Brad Setser

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The evolution of the United States’ external balance sheet in the last decade (wonky)

by Brad Setser
June 28, 2009

On Friday I tried to show why the US net international investment position deteriorated in 2008 – and also why it didn’t deteriorate in the previous years. Even after the market and currency gains of the past evaporated in 2008, the US net debt isn’t quite as big as an analyst who looked at the United States large cumulative current account deficit would expect. Some of the debt that the US thinks it sells to the rest of the world every year seems to disappear when the US goes out and tries to count the total amount owes the world – and how much equity in US companies have been sold to foreign investors.*

Yet even if the US data doesn’t show quite as much debt as it probably should, it still tells a lot going about what was on in the US – and the global – economy in the run up to the crisis.

It is consequently tempting to try to do a bit of forensic accounting to help understand how vulnerabilities built up. One thing quickly becomes clear. The US was piling up external debts in the run-up to the crisis even if the United States’ net international investment position wasn’t deteriorating.

The data in the NIIP can be disaggregated into debt and equity fairly easily. It is also fairly easy to separate out net official and net private claims. There isn’t a separate breakout for “official” investments in equities – as central bank and sovereign funds’ equity investments are aggregated together with their investments in US corporate bonds. But the US survey data indicates that official holds of equities were over three times official holdings of corporate bonds in the middle of 2008, so I don’t feel too bad considering “other official assets” a proxy for central bank and sovereign funds’ investment in US equities.

But don’t get bogged down in the details. There is no doubt that the US was clearly racking up debts to both official and private creditors in the run up to the crisis. Net US external debt (US borrowing from the world, net of US lending to the world) is now close to 40% of US GDP — a fairly high level for a country with a modest export sector.


The steady buildup of US external debt though was long offset by the rise in the value of US equity investment abroad. In my calculations I valued FDI at cost; valuing it at its market value would have pushed net US equity holdings (US equity investment abroad – foreign equity investment in the US) up even faster and, of course, produced an even bigger fall in 2008.

Looking at the net data alone can be misleading. In some cases gross positions offset; it is useful to know if a stable net position reflects a symmetric rise in gross positions (or a symmetric fall).

Look at the data on “gross” official flows.

In 2008, for example, a rise in US “official” lending to the world – essentially the Fed’s swap lines – offset an ongoing rise in gross official claims on the US.


This data helps to clarify the debate on the dollar’s status as a global reserve currency – a debate that I often feel misses a key point. The dollar was a reserve currency in the 70s, 80s and 90s too. But total central bank claims on the US generally were under 10% of US GDP. They jumped a bit in the mid-1990s, when a surge in capital inflows to the emerging world allowed many countries to rebuild their reserves. They dipped a bit during the Asian crisis, as many countries few on their reserves to finance capital outflows. But they only started to soar in 2003, when the dollar started to depreciate against the euro and Japan and a host of emerging economies resisted pressure on their currencies to appreciate.

Somehow the usual debate on the dollar’s status as a global reserve currency suggests that little has changed over the past few years – the question is only whether countries will continue to want the dollar to be world’s leading reserve currency. But the debate over “market share” ignores the real issue: the size of the market. The dollar’s share of global reserves didn’t rise over the past several years. Rather countries holdings of reserves soared, and a constant (or even slightly falling) share and much larger stock produced a big rise in central bank holdings of US debt.

That shift mattered: It left many emerging economies with a lot of exposure to the dollar, and left the US exposed to the risk that key countries might lose their appetite to continue to hold dollars.

What of private debts? I plotted gross bank claims on the US against US bank claims on the world, and US holdings of debt securities against foreign holdings of US debt securities.


Gross banks soared in the late 1970s. Petrodollar recycling. It actually was more than just recycling though. US bank claims on the world increased faster than foreign bank claims on the US; in aggregate, US banks were using US deposits to provide financing to the rest of the world. That has changed.

Gross flows have generally trended up, but foreign claims on the US and US claims on the world rose together. The pace of increase though did pick up just prior to the crisis – probably because of the expansion of the shadow financial sector. But I am just guessing. Setting 2005 though, US banks weren’t a net source of financing to the rest of the world.

