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So, is Michael Mandel right? Did intangible income (dark matter) ride to the rescue in the first quarter, offsetting rising US debt?

by Brad Setser
June 21, 2006

As Michael Mandel has noted, the US income balance improved in the first quarter – contrary to the expectations of “pessimists” like me.  I would say “realists” – rising debt usually implies rising interest payments – who expected the US income balance to deteriorate.

The income balance is the difference between what the US earns on its overseas assets (US direct investment abroad, US lending to the world) and what it pays on its liabilities (foreign direct investment in the US, US borrowing from the world).   

Certainly the improvement in this balance in the first quarter is consistent with one of the core predictions that Hausmann and Sturzenegger made – namely that the net income that the US earns from its investment abroad  — all those intangible assets — would continue to rise, offsetting rising interest payments on growing debts.    That is exactly what happened in the first quarter.  Anualized, the first quarter data suggest that the US earned $172b more on its direct investment than it paid on foreign direct investment in the US.  That is up about $30b from the 2005 total.   A nice little gain.   Something like $600b in new dark matter, to use Hausmann and Sturzenegger’s terminology.  And US net interest payments hardly rose at all – they went from $161.6b in 2005 to $162.5b (annualized) in q1.   The paid more on its debt, but it also earned more on its lending …

On the surface, it certainly fits the dark matter story.  Michael Mandel noted (in a comment on my post) that Goldman must have earned a ton of money abroad in the first quarter … all sorts of intangible trading profits.    But is it so?     What does the more disaggregated data tell us?  Lots of charts and graphs follow.

First, the balance on FDI — which accounts for the majority of the income flows from US equity investment. 

Let’s divide FDI income into two components – dividend payments and reinvested earnings.  Dividend payments are real flows, cash that moves across borders.  Reinvested earnings are virtual flows.   Income from say US investment in Ireland is theoretically paid to the US foreign company and the parent company then uses those funds to invest in its Irish operations (something that it does, of course, for reasons utterly unrelated to Ireland’s low tax rate on corporate profits).   No money actually crosses any border.

 As Daniel Gros of CEPR has noted, there has been a consistent gap between the amount US firms reinvest in their operations abroad, and the amount foreign firms reinvest in their operations in the US.   That gap remains – though in 2006, both foreign firms and US firms seem to be reinvesting a bit more than in the past.    Q1 data has been annualized for the sake of comparison.


The absence of any US reinvestment in 2005 also stands out.  There is an obvious reason.   The Homeland Investment Act (HIA).   The impact of that act shows up even more clearly if we look at dividend payments.


The HIA had a big impact – as I argued before, the very low rate of US investment abroad mean that net FDI flows helped finance the US current account deficit in 2005.   US firms reduced their foreign assets, helping to finance the US current account deficit.  2006 is going to be a bit different.    

What else stands out?  The very low dividend payments from foreign firms operating the US.   Their dividend payments in the first quarter were unusually low – as low as they were in the recession year of 2001.    Lower actually. 

Here is the same data expressed as a percent of the market value of US FDI abroad (and foreign direct investment in the US).  2005 and 2006 stocks were estimated based on flows and an estimated valuation changes – I will update them once the new NIIP data is out.  


Certainly when it comes to dividend payments, the positive US income balance doesn’t come from exceptional returns on US investment abroad, but terrible returns on foreign investment in the US.  And q1 was particularly terrible.

Adding back in reinvested earnings gives the overall estimated return on US FDI abroad and foreign direct investment in the US.  Given how much ExxonMobil and similar companies must be earning on their foreign oil rights, given all the tax advantages of Ireland and given very robust global growth, the 8% return on US FDI doesn’t jump out at me.  Rather, what jumps out at me is the low returns on FDI in the US.   Foreign firms would have been better off holding short-term Treasuries that now pay 5% or so.    

At least if the US data is really capturing their true earnings. 


