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The first thing I'm really going to do is just define some terms.
So I'm going to define the net foreign asset position.
Here NFA, you can see hopefully highlighted is equal to foreign assets
minus foreign liabilities, external assets minus external liabilities.
If I do this from the perspective of the US, I'm a US citizen.
A foreign asset would be, if I were to buy for example,
a share in a Japanese company, I buy a Japanese firm's equity.
That holding by me a US citizen would be A, it would constitute an asset.
Similarly, you can imagine, let's say, China, let's say,
someone in a foreign country, or government's sovereign wealth fund
anyone outside of the US, let's say, buys a US Treasury bonds.
Well then, that's going to constitute from the US perspective L, here,
a foreign liability.
And so, what the NFA is, is it's simply the difference between the two.
It's simply the net claims, that a country's has on the rest of the world.
Its claims on foreign assets less foreign claims on that country's assets, okay?
Now, the first thing to note, is that NFA is not about the country's wealth.
So I'm an American, I live in Chicago and I own my house.
Let's say the value of that house increases from $1 to a trillion dollars,
God willing that would change of course US wealth.
But it would have no bearing whatsoever on the net foreign asset position
because neither there's no cross border position changing there.
So again, NFA is not about wealth.
It's about net claims on the rest of the world.
Now, why do we care about the net foreign asset position?
Well, in an open economy model,
the net foreign asset position is a key state variable.
And why well, it enters essentially the budget
constraint that would allow you from periods, T + 1 and
into the future to potentially consume more than you produce.
For example, if you have a Net Foreign Asset Position of
$100 because I own $100 worth of, let's say Japanese yen.
And an eye as an American, want to spend all that $100 next period,
I can use it to consume $100 of goods in excess of what I produce.
That would take the form of a current account deficit or a trade deficit.
Now, in what I just said, I equated exactly a current account and
a trade deficit.
But for those that have already kind of covered this material at some point in
your PhDs, they're not literally the same.
There is a distinction,
which is what I want to highlight here in the equation at the bottom of this slide.
So you can see that the current account is equal to the trade balance but
plus these two other terms.
First there, there's the NFI, which stands for
Net Factor Income or sometimes Net Foreign Factor Income.
And the idea there would be imagine, an American citizen,
works for a year in Italy and earns $100 of labor income,
that's compensation for that US factor of production.
That would count as a positive entry in the US is net NFA.
Here, Net Foreign Factor Income, I should say.
Now there's of course a net there because, by contrast,
it could be that foreign citizens and Italian works in the US supplies,
their labor input earns $100 and that would then constitute a negative entry.
The reason you can see that the trade balance TB, and
the net foreign factor income here, enter similarly is,
the idea is that in both cases, you're able to consume more than you produce.
Either because you're importing an excess of what you export in terms of goods and
services, or because you're directly importing the factor of production.
That's then you're creating things whether it's labor income,
like I just mentioned or otherwise.
Finally, there's this third term, this negative unilateral transfer, or
I should say unilateral transfers term, and I'm not going to spend any time on
that I just really want to make sure you knew it existed here.
You can think of that as non-economic transfers,
payments that are motivated by something other than an economic exchange.
A good example of this could be debt forgiveness, for example, okay?
So how does this net foreign asset position evolve over time,
remember that the NFA is equal to A minus L at time T.
As a result, if I look here at this a T minus 1 minus LT minus 1.
I can just write that as NFA at T minus 1, so
that the change in the net foreign asset position comes from one of two sources.
It comes from this current account term that I just mentioned before.
It also comes from a valuation change term that I mentioned before.
The current account part of course,
if you just think of it more simply to me as the trade balance side.
Imagine that I start the period with $100 net foreign asset position and
the only thing that happens is I export 100 more dollars this period.
Well, then what would happen is when I export that $100,
I'm not giving it away for free,
I'm of course obtaining assets from the rest of the world worth $100 in exchange.
And as a result in that case, the NFA would go from $100 to $200.
So that's what this first term here is capturing.
The second term is capturing the fact that even if there is no
current account this period.
It could be that there's changes in the value of foreign assets and
foreign liabilities that I accumulated in the distant past up until now.