Foreign and US holdings of debt securities have both increased over time. Foreign holdings of US debt soared in the 1990s. That makes sense. A rising dollar made dollar-denominated US debt an attractive asset. And US firms were borrowing heavily to finance a lot of tech related investment; think of it as the US borrowing to build the information super highway (and no doubt to consume a bit too). The big rise in foreign holdings of US debt from 2002 on is a bit harder to understand. It obviously provided a lot of financing to the US household sector – as foreign demand shifted from “straight” corporate bonds to US asset-backed securities. But these inflows came in the face of a declining dollar. They presumably were done by investors with access to dollar financing – so the investors were taking the credit risk but not the currency risk. The US banking system though wasn’t in aggregate providing credit to the rest of the world, so it wasn’t in a position to finance these purchases. Someone else was supplying a lot of dollar financing in the world’s offshore financial centers (London especially). Figure out who, and I suspect that you have figured out a lot.

A disaggregated plot of the different components of the US net debt position shows that the deterioration in the last decade reflects a rise in (net) official claims on the US, and a rise in (net) private holdings of US debt securities.


The mechanics of the rise in official holdings are well known (China, China, China and to a lesser degree Japan, Russia, Saudi Arabia and Brazil). The mechanics of the rise in net private holdings of dollar securities less so. Who wanted to take US dollar risk as well as US credit risk? And how was the dollar risk of say European banks buying US ABS shed?

A small point: some of the rise in private holdings may reflect disguised official flows, or at least official flows intermediated v private intermediaries. The US data shows that “official” investors had $3.5 trillion in “safe” US assets (I am setting aside official holdings of corporate equities, as those could be held largely by sovereign funds). Counting the PBOC’s other foreign assets and SAMA’s non-reserve foreign assets, the global pool of reserves was around $7.3 trillion at the end of 2008. If 60% of all reserves (a low end estimate) were in dollars, total central bank dollar holdings should be around $4.4 trillion; if 70% of all reserves (a high end estimate) are in dollars, the total rises to $5.1 trillion. That is a gap of between $900 billion and $1.6 trillion — a sizeable sum. Net private holdings of US debt are around $2.4 trillion, though gross holdings are obviously much larger.

At least $300 billion of that is in offshore dollar deposits ($300 billion is the gap between the US data and the BIS data in table 5c), and quite possibly more. Some of the $350 billion in official holdings of “risk” assets shown in the US data is in central bank hands. But between $500b and $1000b is missing – perhaps because it is managed by private fund managers. Central banks handing dollars over to private managers thus could be one explanation for persistent private demand for dollar debt even as the dollar fell. But there are clearly others.

What of equities, and specifically portfolio equities?

The story here is simple. The value of US investment in foreign portfolio equities doubled, as a percent of US GDP, from 2003 to 2007.


That isn’t primarily a reflection of large purchases of foreign equities by US residents. Cumulative purchases of foreign equities by US investors from the end of 2003 to the end of 2007 totaled $560 billion, implying valuation gains accounted for about $2.6 trillion of the $3.17 trillion total rise in US holdings of foreign equities. Rather it reflects the dollars’ depreciation, which pushed up the dollar value of US investments abroad – especially in Europe. And it reflects the fact that foreign stock markets dramatically outperformed the US stock market during this period.

Foreign investors bought nearly as many US equities as US investors bought foreign equities ($520b v $560b); the rapid rise in the value of US equity investment abroad relative to foreign investment in the US reflects the underperformance of US equity markets.

That in some sense is the great puzzle of the last six years. The US ran large deficits – and necessarily attracted large financial inflows – during a period when US markets consistently performed worse than foreign markets. Sure, that changed in the crisis. But the out-performance of the US then (US markets fell less than foreign markets) in the crisis hardly explains the persistence of inflows when returns on both safe and risky investments in the US lagged returns on comparable investments abroad. Foreign investors presumably weren’t buying US assets because they anticipated a US financial crisis.

The ability of the US to finance large deficits – and run up a large debt stock – during a period when returns on US investments lagged is the central puzzle of the global flow of funds. And it seems to me that one at least has to consider the possibility that the financing that supported these deficits weren’t entirely a “market” outcome.

* Some discrepancy between the stock and cumulative flows is to be expected — especially as the stocks get bigger. Things like the repayment of principal on Agency MBS and asset-backed securities make proper calculation of the flow difficult. The presence of a gap in the data isn’t a surprise. The surprise is that the revisions consistency work in the United States favor.


  • Posted by WStroupe

    Brad said, “The ability of the US to finance large deficits – and run up a large debt stock – during a period when returns on US investments lagged is the central puzzle of the global flow of funds. And it seems to me that one at least has to consider the possibility that the financing that supported these deficits weren’t entirely a “market” outcome.”

