ECOX6003 Open Economy Macroeconomics

Global Imbalances

Week 1

Jan-Philipp Dueber

Part 1

Introduction

Countries trade a lot with one another, and the United States is no exception. This fact elicits a number of questions
- How big are international transactions in goods, services, and financial assets for the United States and other countries?
- Does the United States have a trade deficit or a trade surplus with the rest of the world? What about China, Europe, and Latin America?
- Is the United States an external debtor or an external creditor?
- How have the trade balance and the international asset position of the United States and other countries evolved over time?
This week addresses these and other related questions.

Introduction

The main focus of the present week is descriptive. In later weeks, we will ask more positive questions such as
- Why do some countries run trade deficits in some years and trade surpluses in others?
- Why do countries borrow from abroad?
- Can countries borrow forever from abroad?
- What determines the size of a country’s external debt?

Introduction - The Geography of External Debt

Take a look at the heat map in Figure 1. It displays with colours the accumulated current account balances between 1980 and 2021. We will define current account balance more precisely below, but roughly speaking, it is the difference between exports and imports of goods, services, and factor payments. As a result a country’s current account balance in a given year is about equal to the change in that country’s net external debt. So if we add up a country’s current account balances for the years 1980 to 2021, we get the change in its external debt between 1980 and 2021.
- The map shows that the country with the biggest accumulated current account deficit (darkest red) is the United States.
- The countries that have been financing these deficits (deepest green) are Japan, China, Germany, and oil and gas exporting countries (members of OPEC, Russia, and Norway).
Overall, the picture is one of unbalanced international trade, with some countries running protracted current account deficits and others running protracted surpluses. If all countries were in balance, the map would look pastel white. Instead, it looks mostly either dark red or dark green, reflecting large global imbalances.

Introduction - The Geography of External Debt

Cumulative Current Account Balances Around the World 1980-2021

Data Source: World Bank World Development Indicators (Download Here and CSV).

The map shows for each country the sum of current account balances in US dollars between 1980 and 2021 as a fraction of the total deficit or surplus.
Data for former Soviet Union countries start in 1992. Countries for which no data are available appear in grey.
Hover over each country to see the value.

The International Transactions Accounts

In the United States, international transactions are recorded by the Bureau of Economic Analysis in the International Transactions Accounts (ITA), also known as the Balance of Payments.
In the United Kingdom data can be found at the Office for National Statistics
The balance of payments has three components
- Current account
- Financial account
- Capital account (quantitatively unimportant)

The International Transactions Accounts - Current Account

The current account is the sum of three accounts \[ \begin{align} \text{Current Account}=\text{Trade Balance}+\text{Income Balance}+\text{Net Unilateral Transfers} \end{align} \]

The International Transactions Accounts - Trade Balance

An important figure produced in the ITA is the Trade Balance, which measures the difference between exports of goods and services and imports of goods and services \[ \begin{align} \text{Merchandise Trade Balance}&=\text{Exports of Goods}-\text{Imports of Goods}\\ \text{Service Balance}&=\text{Exports of Services}-\text{Import of Services}\\ \text{Trade Balance}&=\text{Goods Balance}+\text{Service Balance} \end{align} \]
Examples of internationally traded goods
- Textiles
- Oil
- Cars
- Wheat
Examples of internationally traded services
- Education
- Medical care
- Consulting

The International Transactions Accounts - The US Trade Balance in 2022

Exports of goods and services: $3.0 trillion
Imports of goods and services: $4.0 trillion
Trade balance is then $3.0 - $4.0 = -$1.0 trillion
When the trade balance is negative, we say that the country has a trade deficit.
Is $1.0 trillion a big or small number?
Let’s relate it to the size of the US economy. In 2022, GDP was $25.5 trillion. Letting $TB$ denote the trade balance, we have \[ \begin{align} \frac{TB_{2022}}{GDP_{2022}}=-\frac{1.0}{25.5}\approx-0.04 \end{align} \]
Or the 2022 trade deficit was 4 percent of GDP. Now is this a small or a big number?
- Shortly, we will see how the accumulation of trade deficits of this magnitude or even smaller has turned the United States from a creditor in the 1980s to the world’s largest debtor in a span of less than 20 years.