Second, debt.  It is a bit more complicated that it seems.  Remember, the US doesn’t just borrow from the world.  It also lends to the world.   Sure it borrows more than it lends.  But its lending is important to this story.  

 Why – because, as I will argue – it seems like the US lending is very short-term.  Thus US interest income from this lending changes quickly as short-term rates rise and fall.    The US has shortened the term structure of its external debt (particularly in 2002 and 2003), but its borrowing still seems to have — relative to its lending —  a longer term structure.

If you look at the disaggregated data on the composition of US borrowing and US lending, that story makes sense.   The US doesn’t own many foreign bonds.    And foreigners own a ton of US bonds.   Bank lending to and from the US basically balances out.  Ergo, the overall term structure of US lending is dominated by bank lending, and the term structure of US borrowing is driven more by the term structure of all the US bonds foreigners hold. 

US interest payments certainly have been rising rapidly recently — a point emphasized by Menzie Chinn.   But so have US receipts on its lending abroad.


US receipts have actually been rising a bit faster than US payments, once you take account of the difference in stocks.  This shows up more clearly if you look at the implied interest rates on US lending and US borrowing (doing this calculation required making some assumptions about dividend payments – since they need to be stripped out of the data.  Trust me, those assumptions don’t drive the calculation)


I tried to explain this to Christopher Swann of the Financial Times – it is what underlies my quote: 

“We did see an increase in the revenues Americans earned from foreign direct investment and overall, US investors benefited from rising interest rates because of the mix of their assets and liabilities. However, there is no reason to believe that the longer-term trend towards a weaker income balance has stabilised”. 

But in all honesty, I didn’t find a good way of explaining it.   There are too many moving parts.   Assets from lending as well as liabilities from borrowing.   Borrowing that is growing faster than lending.  A general shortening of the term structure of US external debt given the shortening of the average maturity of US treasuries.  But even taking this into account, US lending seems to have shorter-term structure than US borrowing and thus moves faster as short-term interest rates change.    

It is the sort of thing that takes charts.   

All in all, then, am I ready to throw in the towel and concede?   

Certainly not.   I wouldn’t be surprised if dividend payments on foreign FDI in the US are revised up.  They seem too low to be true.   And once short-term interest rates stabilize, the US won’t continue to get a (small) boost in its income balance from the fact that US lending “reprices” faster than US borrowing.    Rather, the data will be dominated by the lagged impact of higher US rates on overall US borrowing costs.  And the $1 trillion in new debt the US needs to take on even if the US current account deficit is only $900b. 

Remember, the US borrowing need is actually a bit bigger in non-homeland investment act years than the US current account deficit, since the US needs to borrow to finance its new equity investments abroad.  

And borrowing at 5% or 5.25% to earn 8% isn’t quite as good as borrowing at 2% to earn 7% …


  • Posted by Anonymous

    “We allow free speech in this country, unlike in China, where someone who publishes similar comments about the Chinese government that Mr. Chiang publishes about the US government would be jailed”

    This is self-righteous twaddle. Firstly, this is private property and Dr. Setser is perfectly entitled to decide who posts here. Aside from anything else this is a commercial enteprise and its reputation is hardly enhanced by allowing free reign to the type of individuals who place tin-foil hats on their heads before posting. Secondly, simply because the U.S. has very liberal laws relating to the defamation of public figures doesn’t mean they cannot be defamed. Thirdly, it is cowardly in the extreme to post wild and totally unsubstantiated attacks on public figures anonymously. Fourthly, there is the stench of vicious racism about Chiang’s posts. I will go further: at times it is rather like reading the Chinese version of Mein Kampf.

    Although an adult, Chiang behaves like an unruly child and he should be treated like one. Dr. Setser should send Chiang into a corner to allow him time to reflect on his behaviour. If Chiang persists in acting like a vile brat, he should then be unceremoniously thrown out of the room.