    Isn’t that explained mostly by the lenders’ (emerging market export-based economies) party with the U.S. consumers’ “conspicuous consumption” and the fact that these emerging economies’ central banks needed to keep their own currencies pegged low to the dollar so as to keep the party (Bretton Woods II)going? As an emerging market CB, wouldn’t you buy up Treasuries and other implicitly or explicitly govt-backed U.S. debt to keep your peg to the dollar, and care less about the return on such investments? That would help keep U.S. and global interest rates low, keep the U.S. consumer on his “conspicuous consumption” rocket ride, and keep the wild party going? As the CBs were seen to finance U.S. debt, then wouldn’t much of the unofficial global investment community also get on the bandwagon? Everybody likes a party, after all.

  • Posted by Cedric Regula


    I think that’s what it is, along with my other favorite, the ZIRP fueled carry trade by the “private sector”, if we are still naive enough to believe banks are in the private sector. This decade there has always been a near ZIRP country or two somewhere in the developed world.

  • Posted by ReformerRay

    How much of any of these flows is money returning to the U.S. that was sent abroad to pay for imports in excess of exports?

    In 2006 that number was 696 billion. Accounting conventions require that all that money return to the U.S.

    This flow is not a “market” outcome in the sense that someone made a choice where to send the money. That money has to come back to the U.S.

    Perhaps the data does not permit separating out this source of funds from other sources.

    What we would like to know is the flow of money other than that returned because of the trade deficit. As you suggest, it the flow of money that reflects investment choice or “safe haven” or some other reason other than converting trade deficit earnings into other U.S. assets.

  • Posted by Cedric Regula

    Brad:”It is consequently tempting to try to do a bit of forensic accounting to help understand how vulnerabilities built up. One thing quickly becomes clear. The US was piling up external debts in the run-up to the crisis even if the United States’ net international investment position wasn’t deteriorating. ”

    Isn’t this getting the cart and the horse mixed up?

    The crisis began with “subprime”, or put honestly, everyone started figuring out that CDOs and CDS where a fraud (official word is “toxic”). That means the debt we were selling to the ROW was discovered to be no good. Then that snowballed into concerns about prime mortgages and the large amount of adjustable mortgages(30% of all mortgages originated in 2005-2006).

    Then I have my “the consumer bumped into his credit limit theory”. You can only take out so many HEWs, especially when housing prices stop going up, housing prices got into record unaffordability levels even with low interest rates and even modern bankers may get tempted to calculate loan to income ratios, and next thing you know we get a recession.

    The way I understand the “vulnerabilities” of external debt is that they may decide not to extend it anymore. So we haven’t got to that part yet, except for central banks shifting out of anything besides treasuries, and buying more treasuries.

    So this is like doing forensic analysis on a still live body.

  • Posted by London Banker

    @ Brad

    Like Tom a couple days ago, I believe that the indirect purchasers reporting category changes last month were more likely aimed at obfuscating foreign investment interest in the Treasury auctions rather than providing better transparency.

    With US-based investors now in the indirect category, the category is useless as a measure of foreign interest. If the Fed wanted to improve transparency they would have had US and foreign indirect categories separate.

    With the new blended indirect reporting we can’t tell if the indirect purchases are foreign central banks or Blackrock or the Fed itself. I suspect that the recent machinations around new programs for the toxic asset liquidations – streaming large margin opportunities to Blackrock and PIMCO – are connected to cooperation to support the auctions. It would fit the pattern very well, and would be consistent with the past actions of key players in and out of government.

    There might be innocent explanations, but with this crew that would be the anomaly.

  • Posted by Eduardo Guelman


    For some time you had been arguing that domestic savings would be enough to cover US fiscal financing needs (a claim that seems to be supported by recent BEA data). Are you still in that camp? Or would you say that sudden drop , or rather diminished international appetite for nowadays 100 Bln weekly issues are now a major problem?

  • Posted by bsetser

    Eduardo — I don’t think I have said that US domestic savings would be enough to cover the fiscal deficit. That would imply the US current account deficit would fall to zero (no net borrowing from the world). i have said that with a fiscal deficit of 8-10% of GDP and a 3% of GDP current account deficit, the US is borrowing less from the rest of the world than in the past — and that the majority of treausies sold to finance the deficit would need to be placed domestically. I still believe that.