The International Transactions Accounts - Trade Balances Over Time

Trade Balances Over Time 1960-2023

Data Source: BEA ITA Table 1.1. and ONS (Download Here and CSV).

Is the size of the trade deficit in 2022 typical for the United States? Look at Figure 2 and Figure 3, showing the trade balance since 1960, both in nominal terms and as a fraction of GDP.
Click on the legend to toggle the series on and off.
Also try to use the slider below the diagram.

The International Transactions Accounts - Trade Balances Over Time

Trade Balances as a Share of GDP 1960-2023

Data Source: BEA ITA Table 1.1. and BEA NIPA Table 1.1.5. and ONS (Download Here and CSV).

The US trade balance was practically nil between 1960 and the early 1980s. Since then, trade deficits grew steadily, reaching almost 6 percent of GDP just before the beginning of the Great Recession of 2007-2009.
The Great Recession was associated with an improvement in the US trade balance to around -3 percent of GDP, which has persisted to the present.
From a global perspective, the UK deficit is rather small.
- We will focus on the US

The International Transactions Accounts - Income Balance

Another component of the current account is the Income Balance, which measures the difference between factor incomes received from the rest of the world and factor incomes paid to the rest of the world.
These net income payments are recorded separately for capital and labour.
- Net income from capital is called Net Investment Income and consists of payments such as dividends, interest, or profits.
- Net income from labour is called Net International Payments to Employees and records earnings of US residents temporarily employed abroad and compensation payments to foreigners temporarily working in the United States. We then have
\[ \begin{align} \text{Income Balance}=\text{Net Investment Income}+\text{Net International Payments To Employees} \end{align} \]
In the United States, net international payments to employees has been historically small.

The International Transactions Accounts - Net Unilateral Transfers

A third item in the current account is Net Unilateral Transfers, which keeps record of the difference between gifts received from the rest of the world and gifts given to the rest of the world. These gifts can involve private agents or governments. \[ \begin{align} \text{Net Unilateral Transfers}=\text{Private Remittances}+\text{Government Transfers} \end{align} \]
Net unilateral transfers is typically negative for the US, because the United States typically makes more gifts than it receives.
- The most relevant examples include US residents sending monetary gifts i.e. private remittances to relatives living abroad
- And the US government sending aid to poor countries or to areas of the world suffering from natural disasters or endemic diseases i.e. government transfers.

The Current Account

As mentioned earlier, the current account is the sum of the trade balance, the income balance, and net unilateral transfers \[ \begin{align} \text{Current Account}=\text{Trade Balance}+\text{Income Balance}+\text{Net Unilateral Transfers} \end{align} \]
The current account is an important concept because if the current account is negative, all other things equal, the net external debt of the country goes up, and if the current account is positive, the external debt falls.
Table 1 displays the values of the three components of the current account for some countries in 2023.

The Current Account

Note: Table 1 shows the current account components relative to GDP for some countries in 2023. Data Source: IMF (Download Here and CSV).

In 2023, the United States ran a large current account deficit.
The bulk of the current account deficit is accounted for by a large trade balance deficit.
The country had a deficit in the trade balance on goods and a surplus in the trade balance on services.
- The United States imports manufactured goods (cellphones, computers, or vehicle parts) and exports human-capital-intensive services (higher education, R&D, health care, professional consulting).
- Thus, the United States typically runs a trade deficit in goods and a trade surplus in services. And 2023 was no exception in this regard.
Net investment income is positive, which means that investments of US residents in foreign assets paid more in interest, dividends, and profits, than the investments of foreign residents in US assets.
Net International Payments to Employees was negative but small.
Net unilateral transfers were negative, which means that the United States gave more gifts to the rest of the world than it received. These gifts are largely remittances of immigrants in the US to relatives living abroad.

The Current Account

Trade Balances and Current Accounts as a Share of GDP 1960-2023

Data Source: BEA ITA Table 1.1. and BEA NIPA Table 1.1.5. and ONS (Download Here and CSV).

