Balance of payments ; Capital movements ; International trade ; Investments, Foreign - United States

Michael Hutchison

English

Research Papers in Economics

FRBSF
September 7, 1984 WEEKLY LETTER
Financing Current Account Deficits
The current accountofthe u.s. international bal-
ance ofpayments marked a record $41 billion
deficit in 1983 and will reach newheights this
year, perhaps as high as $100 billion. This repre-
sents a remarkable deterioration from the $25 bil-
lion currentaccountsurplus recorded in 1981.
Becauseourcurrentaccountdeficitrepresentsthe
excess ofu.S. importpurchases over export sales
ofgoodsand services (and nettransfers), itmustbe
financed by a net inflowofforeign funds. The
institutional channels through which foreign funds
have recently been flowing intothe u.s. are iden-
tified in the capital accountofthe balance of
payments. This Letter shows where theforeign-
capital inflows intothe u.S. are coming from, .-
explainshowpresentpatternsdifferfrom pastepi-
sodes with financingourcurrenct accountdeficits,
and considers the outlook.
The capital account
The capital accountofthe balance ofpayments is
the record ofthe financial transactions ofa nation
with the restoftheworld, and maybethoughtofas
the counterpartofthe real sector transactions
(payments and receipts forgoods and services pillS
transfers) represented bythe current account.
Capital accounttransactions are recorded in the
balanceofpayments statistics as thechange in the
foreign asset holdings ofu.s. residents and the
change in the u.s. asset holdingsofforeign resi-
dents (where "resident" includes individuals, in-
stitutions and governments). The purchase of u.S.
assets byforeign residents is aforeign capital inflow
intotheU.S., and the purchaseofforeign assets by
U.S. residents is acapital outflowfrom the U.S. For
example,the 1983 $41 billion u.s. capital account
surplus (or netcapital inflow-currentaccount-
deficit) means that, on balance, foreigners pur-
chased $41 billion more U.s. assets than U.S.
residents purchased offoreign assets.
The capital account is divided between govern-
mentand private sector transactions because of
their generallydifferent motivations for buying
and sellingforeign assets. Governmentsectortrans-
actions are termed official capital flows and, for
themostpart, representofficial sales and purchases
offoreign currencies as governments attemptto
influenceexchange rate values. u.S. government
sales(purchases) offoreign assets and foreign gov-
ernments' purchases (sales) ofU.S. assets arecapi-
tal inflows(outflows) intothe u.s.
In addition, several components ofprivate capital
flows are separated bythe institution involved or
the natureofthe transaction itself. The available
statistics distinguishamongfour basic types of
private capital flows: 1) claims on foreigners
reported by U.s. banks (capital outflowfrom U.S.)
and u.S. liabflitiesto foreigners reported by u.s.
banks (capital inflowto U.S.); 2) purchases of
foreign securities byprivate U.s. residents (capital
outflow) and purchases of u.s. securities-both
U.S. Treasury securities and other u.s. secur-
ities-byprivateforeign residents (capital inflow);
3) U.s. direct investment in foreign businesses
(capital outflow) and foreign direct investment in
U.S. business operations (capital inflow); and 4)
all othergross international asset transactions
involving U.S. residents or U.S. assets. Interna-
tional capital flows may thus take a variety of
forms-privateorgovernmentasset transactions,
bankcapital flows, direct investment, direct
security purchases ofsales, and so on. An impor-
tantpointis thatthe netcapital inflow(outflow),or
capital accountsurplus (deficit), exactlyoffsets, or
"finances," a current accountdeficit(surplus).
Historyand the present
Overthe past25 years, the UnitedStates recorded
a measurable deficiton the current account in
only six years: 1971-72, 1977-78, and 1982-83.
Besides the present episode, the currentaccount
deficitswere large (adding upto $30 billion in
1977-78)only in 1977 and 1978. Thus, on bal-
ance, the u.s. has traditionallybeen inthe position
ofa netexporter ofcapital to abroad (incurring a
capital accountdeficit) by running current account
surpluses.
The financing patterns from the fewprevious epi-
sodes donevertheless provideastark contrastwith
the present circumstances. In particular, in the
1971-72 and 1977-78episodes, u.s. current
accountdeficitswereassociated with largeprivate
capital outflows. Official capital inflows financed
both u.s. current accountdeficits and substantial
private capital outflowfrom the u.s. duringthoseFRBSF
years. (In 1977, forexample, the $14.5 billion
currentaccountdeficitand $18.2 billion net
privatecapital outflowwere financed by a $32.7
billion net official capital inflow intothe U.S.).
Official capital inflowsduringthese years resulted
primarilyfrom the U.S. Treasury sellingforeign
