United States as a Debtor Nation

The Institute for International Economics has a new report on The United States as a Debtor Nation.

The United States has swung from being the world's largest creditor to the largest debtor nation. At the end of 2004, it had net external liabilities of $2.5 trillion, or 22 percent of GDP. The current account (goods and services, transfers, and capital income) is massively in deficit—about $670 billion in 2004, or about 6 percent of GDP. If corrective measures (US fiscal adjustment and a further decline of the dollar) are not taken, the current account deficit will reach about 7½ to 8 percent of GDP by 2010, and net international liabilities will reach about 50 percent of GDP.

The rising imbalance will increasingly put the US economy—and hence the world economy and especially developing countries—at risk of a major crisis, as foreign investors lose confidence and US protectionist pressures mount. The longer the needed adjustment is delayed, the more wrenching it will be, triggering high interest rates, US recession, a greater decline in US households' living standards, and more damage to the global economy.

In the late 1990s, the rising trade deficit and associated borrowing from abroad were benign, and the additional foreign resources were directed toward more investment. But now such resources largely finance US private and government consumption rather than productive investment. A favorable consideration is that the United States has a higher rate of return on direct investment abroad than the rate on foreigners' direct investment in the United States. This has kept net capital income positive, so the United States is not yet a net debtor nation when measured by economic burden of payments. Moreover, when the dollar depreciates, there is a windfall gain on equity assets abroad, which are denominated in foreign currency. But despite these two advantages, the author's projections show a sharp deterioration in the net foreign asset position going forward, as even net capital income swings into large deficit.