In the United States, the trade balance and the current account are similar in size and move in tandem over time.
We saw in the previous Table 1 that for the year 2023, the bulk of the US current account was the trade balance. Figure 4 show that this is indeed true pretty much all the time.
The trade balance and the current account also often move in tandem in other countries

The Current Account

Trade Balances and Current Account Balances Across Countries in 2021

Data Source: World Bank World Development Indicators (Download Here and CSV).

Figure 5 shows the current account (vertical axis) and the trade balance (horizontal axis) as percentages of GDP for 144 countries in 2021. Each dot is one country.
The fact that most dots lie close to the 45-degree line indicates that the trade balance and the current account comove closely across countries. Countries with large trade balances tend to be countries with large current account balances, and countries with small trade balances tend to have small current account balances.
There are 144 countries included in the sample. Countries in the World Development Indicators database with trade balances or current account balances in excess of ± 15 percent of GDP were excluded.

The Current Account

Note: Table 2 shows trade and current account balances as percent of GDP. Data Source: World Bank World Development Indicators (Download Here and CSV).

The previous Figure 5 also shows that the current account and the trade balance need not have the same sign (as is the case in the United States) and that the current account can be either larger or smaller than the trade balance. Any sign pattern is possible, as shown in Table 2.

The Current Account

The current account is \[ \begin{align} CA=TB+\text{Income Balance}+\text{Net Unilateral Transfers} \end{align} \]
Germany \[ \begin{align} \frac{CA}{GDP}>\frac{TB}{GDP}>0 \end{align} \]
- Because Income Balance > 0. Germany is a net creditor, so it receives interest income from the rest of the world.
Costa Rica \[ \begin{align} \frac{TB}{GDP}>0>\frac{CA}{GDP} \end{align} \]
- Because Income Balance < 0. Costa Rica is a net debtor, so it makes interest payments to the rest of the world.
Guatemala \[ \begin{align} \frac{TB}{GDP}<0<\frac{CA}{GDP} \end{align} \]
- Because Net Unilateral Transfers > 0. Guatemalans working in the US and elsewhere send money home, resulting in Personal Remittances of about 10% of Guatemalan GDP.

The Current Account - Who Trades With The US?

The US Goods Trade Balance with China 1985-2023

Data Source: United States Census Bureau (Download Here and CSV).

Figure 6 shows that a sizable fraction of the US goods trade deficit is accounted for by its trade with China.
The fraction of the US goods trade deficit accounted for by deficits with China has increased steadily since China’s accession to the WTO in 2001 from about 20 percent in the 1990s to close to 50 percent by 2018.

The Current Account - The World Map of CA Balances

If the United States is running a large current account deficit, some other countries must be running current account surpluses. Why? Because it must be the case that \[ \begin{align} CA_{US}+CA_{ROW}=0 \end{align} \]
Where ROW stands for rest of the world.
So who is running big current account surpluses?
- Look again at the heat map in Figure 1.

The Current Account - The Net International Investment Position NIIP

A country’s Net International Investment Position $NIIP$ is the difference between its foreign asset position $A$ and its foreign liability position $L$ \[ \begin{align} NIIP=A-L \end{align} \]
If the $NIIP$ is negative, then the country has an external debt.
If the $NIIP$ is positive, the country is a net creditor of the rest of the world.

The Current Account

The US Current Account and Net International Investment Position 1976-2023

Data Source: BEA IIP Table 1.1. and BEA NIPA Table 1.1.5. and BEA ITA Table 1.1. (Download Here and CSV).