In other words last year, if my net exports or
net imports resulted in me holding a bunch of Japanese equities or
resulted in the rest of the world holding dollars in whatever form.
And the value of those Japanese equities or those US dollar assets changes,
well then of course the net foreign asset position will change.
So these are the two key terms to think about here when thinking about
the adjustment of the net foreign asset position.
As I mentioned very briefly in this bullet point here, there is
something else that for those that are going to kind of dig in for this topic.
You want to check out, I'll simply refer you to Curcuru at all for
better understanding of that other term.
So sort of zooming out if we think then what does it mean for a country that's
got a very large negative net foreign asset position relative to its GDP?
Let's say, well, it says that In the future, it's likely to
have some combination of either positive current accounts or
valuation gains or some combination thereof, okay?
Now, it's not strictly true.
I shouldn't say strictly,
it's not true that the net foreign asset position relative to GDP should be
thought of as something that has to sort of, asymptote towards 0.
There's nothing inadmissible about a stable net for an asset position.
The US could have -10% of GDP net foreign asset position forever.
And in fact in a model,
I'll present tomorrow morning that's in fact how it will work.
And there's nothing that is violated by that per se, but we do think that
adjustments should occur such that the net foreign asset position never explodes.
You wouldn't expect a country to be on a path where their net foreign asset
position goes from 10% of GDP, net debt position to 50% to 100, to 2 to 5, etc.
In such a situation, you might expect adjustment to occur for
example with a default, if a country simply doesn't honor its liabilities,
doesn't make payoffs on the value of its bonds that are held by foreigners.
For example, not saying that's a good or a bad thing, but it is something
that in an accounting sense, would cause the value of L here to go down.
Which since it enters with a negative sign,
of course would cause the NFA to revert back toward 0,
bringing back the stability in the long run of that ratio, okay?
So that's what we're capturing in the data, that's the concept that
accumulates previous cross border sales and purchases of assets.
Now, let's just look at the data and ask which countries appear to have
large positive and large negative net foreign asset positions.
And what I'm showing you here is that, you see some very small handful of
countries accounting for the bulk of the global deviations from 0.
Most notably, of course here you see,
the US is by far the biggest net debtor to the rest of the world with a very
large negative this measured in billions of dollars in 2008.
Net foreign asset position and the three other largest economies
of the world here, which is China and Germany and Japan.
They of course offset that they're on the other side of the equation with very
large positive surplus values.
Now, of course, a bigger country for the same economics is going to have a larger
level of their net foreign asset position a larger magnitude.
So I don't want you to get the impression that only those four countries have
meaningful net foreign asset positions relative to their GDPs.
So for example,
China certainly has a very large one of the largest positive NFA positions.
But if you instead express it relative to it's also very large GDP,
you get a value much smaller.
Something, here I'm circling which Is one of the bigger values in the world,
but certainly not as big as some other countries like Switzerland or Norway.
Let's say what you see here on the right.
Similarly, there are some countries whether it's Greece or Portugal or
Spain, which don't have anything nearly as negative a net
foreign asset position as the US does in levels.
But relative to GDP of course these are pretty large negative values, okay?
Right now, I want to give you a pretty quick view, but
on how the US net foreign asset position which hasn't always been negative,
has evolved over the last three or four decades.
So this is a plot showing you with the thick, solid line from the mid 1970s or
so, on how the net foreign asset position evolved to a relatively
negative value near 30% of GDP right after the financial crisis of 2008.
And as I mentioned before, there are two things that can change and
cause the net foreign asset position to evolve to key terms on
the right-hand side of the net foreign asset positions law of motion.
One is the accumulated current account, which you can see, I'll plot
in a second here, and the other of course, is the accumulated valuation changes.
Let me just scroll to where you can see both of them.
You can see that the simple way to at least start by thinking about
the big downward trajectory here that I just plotted in the net for
an asset position in the US is to note that it follows more or
less with the big downward trajectory of accumulated current account balances.
In other words, the US has for
decades now, run negative current accounts, run current account deficits.
And of course that represents a force as it accumulates over
time toward a negative net foreign asset position.
But one uninteresting thing that, certainly 10-15 years ago, got a whole
lot of attention was the fact that, there was this relatively big gap here.