currency reserves and foreign governments pur-
chasing U.S. government securities in their
attemptstostem thefall ofthedollarintheforeign
exchanges.
In contrast, although the u.s. current account
marked asubstantial $9.2 billion deficit in 1982
and an unprecedented $41 billion deficit in 1983,
the dollar has appreciated in the foreign ex-
changes, and there has been a netofficial outflow
ofcapital from the u.s. (including U.s. govern-
ment assets otherthan official reserves). Thus,
unlike previous episodes with current account
deficits, private capital inflows in 1982-83 have
offset both ourcurrent accountdeficits and an
official capital outflowfrom the U.S.
The presentwillingness ofthe private sector to
finance massive current accountdeficits contrasts
with previous episodes with deficits and points to
the different nature ofthe economic policies now
being pursued. In particular, our present policy
mix-an expansionary fiscal policythat is not
accompanied by an expansionary monetary policy
and favorable business and investmenttax
treatment-has created an environmentofhigh
nominal interest rates, a modestshort-term in-
flation outlook, and agood business outlook
relative to abroad. These conditions have provided
strong incentives for net private capital inflows.
In contrast, the 1971-1972 period with current
accountdeficits saw a significant net private
capital outflow, largely in response to investors'
concerns over an overvalued dollar-its strength
artificiallymaintained byofficial exchange market
intervention operations. Similarly, the 1977-78
episode with large U.s. current accountdeficits
also saw a large flightofprivate capital from our
shores. In that instance, investors lostconfidence
in the expressed resolve ofu.s. officials to bring
down the inflation rate. The result was a portfolio
shiftoutofU.S. dollar-denominated assets and a
run on the dollar. This was again met by massive
exchange market intervention undertaken bythe
Carter Administration and foreign governments.
Composition ofprivatecapital flows in 1983
In 1983, the official statistics recorded an un-
precedented $33 billion private capital inflow.
Because ofthe massive "errors and omissions"
category in the balance ofpayments statistics in
1982, showing an unrecorded $33 billion inflow
offunds intothe U.S., ithas notbeen possible to
identifythechannels duringthat year through
which privatecapital flowed intothe U.S. In 1983,
however, the"errors and omissions" component
declined to a more manageable $9.4 billion
unrecorded inflowofforeign funds.
The unprecedented private capital inflow in 1983
nevertheless represents an extraordinary $56 bil-
lion turnaround from the $23 billion recorded
privatecapital outflow in 1982. The recorded net
private capital flows in 1982 and 1983 and its
components are shown in the accompanying
chart. Foreign flows intothe U.S. stock and bond
markets (netsecurities) in 1982 continued in 1983,
increasing somewhat. In addition, moderate
amounts ofnet inward direct investment (at a
slower rate than in 1982) were also recorded.
By farthe mostimportantcomponentofthe private
capital inflow, however, was a massive switch in
the direction ofbanking transactions between the
Eurodollar market and the domestic money
markets. Specifically, the swing in bankflows-
from a$45 billionoutflowin 1982toa$24 billion
inflow in 1983-accounted for 73 percent ofthe
total recorded private capital inflow in 1983. This
turnaround is extraordinary (amountingto a $71
billion reversal), particularly in lightofthe net
outflows through the banking system for every
year buttwo (1969 and 1979) ofthe last 25 years.
Furthermore, first quarter 1984 statistics indicate
that bank capital inflows (at $9.4 billion) are con-
tinuingto finance the bulkofour $19.4 billion
current accountdeficitand to make upthe lion's
share ofrecorded private capital inflows.
Causesofbank inflows
The recent swing in bank flows resulted from the
sharp $84 billion drop-off in loan volume to
foreigners by u.s. banks-from $109 billion in
1982 to only $25 billion in 1983. However, gross
liabilitiesto foreigners, Le., borrowing from
foreigners, reported by U.S. banks also declined
over the 1982 rate ofincrease by $13 billion in
1983. Nevertheless, foreign borrowings by U.S.
banks in1-983 remained fairly strong by historical
standards at $51 billion. Otherstatistics show thatPrivate Capital Flows: 198311982 Comparison
Sbillions
60
50
Total Bank Net Net Non·
40
Reported, Securities Direct Bank,
Net Investment Net
30
Inflow 20
10
0
-10
6 +4 6-11
Outflow -20 6-8
1
-30 '"---'
-40
Net Change:
+58
-50
-60
1982
6+71
Source: Department of Commerce
these funds were generated primarilyfrom u.s.
bank branches in majorfinancial centers around
the world gathering Eurodollardeposits that were
then borrowed by parent banks in the u.s. In
addition, u.S. banks in 1983 borrowed significant