Figure 7 shows the US current account $CA$ and the US net international investment position $NIIP$ for the period 1976 to 2023, both in percent of GDP.
The $NIIP$ was positive at the beginning of the sample in 1976.
The large $CA$ deficits of the 1980s brought the $NIIP$ to negative territory.
Even larger $CA$ deficits occurred during the 1990s, and the US ended that decade as the world’s largest external debtor.
The $CA$ deficits continued to increase until the onset of the Global Financial Crisis in 2007, reaching 6% of GDP.
During the Global Financial Crisis, the $CA$ deficits became smaller, but still sizable at around 2.5% of GDP.
By the end of 2022, the $NIIP$ stood at -16.2 trillion dollars or -63 percent of GDP.
A natural question is whether the US $CA$ deficits are sustainable over time.
- Addressed in week 2

The Current Account - Stock vs Flow

The $CA$ is a flow and the $NIIP$ a stock
All else equal, the net international investment position increases when the current account is positive and decreases when the current account is negative.
- Thus, the current account is a flow variable and the net international investment position a stock variable.
To understand the difference between a flow and a stock variable in this context, think of a water tank. The level of water in the tank (a stock) is the net international investment position of the country. The current account is the flow of water that might enter or leave the tank through pipes. When the flow of water that enters the tank through pipes is larger than the flow of water that leaves the tank, the current account is positive, and the stock of water in the tank, the $NIIP$, rises over time. By contrast, when the flow of water that leaves the tank is larger than the flow of water that enters the tank, the current account is negative, and the level of water in the tank, the $NIIP$, falls over time.

The Current Account - Stock vs Flow

As we saw earlier, in the United States the current account is similar in size to the trade balance. So in the analogy of the tank, periods in which the flow of water entering the tank through pipes is larger than the flow of water leaving the tank typically represent periods in which imports of goods and services are smaller than exports of goods and services. Of course, other components of the current account, such as net investment income and net unilateral transfers are also part of the flows of water affecting the level of water in the tank (the $NIIP$).

Part 2

Valuation Changes

The US Current Account and Net International Investment Position 1976-2023

Data Source: BEA IIP Table 1.1. and BEA NIPA Table 1.1.5. and BEA ITA Table 1.1. (Download Here and CSV).

Notice that not all years in which the current account is negative correspond to years in which the $NIIP$ falls. This is particularly evident just before the beginning of the Great Recession in 2007.
- In general, changes in the $NIIP$ are not always exactly equal to the changes in the $CA$.
This is because the current account is not the only source of changes in the net international investment position.
- The $NIIP$ can also change when the market value of the country’s international assets or liabilities change due to movements in stock prices, bond prices, or exchange rates.
- This source of changes in the $NIIP$ is known as valuation changes.

Valuation Changes

So we have that the Net International Investment Position changes for two reasons, surpluses or deficits in the current account and valuation changes \[ \begin{align} \Delta NIIP=CA+\text{Valuation Changes} \end{align} \]
With valuation changes being changes in the market value of the country’s foreign asset and liability positions due to currency appreciations or depreciations changes in stock prices, etc.
Let’s analyse by means of an example how valuation changes can affect the $NIIP$.

Valuation Changes - Example

International assets $A$ are 25 shares in Italian carmaker Fiat. The price of each share is 2 euros. The exchange rate is 2 dollars per euro. Then \[ \begin{align} A&=25\times2\times2\\ A&=100\text{ dollars} \end{align} \]
International liabilities $L$ are 80 US bonds held by foreigners. Price 1 dollar per unit. Then \[ \begin{align} L&=80\times1\\ L&=80 \end{align} \]
And the $NIIP$ is \[ \begin{align} NIIP&=A-L\\ NIIP&=100-80\\ NIIP&=20 \end{align} \]

Valuation Changes - Example

Now suppose that the euro depreciates to 1 dollar per euro. Then \[ \begin{align} A&=25\times2\times1\\ A&=50 \end{align} \]
$L$ unchanged since US bonds are denominated in dollars \[ \begin{align} NIIP&=A-L\\ NIIP&=50-80\\ NIIP&=-30 \end{align} \]
Conclusion
- Just because of a change in the exchange rate, the country went from being a creditor to being a debtor of the rest of the world.

Valuation Changes - Example

Suppose now that the price of the Fiat share jumps to 7 euros. Then \[ \begin{align} A&=25\times7\times1\\ A&=175 \end{align} \]
$L$ unchanged. \[ \begin{align} NIIP&=A-L\\ NIIP&=175-80\\ NIIP&=95 \end{align} \]
It follows that a change in stock prices has an effect on the country’s $NIIP$. In this example, the country went from being a net debtor to being a net creditor.
Conclusion
- The above hypothetical examples illustrate how a country’s net international investment position can display large swings because of movements in asset prices or exchange rates. This is indeed the case in actual data as well, as we will see next.