    At the same time, equilibrium in the treasury market requires that central banks at a minimum continue to hold their existing stock — and that means rolling over maturing claims (e.g.) showing up at the auction. And at times when private demand for foreign assets is strong — i.e. the market would push the US current account down further – the current equilibrium likely requires their ongoing willingness to intervene and then send the proceeds back to the US.

    Any sudden change tends to be a problem. But i still believe that on a flow basis, the US is gonna borrow less from the rest of the world this year.

  • Posted by anon

    “Rather countries holdings of reserves soared, and a constant (or even slightly falling) share and much larger stock produced a big rise in central bank holdings of US debt.”

    A graph of central bank reserves versus the global current account imbalance would be interesting.

  • Posted by Indian Investor

    Dr. Setser, could you please edit this sentence?
    “Some of the debt that the financial assets that the US sells the world seem to disappear when the US goes out at tries to count how much debt it owes the world – and how much equity in US companies have been sold to the rest of the world.*”

  • Posted by FollowTheMoney

    Be it public or private, debt only adds to the problem, unfortunately not the solution. It’s a vicious cycle…we maybe able to borrow from the world this year and next, but what about 5-10-15 years out?

    Everything i’m seeing is like an illusion, simply artificial, bad dream of large scale intervention to re-live “what was”, instead of “what now”.

    I hate to sound this way, but i believe we are witnessing what could turn out to be a “VL” recession. Nobody has spoken of a “VL” recession, but i’m more inclined to VL than W ( or V as most analysts on Wall Street believe).

  • Posted by FollowTheMoney


    “Net US external debt (US borrowing from the world, net of US lending to the world) is now close to 40% of US GDP — a fairly high level for a country with a modest export sector.”

    what level would you consider to be significant danger zone?



  • Posted by guest

    Thanks for your fine artcraft with numbers.It is worth reading your analysis in conjonction with BIS statistical figures
    Europe has more foreign claims (I would emphasize abnormal when compared to countries respective GDP than the USA) TAB 2
    When it comes to debts issuance the financial world has dwarfed all other sectors (TAB 3) Europe is by far the most proeminent debt issuer in the financial sector.and the international arena, when the USA debts issuance has in 2008 been more domestic.
    One may through these reading see the abnormal weighing of the financial industry in the world s economy, and I promtly add that discrepancies or statitical weighing can easily be directed to the financial sector and their dealers the central banks.

    Why and how could this situation be let to happen?

  • Posted by jonathan

    Is there anything in BIS & IMF data that might help? I refer back to your post regarding the shadow financial system and am wondering how those papers relate.

    The 2nd graph of Official Claims is striking.

  • Posted by Indian Investor

    Brad: But the debate over “market share” ignores the real issue: the size of the market.

    Me: The debate isn’t over “market share” at all. The constraint imposed by trade settlement in USD, denomination of forex reserves in USD and excessive price speculation in crude is that non resource exporting countries can’t make public outlays required for the development of their local economy. Under the dollar system, high public outlays in imported-oil dependent countries would lead to massive increases in those imports and insolvency from an external financing perspective. Systemically, they are constrained to remain in poverty and underdevelopment, with marginal exceptions in their export oriented sectors.
    China is the only country to have found a peaceful and sustainable way out of the dollar hegemony, an example well worthy of note and emulation if the hegemony continues.

  • Posted by Cedric Regula


    I’ve always wondered why India doesn’t buy oil from Russia, and just use whichever “R” currency they decide on?

    There must be some reason, but I have no idea what it may be? Himalaya Hegemony maybe?

  • Posted by Lupita

    How do global black market transactions (drugs, arms deals, money laundering) fit into official statistics? This market is worth several trillion and it must distort something somewhere, maybe a missing trillion in private holdings?

  • Posted by yoda

    FED target 0% fed fund rate = cheap money for a long long time. though cheap money stay as excessive reserve in banks, the notion that FED can soak up these money via magic tools or hiking rate when banks start to lend out excessive reserve is ridiculous. and the idea of banks have money other than excessive reserve is equally ridiculous -> FED will continue to pump out cheap money for a long time even when banks start to lend them out. at any rate, we will be 0% fed fund rate for a long long long time.

  • Posted by Michael


    My question – perhaps the same as Eduardo is asking – is do you still believe that the U.S. domestic savings rate will rise (and stay risen) sufficiently to cover the growing deficits in the scenarios a)ROW Treasury purchases level off b)ROW Treasury purchases decline?

  • Posted by Cedric Regula


    Do not underestimate the power of the Dark Side.

    True, the Fed no longer has the traditonal inflation fighting weapons. But consider these.

