Asymmetric investment returns and the sustainability of US external imbalances

A little-remarked aspect of the widening of United States trade and current account deficits since the late 1990s has been their limited effect on United States net foreign liabilities and, especially, net income. This has been possible because the United States has enjoyed both higher yields and larger valuation gains on its foreign assets than on its foreign liabilities. The gain from this asymmetry in returns has increased over time as declining 'home bias' has increased the size of gross foreign asset and liability positions. This highlights a major shortcoming in the standard analysis of external sustainability, which assumes symmetric investment returns. While some of this advantage might be due to transitory factors or measurement error, most of it seems to be explained by structural factors. The United States is a relatively safe investment destination. Its foreign liabilities are mainly in the form of debt, while its assets are mainly equities, which tend to yield higher returns (including valuation gains). If the factors underpinning the United States comparative advantage as a provider of safe, liquid financial assets persist and declining 'home bias' continues apace, then the need for external adjustment might be less than conventional analysis suggests. That said, future outcomes are subject to considerable uncertainty, as an increasingly-leveraged external balance sheet means that the United States is also more exposed to risk.