Valuation Changes

US Valuation Changes as Share of GDP 1977-2022

Data Source: BEA IIP Table 1.1. and BEA NIPA Table 1.1.5. and BEA ITA Table 1.1. (Download Here and CSV).

Figure 9 plots valuation changes in the United States since 1977. It shows that
- Valuation changes can be large. We have observed valuations changes as large as ±15 percent of GDP.
- Large valuation changes are a recent phenomenon. Until the year 2003, the typical valuation change was ±3 percent of GDP.
- The United States experienced valuation gains more often than valuation losses, 28 versus 18 times.

Valuation Changes - Before and After the Global Financial Crisis

From 2002 to 2007, the US cummulative $CA$ deficit was 3.9 trillion or 32% of GDP.
Yet, the $NIIP$ improved by 80 billion.
This means that valuation changes during this period amounted to more than 4 trillion. This is how
- The dollar depreciated by 20%. This cause large positive valuation changes because US assets are mostly in foreign currency, whereas its liabilities are mostly in dollars.
- The stock markets in foreign countries significantly outperformed the US stock market: cummulative return from 2002 to 2007, 190% abroad and 90% in the United States. As a result, the US net equity position went from virtually nothing to 3 trillion.
This came to a sudden stop in 2008 (look at Figure 9)
- That year, valuation changes were -15% of GDP, mostly from an enormous drop in foreign stock markets.

Valuation Changes - Before and After the Global Financial Crisis

Points above the line correspond to years with positive valuation changes and points below the line to negative valuation changes. 28 observations are above the line and 18 are below.
If valuation changes were quantitatively unimportant, most observations should lie in a narrow corridor around the line. The graph shows that this is not the case. On the contrary, deviations from the line are both frequent and large. The largest valuation changes (positive or negative) occurred after 2000.

Valuation Changes - A Hypothetical NIIP

Figure 10 shows the cummulative impact of of valuation changes on the $NIIP$. It plots the actual US $NIIP$ since 1976 and a hypothetical $NIIP$ constructed by removing valuation changes from the actual $NIIP$.
To construct the hypothetical $NIIP$ for a given year, start with the $NIIP$ of the initial year, $NIIP_{1976}$, and add all of the $CA$ balances from 1977 until the year of interest.
For example, for 2016, the hypothetical $NIIP$ is given by \[ \begin{align} \text{hypothetical} NIIP_{2016}=NIIP_{1976}+CA_{1977}+CA_{1978}+\cdots+CA_{2016} \end{align} \]
Figure 10 plots the actual and hypothetical net international investment positions over the period 1976 to 2022 in percent of GDP.

Valuation Changes - A Hypothetical NIIP

Actual and Hypothetical US NIIP in Percent of GDP from 1976 to 2022

Data Source: BEA IIP Table 1.1. and BEA NIPA Table 1.1.5. and BEA ITA Table 1.1. (Download Here and CSV).

The hypothetical $NIIP$ for a given year is computed as the sum of the $NIIP$ in 1976 and the cumulative sum of $CA$ balances from 1977 to 2022.
Until 2002 actual and hypothetical $NIIP$ were not much different from each other so that valuation changes were not sizable.
In 2002 the hypothetical $NIIP$ starts to fall at a much faster pace than the actual $NIIP$ so that large positive valuation changes.
Without this lucky strike, the $NIIP$ in 2007 would have been -46% of GDP instead of the actual -9 percent.
The reversal of fortune in the Global Financial Crisis brought the actual and hypothetical $NIIP$ almost as close to each other as before 2002.

Valuation Changes - Gross Positions

US-Owned Assets Abroad and Foreign-Owned Assets in the US 1976-2022

Data Source: BEA IIP Table 1.1. and BEA NIPA Table 1.1.5. (Download Here and CSV).