    1)They can print money to pay higher interest on bank reserves and induce the banks to keep higher reserves at the Fed.

    2) They could just increase reserve requirements.

    3) With Congress approval, they can issue sterilization bonds.

    But you are probably right that the Fed will not choose to fight inflation, but rather choose to grow employment in the Empire, which they believe is done with cheap money.

    So it will be the task of the Bond Jedi to defend the long end of the yield curve!

  • Posted by bsetser

    anon —

    I have graphed reserves v imbalances frequently in the past, and probably will do so again when the IMF COFER data for q1 comes out tomorrow.

    indian investor — you are right; that particular sentence was especially garbled, even by my standards. hope it makes more sense now.

  • Posted by Rien Huizer

    Excellent post, Brad

    This has (forensically speaking) the fingerprints of governments fighting markets all over it. And as we all know, when governments fight markets, opportunities for opportunistic behavior abound. I guess that quite a few people in the US benefited from the gigantic valuation losses incurred by non-US investors (incidentally, I guess that your forensic analysis has not extended to marking the foreign-owned bonds to market!).

    And where these investors were leveraged, and foreign financial institutions (like those adventurous German state banks setting up conduits with the help of Lehman’s Hamburg office) were liable, those claims are/were probably more robust than the assets they funded.

    One of the things that may be connected is the strange anomaly that European banks keep around EUR150 bn in excess reserves at the ECB. Simultaneously the ECB and BoE extend record levels of credit and both make extensive use of swap lines. In essence the central banks involved (FED, ECB and BoE are sitting on a gigantic market failure: some banks borrow to support the toxic portfolios in conduits (do not forget the tax aspects). They cannot (or will not because of expense) borrow from the market. Other banks cannot find efficient (in risk-adjusted terms) increments to their portfolio, or are in the process of augmenting Tier 1 capital) or both, and find ECB reserves the optimal investment.

    What will a gradual decrease in market viscosity (when capital is adequate again, helped by gvt stimulus that helps businesses remain more or less solvent) have for an effect on this position. If the NIIP captures the effect of transactions on the value of holdings (which it may not).

    But anyway, an extremely interesting piece.

  • Posted by bsetser

    rien — thanks for taking the time to read my post/ look at the graphs.

    I am trying to improve my diplomatic skills, so i only reported my data from the US point of view. And from that point of view, the US experiences (in $ terms) a rise in its external wealth when the dollar depreciates (and say the euro appreciates) pushing up the dollar value of us assets abroad. the dollar value of foreign investments in the US (US liabilities) is unchanged.

    Of course, from the point of view of the rest of the world, a dollar depreciation reduces the value of the rest of the world’s dollar holdings (in terms of their currencies) and thus produces valuation losses …

    full analysis though needs to take into account stock market moves, and there the language gets more complicated, as the us valuation gains reflected greater upward moves in non-us markets than in us markets — a similarly outsized moves on the downside.

  • Posted by bsanchez

    Again, a Spaniard reads your post with jealousy.

    The Bank of Spain just published Q1 NIIP and external debt data today. NIIP: -86% GDP, external debt: -165% GDP.

    I have tried to replicate your analysis with the Spanish data in my latest post a few minutes ago. Of course the Spanish story is a lot less interesting from a global perspective than the US experience. Still, 44 million people facing a much grimmer outlook than virtually anybody else in the OECD.

  • Posted by yoda

    Bond Jedi? if i am not mistaken, jedi anakin wiped out all Jedi and left Obiwan and me in exile. We need a new hope and dont see one.

  • Posted by Rien Huizer


    Perhaps to clarify: my “valuation” comment referred to the market value (in USD) of private debt securities (like CDOs) . Unlike equities, I suspect that the statistics use either pruchase price of nominal value. But many private debt securities (I know of one European bancassurance group that needed (disclosed) gvt assistance in the tens of billlions to remain adequately capitalized.

    Probably one level of realism to far for the record keepers.

  • Posted by bsetser

    random spaniard — well, if spanish real estate values fall, the fall of british direct investment in spanish real estate will fall too, helping the NiiP. My guess is that the rest of Europe is long spanish real estate.

    But there is no doubt that with bigger current account deficits in the run up to the crisis and no offsetting currency valuation effects, Spain is in a difficult place. Classic boom/ bust — though some Spanish policies seem to have helped (partially) protect the financial sector so a bigger real estate crisis may not produce a bigger banking crisis.