    Dr. Setser is that rare bird, a genuinely nice person. On the other hand, I suspect that he is too nice for his own good on occasion.

  • Posted by Anonymous

    “Fourthly, there is the stench of vicious racism about Chiang’s posts. I will go further: at times it is rather like reading the Chinese version of Mein Kampf.”

    Obviously with Americans taking the place of Jews.

  • Posted by Guest

    ‘Exactly – ‘DOR’???. You don’t know who I am, so not sure why you’ve developed such a thing about me.

    I could develop a false, or semi-false front like you and everyone else. Are you saying that establishes ‘credibility’ in your mind?

    I’m not pretending to be anyone or an authority representing any specific interest and I’m not launching personal attacks on anyone. You may also have noticed that I try more to focus on responding to text than the people who write them, as I don’t know who they are – although when certain participants represent themselves as authorities in this and that, I do look for some indication of credibility.

  • Posted by Guest

    re: “Obviously with Americans taking the place of Jews.”

    A quick review of Wikipedia’s Democide page will remind you that Jews are actually a small minority of people who have suffered that sort of atrocity. My dead relatives were farmers starved to death with millions, upwards estimates of 10s of millions, of others – in their own homes – as the ‘army’ kept coming through and confiscating all their crops. I don’t know how the members of my family got out – with absolutely nothing. They don’t talk about it. There are no records. Unlike Germany, more than 70 years later the nation that perpetrated the crime not owned up.

    So one reason ‘Chiang’ (whoever that is) may be so successful at hijacking discussion could be that so many millions have very distinct memories of consequences that can be associated with that sort of rhetoric – and that we are not out of the woods yet. Democide, xenophobia, propaganda are all alive and well.

    I do think that Brad damages his own credibility by dedicating so much time acknowledging ‘Chiang’ (whoever that is), at the expense of topics and other participants, when no one seems to know who that is, how that person is funded and where or why that person gets so much time to stalk participants on this site.

    I was running my own conference and one of the reasons I shut down was that I was being stalked by too many of these sorts of people. Whether or not they’re just losers with too much time on their hands who seek legitimacy and attention by participating in this sort of thing – depressing to see how much they get – or whether they represent something more sinister.

  • Posted by Guest

    My problem with Chomsky is that he doesn’t tell the other side of the story.

  • Posted by Guest

    Gosh – Speaking of fronts, ‘Admiral Acquisitions’ led by the investment bank Goldman Sachs has “moved closer to acquiring Associated British Ports”. Does ‘dark matter’ account for the ports and shipping sector?

  • Posted by Guest

    I think that one can only laud Prof Setser’s willingness to engage all comers on his blog. Chiang is the worst kind of kook – half the kind speaking sense, the other half paranoid nonsense – so it gets hard to distinguish between the two.

  • Posted by Guest

    If Brad wants to dedicate his time to engaging the ‘Chiangs’ at the expense of other participants, he’ll be locked into a pretty futile battle at the expense of more productive work.

  • Posted by Gcs

    need a diversion at the blog site??

    need a feller ready to take on the house

    ready to throw a low punch but take one too

    unleash chiang

    i think brad may have invented him

    either him or mighty joe or both

    they are both grace notes and sharpening stones
    here in my mind

    but i dearly love his ceaseless scrap

  • Posted by MTC

    “Guest” writes –

    “My problem with Chomsky is that he doesn’t tell the other side of the story.”

    That’s odd. My problem with Chomsky is that he doesnt’t tell HIS side of the story.

    Gcs writes regarding a Certain Individual:

    “but i dearly love his ceaseless scrap”

    Oh, Gcs–you clever dog! Even a dullard like me can see that you put one “s” too many in your phrase!

    Dr. Setser – two questions

    As regards the low rate of returns on FDI into the United States–are there not strong incentives to keep these returns low in nominal terms? I recall your post on the fate of the poor PBOC official who tried to be sensible and diversify the PBOC reserves, only to get tripped up by the requirement that he report his results to his superiors in dollars.

