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Exorbitant privilege and the income puzzle in the U.S. How to gain investment income despite being in debt


For most of us, the returns we gain on our assets are typically lower than the interest payments we make on debt and liabilities. This applies to most countries, too. The U.S., however, is an exception: For the U.S., liabilities with foreigners greatly surpass U.S. assets and claims on foreigners. In other words, the U.S. net international investment position is currently negative and has been for a long time. However, net income received by the U.S. is positive, which is not what we’d expect. This rather puzzling feature of the data is referred to as the U.S. income puzzle.

FRED can illustrate this puzzle for us: In the graph, the blue line tracks the U.S. net international investment position, and the red line tracks the U.S. balance on primary income (or U.S. asset earnings less liability payments). Both are shown as a percentage of annual GDP. The red line shows that, despite having a negative investment position, the U.S. still has a positive income balance. In fact, as the investment position has worsened, the income balance has actually improved.

Research on this topic has identified that the U.S. income balance remains positive primarily because returns on U.S. foreign direct investment (FDI) in other countries and on foreign financial assets that the U.S. government and residents hold far exceed returns from foreigners’ FDI in the U.S. or their holdings of U.S. assets. Why? The U.S. dollar is the world’s reserve currency, which benefits the U.S., for example, in terms of low interest payments. And foreigners hold financial reserves in the form of high-quality assets to use as a buffer in case of financial distress. By and large, these high-quality, safe assets are denominated in U.S. dollars (for example, U.S. bonds), which are in high demand and pay relatively low returns. Economists have coined a term for this benefit the U.S. enjoys: exorbitant privilege.

How this graph was created: Search for U.S. net international investment position in FRED and plot the annual series. Click on the “Edit Graph” button and add to the line annual nominal GDP and then apply the formula a/b/10. The 10 allows you to express the result as a percentage (after adjusting the units). Select the middle menu to add a line and search for the U.S. primary income balance. Add the annual data series to the graph as a new line. Repeat the exercise of dividing the series by nominal GDP.

Suggested by Maximiliano Dvorkin and Hannah Shell.

View on FRED, series used in this post: GDPA, IEABCPIA, IIPUSNETIA


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