Friday, July 01, 2005

The U.S. as a gigantic hedge fund

Yesterday, the Bureau of Economic Analysis reported that the net international position of the U.S. –which is the amount of U.S.-owned assets abroad minus the amount of U.S. assets held by foreigners--was minus 2,484.2 billion dollars at yearend 2004, higher than the minus 2,156.7 billion level in 2003 (figures at market value).

At the end of 2004, Americans owned nearly 10 trillion dollars worth of foreign assets, while foreigners owned U.S. assets worth 12.5 trillion dollars.

This comes as no surprise. After all, the U.S. has been running current account deficits (i.e. has been a net barrower) for a long time.

The real shock comes when one sees the returns earned by these assets held by each party. According to the latest balance of payments data, the income earned by U.S.-owned assets in 2004 was equivalent to 4.5% of yearend assets at market value, while foreigner earned just 3.2% on their American assets.

That’s not all. The BEA breaks down the changes in value of assets price appreciation, foreign exchange gains and others by source (price appreciation, foreign exchange gains and others). Assets owned by Americans appreciated 5% in 2004 (before taking into account foreign exchange gains/losses and with yearend 2003 values as the base level). Foreign-owned U.S. assets gained only 2.7%.

As a result, U.S.-held assets gained 9.7% (price appreciation + income), while foreigners gained 5.8%. Obviously, by taking yearend 2003 assets, these returns are somewhat overstated, but still indicative.

Why are U.S.-owned assets more profitable? The answer composition of the assets. In first place, 97% of the assets held by Americans are privately held, a percentage that falls to 84% in the case of foreigners (the remaining 16% is held by governments and official institutions such as central banks). One would expect privately held assets to yield higher returns.

But there are significant differences even in private assets. In the case of U.S.-owned assets, holdings of equity, either as foreign direct investment or foreign stocks, were 60% of the total in 2004, while foreigners held only 45% of their private assets in these two categories. In general, equities should also yield higher returns, although their risk is also higher.

So, in a way, the U.S. borrows short to lend/finance long. If it weren’t for the sheer scale of its borrowing, it’s actually a pretty smart strategy that plays to America’s comparative advantage in finance.

Brad DeLong links to a study that takes a deeper look at this phenomenon. Interestingly, the U.S. earns more even within specific asset classes.