Lecture 1B: The NIIP and valuation changes

The net international investment position (NIIP)

The NIIP is a stock, the current account the flow that fills or drains it (the bathtub again): NIIP_t = NIIP_t−1 + CA_t. Later in the course the NIIP is written as B_t, so B_t − B_t−1 = CA_t. Example: the US 2020 deficit of $647 bn had to be financed by selling assets or borrowing, so it lowered the NIIP.

The US story: a net creditor in 1976; the deficits of the 1980s pushed it into debt; by the end of the 1990s it was the world's largest external debtor; deficits reached 6% of GDP by 2007, then about 3%. End 2020: NIIP −$14.1 trillion (−67% of GDP). End 2025: about −$27.5 trillion (close to −80%), almost doubling in five years. Can that go on? That is the question of current account sustainability, later in the course.

Valuation changes: the NIIP can change without any trade

The NIIP is measured at market value. So it also changes when prices of foreign assets and liabilities change, through stock prices, bond prices or exchange rates:

Step-by-step example.

1. Start: the US owns 25 shares of Fiat (an Italian firm) at €2 each, and €1 costs $2. A = 25 × 2 × 2 = $100. Foreigners own 80 US bonds of $1: L = $80. NIIP = 100 − 80 = +$20 (creditor).
2. The euro falls to $1: the Fiat shares are now worth 25 × 2 × 1 = $50. The bonds are in dollars, so still $80. NIIP = 50 − 80 = −$30. The country became a debtor without buying or selling anything.
3. The Fiat share rises to €7: A = 25 × 7 × 1 = $175; NIIP = 175 − 80 = +$95. A creditor again, just because Italian stocks rose.

In the real US data:

• 2002-2007: the US ran deficits of $3.9 trillion in total, yet its NIIP improved by $80 bn, because valuation gains of almost $4 trillion made up for them. Two reasons: (i) the dollar fell 20%; US assets abroad are mostly in foreign currencies (worth more in dollars when the dollar falls), while its debts are mostly in dollars (unchanged); (ii) foreign stock markets rose much more than US ones (190% versus 90%).
• 2008: foreign stock markets crashed: valuation loss of 15% of GDP in one year.
• Since 2010: mostly losses (−$7.2 trillion by 2020), because US stocks did better: when Wall Street rises, the US shares owned by foreigners (US liabilities) become worth more, so the NIIP falls. 2020-2025: these losses even exceeded the current account deficits; valuation, not trade, explains most of the fall to −$27.5 trillion.
• Valuation changes used to be small (about ±3% of GDP until 2003) and have become large (up to ±15%).
• Hypothetical NIIP = NIIP in 1976 + all current accounts since: what the NIIP would be without valuation changes. Without the lucky 2002-2007 gains, the 2007 NIIP would have been −46% of GDP instead of −9%. By 2020 the gap had closed and the two lines crossed: over 1976-2020 positive and negative valuation changes roughly cancelled out, with a small net loss. (Watch out: the slide says the hypothetical NIIP "fell below" the actual one. Logically, a net valuation loss means the actual NIIP ends below the hypothetical one, because actual = hypothetical + all valuation changes. Remember the conclusion: on balance no gain.) So the idea that the US always profits from valuation changes is questionable.
• Why valuation got so big: gross positions (total A and total L) have grown enormously since the mid-1990s. Example: country x has A = L = 1, country y has A = L = 1000, both with GDP 100, so both have NIIP = 0. If foreign assets rise 10%, x's NIIP becomes 0.1 (0.1% of GDP) but y's becomes 100 (100% of GDP). Big balance sheets, big swings.