amounts from unaffiliated foreign banks and from
nonbankforeigners.
Thus, although u.S. bank liabilitiesto foreigners
(borrowings) slowed somewhatin 1983,adramatic
reversal from bankcapital outflowto inflow
nevertheless resulted because ofthe 80 percent
dropoff in U.S. bank loans to their own branches
abroad, to unaffiliated banks abroad and to
foreigners directlyfrom domestic offices (including
from International Banking Facilities-IBFs).
Although the 1982 U.S. bank loan figures are in-
flated somewhat because ofthe rebookingofoff-
shore loans to newlycreated IBF facilities within
the U.S., this decline between 1982 and 1983 is
nevertheless significant.
MajorU.S. commercial banks in 1983were largely
responsible for channeling netfunds inflows into
the U.s. because oftheir established presence in
worldwide money markets, large scale ofopera-
tions and recent desire todivert lendingfrom
foreign to domestic borrowers. Thus, they were ir;l
a key position to take advantage of high domestic
interest rates in channelingfunds to the U.S. from
abroad.
Outlook
Recent developments in the Eurodollar markets
indicate thatthe directsales of U.s. securitiesto
foreigners-particularly U.S. Treasury bonds-
could play an increasingly important role in
directingforeign funds intothe United States. This
development has been spurred both bythe sheer
volumeofTreasurydebtthatneedstobemarketed
and the elimination ofthe 30 percent U.S. with-
holdingtax on interest accruingto foreign holders
of U.S. securities.
The movementoftraders from morethan a dozen
governmentsecuritiesfirms in NewYorktoLondon
in the last nine months indicates their intensified
sales efforts in new markets and with newbuyers
overseas. In addition, European investment bank-
ers would liketo see the U.s. Treasury create a
special class ofsecuritiestailoredtoforeign buyers.
The European banks have argued that foreign
individuals represent the biggest untapped source
for Treasury securities because foreign institutional
buyers were never seriously inhibited bythe U.S.
withholdingtax (they often paid the tax and
received ataxcreditfromtheirowngovernments).
In sum, there is some indicationthatdirectsalesof
U.S. securities to foreigners may increase in the
future as a proportion oftotal u.s. net private
capital inflows. Withoutashiftin U.s. andforeign
fiscal and monetarypolicies, substantial netprivate
capital inflowsare likelyto continue financing
large U.s. current accountdeficits-although the
composition of U.S. assets held by foreigners may
vary-and official capital flows will likely playa
secondary role.
Michael Hutchison
Opinionsexpressed in this newsletterdo notnecessarily reflecttheviews ofthe managementofthe Federal Reserve Bank ofSan
Francisco,orofthe BoardofGovernorsofthe Federal Reserve System.
Editorialcommentsmay beaddressedtotheeditor(GregoryTong) ortotheauthor....FreecopiesofFederal Reservepublications
can be obtainedfrom the Public Information Department, Federal Reserve Bank ofSan Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.uo~6U!ljsom ljo~n U060JO 0POI\0U
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BANKING DATA-TWELFTH FEDERAL RESERVI: DISTRICT
(Dollaramounts in millionsl
Selected Assets and Liabilities
Large Commercial Banks
Amount
Outstanding
8/22/84
Change
from
8/15/84
Change from 12/28/83
Percent
Dollar Annualized
Loans, Leases and Investments1 2 180,833 -1,278 4,808 4.1
Loans and Leases1 6 161,811 -1,252 6,456 6.3
Commercial and Industrial 48,391 - 294 2,428 8.0
Real estate 60,747 107 1,848 4.7
Loans to Individuals 29,327 96 2,676 15.3
Leases 5,028 4 - 35 - 1.0
U.S. Treasury and Agency Securities2 11,839 - 25 - 668 - 8.1
OtherSecurities2 7,184 1 - 979 - 18.3
Total Deposits 187,947 -1,773 - 3,050 - 2.4
Demand Deposits 43,087 -2,040 - 6,150 - 19.1
Demand Deposits Adjusted3 28,363 - 901 - 2,968 - 14.4
OtherTransaction Balances4 12,155 - 139 - 620 - 7.4
Total Non.Transaction Balances6 132,706 407 3,721 4.4
MoneyMarketDeposit
Accounts-Total 37,699 25 - 1,898 - 7.3
Time Deposits in Amounts of
$100,000or more 41,135 323 2,970 11.9
Other Liabilities for Borrowed MoneyS 19,385 - 492 - 3,622 - 24.0
Weekly Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+l/Deficiency (- l
Borrowings
Netfree reserves (+l/Netborrowed(- l
Penodended
8/13/84
43
24
19
Penodended
7/30/84
61
111
50
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading accountsecurities
3 Excludes U.S. government and depository institution deposits and cash items
4 ATS, NOW, Super NOWand savings accounts with telephonetransfers
S Includes borrowing via FRB, TI&L notes, Fed Funds, RPs and other sources
6 Includes items notshown separately

Financing current account deficits

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Financing current account deficits

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Research Papers in Economics