The fact that the US net foreign asset position was not nearly as
negative as the current account deficits that it had run for
decades on their own would have generated.
And what does that mean?
Well, exactly as you see here, the adding up equation simply means that
the valuation changes had to have helped the US.
In other words, it borrowed year-on-year from the rest of the world.
But over this period of time, the return it got on its foreign investments
exceeded what it had to pay on its foreign liabilities in a way that prevented its
overall debt position from accumulating as rapidly as it otherwise would.
One interesting thing is if you fast-forward all the way to today,
to 2018,
you see that this valuation effect that I'd showed you went up has come back down.
And so, if you instead consider the full trajectory of the net foreign asset
position from essentially the mid to late 70s, all the way through till now,
you can see that the red and the black lines co-move quite tightly.
So at least over this longer haul of 30 some odd years, 40 some odd years.
The right way over that long period of time to think about how the US net foreign
asset position has gone so negative is simply to say,
the US has accumulated more and more negative positions.
Sorry more and more negative current accounts.
Now, the current account itself, the deficit that the US has run,
as I mentioned can be itself divided between an accumulated trade balance or
an accumulation of these other terms like the net foreign factor income term.
Here, it's very clear you can see by the co-movement of the red and
the black line that you largely can ignore all the non-trade balance terms.
So putting it all together, the last 40 years even though there's been cyclical
and short term fluctuations from it.
This paints a picture of a country running trade deficits that have
accumulated into a large negative net foreign asset position, okay?
Now, in thinking about the dynamics,
here I'm just sort of telling you what happened.
But we might write that want to either predict what happen or
understand co-movement or predict what will happen.
Or understand co-movement in other micro variables together with this
asset positions and for that purpose, is actually interesting to split up,
the foreign asset position by the type of position.
So each of external assets and liabilities can be broken down.
For example, there are four categories I'll talk about FDI,
foreign direct investment is one of them.
You can think of FDI is when there's essentially a large or
controlling interest involved in the cost cross border transaction.
I buy a factory abroad or I'm a company that opens up a retail shop abroad.
There's also portfolio investment, which of course, if it's a stock or
a bond or I should say if it's an equity, it implies ownership.
But the point is it doesn't really imply control, if I buy a share representing
a ten-thousandth stake of a foreign publicly listed company.
But that would be portfolio investment.
There's also category other investments,
and I noticed there's a typo here that should say OI,
which is largely bank lending, and finally a category derivatives.
Now why does it matter what this decomposition across these four categories
are for understanding the evolution of A and L?
Well, one reason is you can, I mean, think about it this way.
If I ask, how quickly will A or L adjust to the conditions in a country?
Well, both academics and policymakers presume that FDI will adjust
much more slowly after all, FDI is represents an investment in something.
Oftentimes, you can think of it as even purchasing a physical factory or space.
It's much harder to liquidate that even if times are tough in that country to which
you're investing.
On the other hand, portfolio investment you could easily sell and
withdraw with the click of a button.
Similarly, if I think about how the value of these positions will move,
portfolio investment in equities or stocks is likely to track
a stock market almost perfectly, portfolio investment in bonds.
We'll move to some extent, mechanically with the exchange rate.
If I buy a bunch of yen positions, the dollar value of that will
move quite a bit quite closely with the dollar-yen exchange rate.
So understanding the type of investments that have been made, really matters.
I'm only about two minutes behind what I wanted to stop and open up for Q&A.
So rather than present this slide and kind of go through, let me just ask,
you'll have this as part of the downloadable materials, and
now the recordings.
But here at the top three bullet points, I'm listing a bunch of papers that I find,
over the first two I can claim I think are really interesting and
important contributions.
And the third, I guess I would also say that but
at risk of sounding arrogant since it's our own, but
these are some papers that I think are exciting and bring new analysis.
Of these issues into play and are worth double-clicking on,
if you're interested in this topic.
Similarly, looking at things like the exorbitant privilege, and even for some of
you that haven't been thinking as much about international finance per se but
are interested in macro public finance.
There are some interesting areas like the discussion of the border adjustment
taxes for instance, in the US in 2016 and 2017.
Which really bring up and require knowledge of,
how net foreign asset positions look and evolve over time.
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