and continuously update this figure with currency and market fluctuations. It is probably a little easier to put a dollar figure on the assets foreigners hold in this country, but not much. If it makes Hausmann and Struzenegger happy to claim that we really own $13.2 million worth of assets abroad, so be it. The truth is we will never really know the value of what we own abroad nor will we know the value of what foreigners own in this country. Most records (particularly real estate) are buried away in local bureaucratic institutions and private data banks and the cited figures are the barest guesses at best, and grossly inaccurate at worst.

    It is quite likely that H&S are correct in their basic assumption that the numbers are wrong. The US ran trade surpluses every year from 1880 to 1980 and only small deficits until 2001. We have built up a century’s worth of assets which we own and earn revenue from. A few years of trade deficits will not change this dramatically in the same way that a few years of losses in a company that has earned record profits for a century will not send that company into bankruptcy court in the short run.

    In the long run of course, if we continue to run $800 billion trade deficits year after year, we will eventually face a problem.

    WHAT REALLY MATTERS

    The most important point is that it is not important how much we own abroad nor is it important how much foreigners own in this country. What is important is what they do with their assets.

    If we pay Saudi Arabia $100 million for oil and they put this money in treasury bills, the effect on our living standard and currency exchange rates is positive. We get the oil essentially at no current cost. If the Saudi’s attempt to convert these dollar holdings into Euros, Yen, Pounds or other currency, then the effect on our living standard and currency is negative. They dollar will fall and we will either face inflation, high interest rates or both.

    It makes no difference whether the Chinese or Japanese earn 2%, 4%, 6% or 8% on their investments here as long as they are willing to keep their money here and add to their holdings every year. We can continue buying foreign goodies and the dollar will remain strong. If they decide that they do not want to keep holding dollars, the result will be catastrophic. With their huge holdings of our currency, the Asian countries control the value of the dollar and much of our economic future. They can destroy our economy if they so wish. The can continue supporting our economy if they so wish. We have no control over what happens.

    To be bullish or bearish on the dollar implies that you have an understanding on the inner workings and mindsets of the central bankers in Japan, China, Korea, India and Taiwan (who are the principal foreign holders of our currency). It implies that you know just how much these countries will continue to sock away in treasury bills and other investments, and whether they will see it as in their best interest to continue doing so in the future. It is a risky bet.

    The world’s investors are currently engaged in a huge game of chicken. As long as nobody attempts to take money out of the US, their holdings remain very valuable. If too many people attempt to repatriate their US holdings to the native currencies, everybody loses. The danger is that a country such as Venezuela or Iran will decide to stop holding US dollars and be the first to pull their money out of this country. This will precipitate a run on the dollar with dire consequences for the US.

    There has never been a time in our history when this country has had so little control over it’s destiny and been in such as weak position as today.

  • Posted by BullionVault

    Thank you for helping me understand. “The Economist” referenced your article, and the unpunished US current account deficit is something needing explanation. Mises said something about the risk of ‘keeping warm by burning the furniture’. It is not hard to understand why an executive would build a factory in China, and multiply his short term returns – via FDI – from maybe 3% at home to 40% abroad. But the furniture is being burned. Many western firms find that after a couple of good years a near duplicate factory appears on the same Chinese industrial estate.

  • Posted by TJ

    Can’t let the blog end on such a “downer” note, otherwise I simply won’t be able to get up and go to the work in the morning.

    The US has not abdicated control of its future to foreigners. Foreigners (increasingly Asian central banks (ie: China)) own US assets, and the US owes payments against these. If foreigners attempt to start massive selling of U.S. assets, they wipe out not only our economy, but also their own. This would not be “hot” money fleeing a small open economy, so analogies to Argentina or the Asian tigers simply don’t hold water. What we are talking about is economic “mutually assured destruction” of the two engines of the global economy. Congruent interests have an interesting way of obtaining cooperation. The newfound interdependence of China and the U.S. actually lessens the chance that either country will do something regrettable regarding, say, Taiwan. The world is actually safer in 2005 than it was in 2001 during the spy plane incident. Given the equilibrium established by the mutual deficits of China and the US, the world can now get on with global trade.