Figure 11 shows that gross positions i.e. international assets and international liability positions have expanded enormously since the 2000s.
This explosion in gross positions represents one reason why valuation changes have become so large in absolute value over the past two decades.

Valuation Changes - Gross Positions

To see this, consider the following example.
Suppose in country x $A=L=1$ and in country y $A=L=1000$.
Suppose GDP is 100 in both countries.
Then, in both countries $NIIP$ is 0% of GDP.
Suppose the value of assets increases by 10% in both countries.
This causes the $NIIP$ to go from 0 to 0.1 in country x, and from 0 to 100 in country y.
- The $NIIP$ increases by 0.1% of GDP in country x and by 100% of GDP in country y.

The Negative-NIIP-Positive-NII Paradox

Suppose you had a negative balance on your credit card. Would you expect to receive interest payments from your credit card company or to have to make payments to your credit card company? Most likely the latter.
Well, that is not what happens with the United States. Look at Figure 12. Even though the US is the largest external debtor in the world, it receives investment income from the rest of the world.
At the end of 2022, the US net international investment position stood at -$16,172 billion, and its net investment income was +$164.6 billion.
How can this paradoxical situation happen? Here are two suggested explanations
- Dark Matter
- Return Differentials
After the next figure, we will spell them out.

The Negative-NIIP-Positive-NII Paradox

Net Investment Income and the Net International Investment Position of the United States 1976-2022

Data Source: BEA IIP Table 1.1. and BEA ITA Table 1.1. (Download Here and CSV).

What is plotted?
- The blue line shows the Net International Investment Position $NIIP$, given by international assets minus international liabilities, and represents the US net foreign wealth.
- The red line shows the Net Investment Income $NII$, which are income receipts on US owned assets abroad (dividends, interest, or profits) minus income payments on foreign-owned assets in the United States.

The Negative-NIIP-Positive-NII Paradox - Dark Matter

The Dark Matter hypothesis maintains that in reality the US net international investment position is positive, but that the Bureau of Economic Analysis fails to account for all of it.
- Example: because of brand value, the market value of a McDonalds restaurant is much larger than the value of the lot, the building, and the furniture, which is the only part the BEA counts.
Assuming this theory is valid, how much dark matter is there in the $NIIP$? Let’s make a simple calculation. First some notation
- $TNIIP$ is the “true” net international investment position.
- $NIIP$ is the observed net international investment position of -16.172 trillion in 2022.
- $NII$ is net investment income of 164.6 billion in 2022.

The Negative-NIIP-Positive-NII Paradox - Dark Matter

Net investment income is the return on the True Net International Investment Position. So, letting $r$ denote the interest rate, we have \[ \begin{align} NII=rTNIIP \end{align} \]
Let’s take a value of $r$ of 5% per year. Then solving for $TNIIP$ we have \[ \begin{align} TNIIP=\frac{NII}{r}=\frac{0.1646}{0.05}=3.292\text{ trillion dollars} \end{align} \]
Dark matter is the difference between the true and the recorded $NIIPs$ \[ \begin{align} \text{Dark Matter}&=TNIIP-NIIP\\ \text{Dark Matter}&=3.292-\left(-16.172\right)\\ \text{Dark Matter}&=19.464 \end{align} \]
That is 19.464 trillion dollars in 2022 of dark matter!

The Negative-NIIP-Positive-NII Paradox - Dark Matter

So, according to the dark-matter theory, the US doesn’t owe $16.172 trillion to the rest of the world. On the contrary, the rest of the world owes $3.292 trillion to the United States. $19.464 trillion of dark matter seems like a big figure to go unnoticed by the BEA (and the IRS!).