    Could we not have a similar situation here? Since European firms at the end of the day must report to their shareholders in euros, would not European-owned firms try to keep as many of their internal transactions within the Eurosphere as possible, even though, technically, the transactions intersected with the Dollar Zone? As for Japanese companies, the tax system (JM, please correct if I am wrong on this) still penalizes profitability, encouraging losses shifting between subsidiaries and the center.

    As regards the behavior of the interest payments, is this not the pattern predicted by Gourinchas & Rey–rising euro increasing U.S. receipts, declining dollar drying up the U.S interest income streams of European investors?

  • Posted by FR

    I wholeheartedly agree with Gcs’s last post.

    Please do not censor Dave Chiang. I think most of us are reasonable enough to separated the wheat from the chaff in Dave’s posts, even if there is 90% chaff.

    Thanks to Dave for introducing me to Chalmers Johnson, who has great merit in reminding us of certain truths that we might overlook in the Sargasso Sea of conventional wisdom.

    Johnson’s technique is to take a grain of truth and to exaggerate and develop it.

    Dave’s problem is that he takes everything that Johnson says as gospel and exaggerates and develops several steps further.

    The worst part of this is what the French call “procès d’intention”. The closest I can get to this in English is what Fritz Perls used to call mind f—ing. In economics I suppose it means supposing that unforeseen consequences were actually intentions of policy makers. Marxists often fall into this trap. Well meaning transplants from Wall Street become the objective allies of the nasty imperialists. And after the revolution, the first categary are likely to go before the firing squad not long after the second.

    What Dave doesn’t realize is that this kind of mind f—ing so infuriates some people, that they reject not only the chaff, but also the grain of truth that he is trying to get across to us. Brad has tried to point this out to no avail. Anyway, everything I’ve said here is obvious to other participants. Bandwith is cheap – why censor?

  • Posted by Dave Chiang

    American Economic policy needs to stop scapegoating foreigners

    ” The US must adopt a pro-saving policy — facing up to structural budget deficits and the pro-consumption biases of the tax code and a bubble-prone central bank; such an approach would tilt national saving to the upside — reducing the risk of increasingly contentious current-account and trade deficits.

    But the protectionists certainly haven’t run for cover. China bashing remains a real threat in Washington — underscored by misplaced perceptions of “fair value” for the bilateral exchange rate between the renminbi and the dollar. In my view, currency manipulation is a real “red herring” in this debate.

    US-China trade tensions are a microcosm of what’s wrong with globalization. America’s excess consumption is placing an enormous burden on the rest of the world. ”

    – Stephen Roach
    Morgan Stanley Chief Economist

  • Posted by Dave Chiang

    Hi Brad,

    Just one point I would like to make about Indonesia. As a sovereign independent nation, Indonesia’s domestic politics should not have been any national security concern to the Clinton Administration. Under the guise of human rights, Interference in the domestic internal affairs of Indonesia by the IMF resulted in a bloodbath that continues today. The impoverishment of millions of families across Indonesia has led to the Muslim blowback against the United States that has cumulated into a clash of civilizations. The Clinton Administration deliberately blocked efforts by the Japanese government to stabilize the political and economic situtation across Indonesia.


  • Posted by bsetser

    I’ll associate myself with Barkley’s comment:

    “Chiang’s posts are only partly wacky. He is off on his charge that Rubin coordinated a hedge fund attack on Indonesia. He is not off that Stiglitz and many others criticized the policy of the IMF, backed by the US Treasury, after the crisis happened. However, brad setser is also correct that the situation was a lot more complicated than it seems on the surface, especially in Indonesia. The hard fact is that nobody knew what was going to happen, how bad the crisis would be or what would happen after it.”