    The balance of payments do not fully capture investors’ utility theory. The US current account has deteriorated monotonically since China pegged its exchange rate in 1995. I’d argue that they’ve received dark matter as quid pro quo for accepting lower returns:
    1) A credible central bank and monetary policy (look at how China’s inflation collapsed in the late ’90’s),
    2) liquidity to release excess savings that they did not want to keep trapped in their domestic economy, where it would cause overinvestment that has ended in tears for many emerging economies
    3) rule of law and property rights in the form of US capital markets and securities regulation
    4) banking intermediation that the Chinese banking sector does not have
    5) an FX “war chest” to prevent capital outflow dislocations in the event of some economic emergency.

    The dichotomy in returns is easily realized when one drops a very naive assumption that doomsayers make: that trading partners are identical, or even similar to one another.

    Nor do we need to look at China’s emerging economy to see the US economy as radically different. The US’s form of capitalism provides a much more efficient economic system (derided above as “American know-how”) than either of its nearest peers: Europe and Japan. In recent years, I’ve had a Japanese official state diplomatically that he did not think that the Japanese could fully embrace American “jungle capitalism”, and a British colleague state that he would rather go down with the “European ship” than embrace anglo capitalism that his country gave the world via its banking and economics expertise as well as common law. But the realization that American capitalism is “different” is not a recent phenomenon – read de Tocqueville’s Democracy in America.

    Yet despite the noted diffences, for the last several decades, most economists have accepted the notion that the US, Japan and Europe are economic “equals”. There is a problem with that. The US started out in a huge hole post-WWII because it had funded the rebuilding of Japanese and German industry. Consequently, post-war, US factories built in the early 1900’s and retooled for WWII and then again for peacetime were competing against state of the art factories. Little wonder that Germany and Japan looked so ominous even up to the 1990’s. Rent the movie, “the Rising Sun”, starring Sean Connery / Wesley Snipes, if you don’t remember the awe with which Americans viewed the Japanese economic juggernaut. Furthermore, the US economy experiences a unique, ongoing drage in the form of its military spending. This began in the Cold War and continues currently as the US wields the only military power capable of “exporting” security globally. Since WWII, no major nation states have plunged the world into the destruction of a global war. The US economy has financed the investment that made this possible, and while the unilateral effort is often ridiculed as “empire building”, most of the world’s economies have benefited from the expense of one.

    In spite of these drags, the US economy has continued to outpace its industrial “peers”. The productivity revolution of the late-90’s was not a mythic bubble after all. Consequently, before attempting to look at every line item of the BoP for evidence of transacted “American know-how”, I’d suggest stepping back, looking at the big picture, and accepting that the US version of capitalism is different and that the difference has been noted for centuries by Americans and non-Americans alike.

  • Posted by Arjun

    Brad,

    A question. How much does the global glut in dollar denominnated reserves among developing countries factor into this? There appears to be no research on the reasons for the massive build up (except a hearsay about fears of financial crises and capital outflows).

    Since this build up has been masssive, as the Euro gains more friends and countries switch to Euro reserves, will the dark matter reduce significantly?
    Arjun

  • Posted by Tsuk

    Your choice of Eurodisney as the example of the capacity of the US to earn superior returns strikes as very odd. Eurodisney has been in the red for the past four years and has lost a lot of money both for the parent company and forthe outside investors !

  • Posted by bsetser

    Tsuk — Eurodisney was the example that Hausmann and Sturzenegger used, I guess it doesn’t stand up to close scrutiny.

    Arjun — the fact that the US was able to add significantly to its stock of outstanding debt even when interest rates were low was a function of central bank buying (in my view) and since it both kept the interest payments on the “net debt” (2.5 trillion) and the “debt for equity” (1.2 trillion) parts of the US balance sheet lower, it contributed to the surge in dark matter that helped offset the rise in US gross debt from say 01-04. Now that rates have turned, some of that dark matter will disappear. and if central banks stopped buying altogether/ oil exporters started spending, pushing overall us rates up, that too would truly reduce the stock of dark matter.

    conversely, if the fed starts cutting and interest rates fall again, dark matter (as defined by sturzenegger and hausmann) would rise. I think they confuse low fed rates with us know how.

    but there argument doesn’t boil down to low us rates either — the gap on FDI is a seperate point.

  • Posted by Anonymous