The Negative-NIIP-Positive-NII Paradox - Return Differentials

This second explanation is motivated by the observation that the gross international asset position of the US is mostly composed of risky but high-return assets, such as foreign stocks, whereas its gross international liability position is composed of safer low-return assets, such as US government bonds e.g. T-bills.
- This idea is sometimes referred to as the exorbitant privilege
Let $A$ continue to denote the US international asset position and $L$ its international liability position. Then \[ \begin{align} NIIP=A-L \end{align} \]
Let $r_{A}$ be the return on $A$, and $r_{L}$ the return on $L$.
The question is how large does the interest rate differential on assets and liabilities, $r_{A}-r_{L}$ , have to be to explain the paradox.
Start by noting that the $NII$ must equal the difference between investment income and investment payments, that is \[ \begin{align} NII=r_{A}A-r_{L}L\label{eq:nii} \end{align} \]

The Negative-NIIP-Positive-NII Paradox - Return Differentials

Now let’s put some numbers.
- In 2022, the US gross international asset position was $31.6 trillion, and its gross international liability position was $47.8 trillion.
- In addition, the average real rate of return on US T-bills, which we will use as a proxy for $r_{L}$, was 2.25% per year.
- Finally, as we mentioned earlier, $NII$ was $164.6 billion.
- Thus, we set $A=31.6$, $L=47.8$, $NII=0.1646$, and $r= 0.0225$.
We wish to find the value of $r_{A}$ that solves the paradox. To this end, solve equation (\ref{eq:nii}) for $r_{A}$ \[ \begin{align} r_{A}=\frac{NII+r_{L}L}{A}=\frac{0.1646+0.0225\times47.8}{31.6}=0.0392 \end{align} \]
That is, $r_{A}=3.92\%$, or an interest rate differential between the US foreign assets and liabilities of $r_{A}-r_{L}=1.67\%$ per year.
- This doesn’t look like an exaggerated premium.

The Negative-NIIP-Positive-NII Paradox - Return Differentials

Why is it that a relatively small interest rate differential suffices to explain the NII − NIIP paradox?
Recall that gross asset and liability positions of the US have become very large relative to the net position with $A=31.6$ and $L=47.8$. Hence just a relatively small rate of return differentials can lead to a positive $NII$ even though the $NIIP$ is negative.

The Negative-NIIP-Positive-NII Paradox - The Flip Side of the Paradox

Net Investment Income and the Net International Investment Position of China 1982-2021

Data Source: Lane and Milesi-Ferretti (2017) and IMF (Download Here and CSV).

If the return-differential hypothesis is correct, then some country or group of countries in the rest of the world must experience a flip version of the paradox, that is, negative $NII$ and a positive $NIIP$.
A natural candidate is China. This country holds large amounts of US government bonds, which are safe, earn low return. At the same time, the rest of the world invest in more risky but higher return assets in China, such as stocks or FDI.
Figure 13 shows that this is indeed the case. Since 2000, with the exception of the Great Contraction years of 2007 and 2008, China has displayed a positive $NIIP$ and a negative $NII$ measured relative to US GDP.

Summing Up

The current account $CA$ keeps record of a country’s net exports of goods and services and net international income receipts.
The $CA$ has three components, the trade balance $TB$, the income balance, and net unilateral transfers.
For most countries, including the United States, the $TB$ is the largest component of the $CA$.
In the United States, the $TB$ and the $CA$ move closely together over time.
The United States have been running large $CA$ deficits since the early 1980s.
$CA$ deficits deteriorate a country’s net international investment position $NIIP$, which is the difference between a country’s international asset position and its international liability position.
Due to its large $CA$ deficits, the United States turned from being a net external creditor to being the world’s largest debtor.

Summing Up

A second source of changes in a country’s $NIIP$ position is valuation changes, originating from changes in exchange rates and in the price of the financial instruments that compose a country’s asset and liability positions. In the United States, valuation changes became large in the early 2000s, reaching values as high as plus or minus 15 percent of GDP in a single year.
Paradoxically, the United States has a negative $NIIP$ and positive net investment income $NII$. Two stories aim to explain the NIIP − NII paradox: the dark matter hypothesis and the rate-of-return-differential hypothesis. The NIIP − NII paradox in the United States must have a flipped paradox in the rest of the world. We documented that China has had a positive $NIIP$ and negative $NII$ since the 2000.
Global Imbalances: Worldwide, the distribution of external debts and credits is not even. Some countries, like the United States, are large debtors and some, like China, are large creditors.