    Dave — all bailouts come with conditions. Japanese bailouts too. the US and IMF may have gotten the conditionality wrong. But the choice wasn’t a bailout with no conditions v. what Indonesia got. the choice was between no bailout and a bailout with serious conditions. indonesia was a very corrupt country. no more on this from me.

  • Posted by bsetser

    MTC — well, in q1, the euro wasn’t that strong — so the $ denominated revenues of european firms weren’t pushed down in euro terms, and the euro revenues of US firms weren’t pushed up in $ terms. and i don’t think euro/$ explains why the profits of european firms reported in the US are low in $ terms. Tis a puzzle. I suspect they do have incentives to undercount (linked to taxes), and i don’t know why there is such a big gap in reinvested earnings.

    as for Japanese firms incentives, i am not an expert, at all. but your suggestion is interesting.

  • Posted by FR

    I wrote –

    “What Dave doesn’t realize is that this kind of mind f—ing so infuriates some people, that they reject not only the chaff, but also the grain of truth that he is trying to get across to us.”

    On second thought, he probably does realize it, but enjoys watching the sparks fly.

    I also thought it might be worthwhile to extract some of the nuggets of truth explicit or implicit in Dave’s posts.

    Problems of free trade and capital movements –

    The doctrine of comparative advantage is only valid in the long term and/or at a macro – level. Meanwhile the pain is felt at the micro level and in the long run we’re all dead. The benefits accrue to those at the top and refuse to trickle down. The negative effects are magnified when governments refuse to intervene.

    There is little or no regulation of trans nat trade and investment at the international level. The US and subservient international organizations fight against any expansion of international law or cooperation, and the US even refuses to be governed by existing international law. Meanwhile, Big companies get bigger and bigger in order to compete successfully in a global economy, and national governments no longer enforce anti-trust legislation. Trans nat companies become more powerful than national governments. Thirty years ago, I heard the Vice Chairman of an international bank say to a closed gathering ” We are already more powerful than most national governments”, so I can imagine what the situation is today, even if I have not experienced it directly for some time.

    This situation actually suits many in American government, because they feel they can – or must – interfere in the internal politics of other nations. There is no need for international cooperation – we’ll enforce our law as we see it. As Dave chianf so rightly points out.

    An old problem getting worse –

    The only people capable of running the US Treasury are transfuges from Wall Street. This means they’re conditioned to think like Wall Street bankers. It’s been that way since Andrew Hamilton, maybe even before. Or you had people like Salmon P. Chase (my very distant cousin) an honest but disagreable man, who was forced to compromise himself with Jay Gould in order to finance the Civil War (and pay his own expenses). Andrew Jackson was one of the few to go against high finance and he brought on a recession.

    How can we liberate ourselves from Wall Street? Please tell us, Dave.

  • Posted by Dave Chiang

    Hi FR,

    Let’s start by dispensing with the propaganda nonsense that the Clinton Administration was ever out to altruistically help the Indonesia, Malaysian or Thai people. Every government in the world looks after only its own economic interests. Period. Under the guise of human rights, the Clinton Administration attempted to restructure Asian economies for the exclusive benefit of Wall Street financial institutions and hedge funds. Likewise, the Japanese supported the Indonesian government to protect their huge industrial investment across Southeast Asia. From a certain perspective, the Asian Economic crisis was a clash between the Japanese Industrial capitalist model versus the finance-driven Neo-liberal US capitalist model. The Bush Administration invasion of Iraq was also most certainly influenced by consideration of that nation’s massive untapped energy reserves, second in the world after Saudi Arabia.


  • Posted by EthanJ


    I did not say “higher US inflation = lower CA deficit ?”

    Rather, I argue that net international investment income (line 74 in the BEA numbers) (a) will remain stubbornly positive for reasons not fully understood, and (b) correlates most strongly with inflation.

    I suspect (a) is the result of a complex set of interrelated feedbacks that have allowed the US to always find some new way of coming out ahead, and those feedbacks arise from the unique position of the US at the center of the global economy. So the US can suck up $5 trillion in global debts over the last 30 years, at an interest rate of ZERO. Furthermore, this situation will continue into the near and medium term future – at least the next 5-10 years or more, probably much longer, barring (1) any serious global effort to directly address it, or (2) the displacement of the US as the single largest, strongest, most transparent, most flexible, and most important economic and financial actor in the global economy.

    Call it “Dark Matter” if you want, but it exists and is closely related to US inflation.

    However, I’m also not sure what your historical record shows. Higher US inflation will reduce the purchasing power of households and businesses, thus reducing consumption of imported goods. US inflation will also increase the dollar price of dollar-denominated commodities. For trading partners with floating currencies, higher US inflation will represent a real depreciation in the dollar. Most developed economies are in this category, for whom intellectual property and labor are significant costs while commodity prices are a small portion of total cost. As those currencies strengthen, US imports from those countries will decline and exports will pick up – reducing the CA deficit. For trading partners with currencies fixed to the dollar, higher US inflation will be imported as higher commodity prices (esp. energy). These countries tend to rely on cheap labor and are highly sensitive to commodity prices, meaning that the cost of their importing their goods to the US will rise, and US manufacturers will become more competitive, again reducing the CA deficit.

    Inflation will do what the currency markets are being prevented from doing: alleviating global imbalances. And, at the same time, punishing the returns of foreigners investing the US while improving the returns to US investment abroad, once more improving the US net investment position.

  • Posted by EthanJ

    More interestingly, the corrolary to (a) in my theory above is that the sum of all changes to the US net international investment position cannot cause it to become negative for any significant period to time. If you are predicting that there will be a substantial change in the nature or magnitude of US investment income this year that will cause it to be negative, I predict that equally large offsetting changes will occur to balance out.

    Note that even the brief dip into the red in Q3 last year followed immediately after the largest positive net investment income of the last two years. Indeed, Q2 2005 numbers were more than twice the average of the preceeding three quarters.

  • Posted by DOR

    Movie Guy raises and interesting – and important – point: the different nature of different types of FDI.

    Consider manufacturing vs services. In manufacturing, investments tend to be larger in capital terms (excluding financial sector capitalization requirements for the purpose of this argument, if you please) and result in – at least in the case of US FDI in the PRC – merchandise exports to the US. The deal involves a technology transfer license fee, regular royalties and components from highly similar companies around the industrial zone.

    Services sector FDI, however, is a very different animal. Imagine the Hong Kong-based lawyer or management consultant who flies up to Shanghai to advise a foreign-invested exporter. Because his firm has an office in Shanghai, there is an FDI component. But, he is “imported” from Hong Kong to do the actual work, which is billed in Hong Kong and doesn’t involve US or PRC balance of payments. Until, that is, the company decides to repatriate some profits or pay out a dividend.

    RE: how real is US FDI, there are very large numbers of PRC FDI statistics that do not accurately capture the origin of the investor. (Regulars will recall my infatuation with statistical accuracy as it fails to apply to China.)

    Take the case of a US company that invests in Taiwan 1964. Over the years, the foreign investor heavily localizes management to the point where by 1994 virtually all top management in Taiwan are locals. The invested company then decides to make an investment in China and, a decade on, becomes mainly a PRC-based company.

    Question: Who’s your daddy?

    * * *


    As someone who studied under Chalmers Johnson and who has met numerous Asian business and political leaders, I’ll say this: you’re speaking from ignorance. The fact that he isn’t your “kindered spirit” says as much about you as about Dr Johnson.

    Anonymous thinks Dave Chiang’s posts are racists? That’s rich! I don’t recall anyone named Gomez being told “You wouldn’t be allowed to say that in Nicaragua!”, do you?

    Guest, the name you post under is the default setting. No one knows whether you’re “Guest” or guest. Was that you throwing in a one-liner about Chomsky? No one can tell. In other words, you have no track record. Now do you understand?