Major-country balances on current and financial accounts
Table 3.3 shows the current-account balances of China, Germany, Japan, the UK, and the USA
from 1994 to 2001. Several inferences may be drawn from the table. First, the two largest
economies in the world – the USA and Japan – have incurred massive current-account imbal-
ances since 1994. Second, the British current-account balance has been in large deficit since 1999.
Third, the Chinese current-account balance has increased sharply since 1994.
The current-account balances of China, Japan, and the USA since 1995 largely reflect the
Asian financial crisis of 1997–8. Several factors have been singled out as leading causes of a huge
rise in the US deficit for current-account balance from 1998 to 2002: faster economic growth
in the USA than in its major trading partners, the strong US dollar, and reduced US exports to
those Asian countries hit hard by the Asian crisis.
Table 3.4 shows the financial-account balances of China, Germany, Japan, the UK, and the
USA from 1994 to 2002. Apparently, the US current-account deficit was largely offset by massive
inflows of capital (the financial account). On the other hand, the financial account of Japan,
which reflects the net financial outflow from the trade surplus, has been systematically negative.
China had mostly maintained surpluses in both the current account and the financial account
until 1996, thereby increasing its reserve assets. After 1996, however, China’s current-account
surplus declined until 2001 and its financial-account balance had reversed as it entered the WTO
in 2001.
The world balance of payments
Table 3.5 shows that the expansion of world trade averaged 6.4 percent per year between 1991
and 1999, while the growth of global output averaged only 2.4 percent per year during the same
period. As a result of the 1997–8 Asian crisis, world output grew 1.9 percent in 1998 and 2.9
percent in 1999. With such a slow output growth, world trade growth fell from 1997’s excep-
tional 9.5 percent, but maintained a 4–5 percent pace in 1998 and 1999. These statistics indi-
cate that the share of production traded increased substantially during the 1990s; this reflects the
re lative openness of markets and the ongoing integration of the global economy.
The value of world merchandise trade reached a new record of $6 trillion in 2002. Table 3.5
shows that world trade had grown about 2.7 times as fast as world output in the 1990s. In 2001,
world merchandise grew slower than world output for the first time in modern history, perhaps
due to the September 11, 2001, attacks. However, the World Bank forecasts that world mer-
chandise trade will grow two or three times as fast as world output from 2002 through 2005
again. It seems that the excess of trade over output in the twenty-first century will be as great as
that in the 1990s. The head of economic research at the World Trade Organization has said that
the gap between exports and output “is the handiest practical measurement of the pace of glob-
alization” of manufacturing.
Globalization represents a huge opportunity for countries at all levels of development. The
rapid increase in trade volume over the past 30 years has been one of the most important factors
in the rise of living standards across the globe. Because a fresh wave of market-opening initia-
tives alters economies, many forecasts predict an annual global-trade growth of 10 percent for
the next two decades.
The international investment position
Trade balance is a flow concept because it measures the economic activities of a country over a
1-year period. The international investment position is a stock concept because it summarizes
a country’s assets and liabilities on a given date. Tables 3.6 and 3.7 show the international invest-ment position of the USA and of Japan from 1994 to 2002.
These two tables reveal striking differences in the international investment position between
the two countries. First, the USA is the largest net debtor nation in the world, while Japan is the
largest net creditor nation. For the USA and Japan over the same period, a largely reciprocal rela-
tionship is evident. Growth in the net international investment position of the USA coincided
with the rapid increase of Japan’s net investment position during the 1990s. The US net over-
seas investment evolved steadily from $6 billion in 1919 to $358 billion in 1983. This long-term
increase in the US net investment position has decreased dramatically since 1983. In 1987, the
USA became a net debtor nation for the first time since World War I. As shown in table 3.7, its
foreign debt reached $2.6 trillion in 2002. This is about 60 percent of the combined total debt
of some 140 developing countries. Huge trade and budget deficits, caused by major shifts in
macroeconomic policy in the first half of the 1980s, turned the USA from creditor to debtor.
Persistent trade and budget deficits, along with more foreign acquisitions of US assets than US
acquisitions of foreign assets, caused US foreign debt to grow continually.
Second, FDI in the US accounts for approximately 35 percent of foreign assets in the USA,
but FDI in Japan amounts to about 10 percent of foreign assets in Japan. Critics charge that
Japanese firms participate in keiretsu to insulate themselves from outside competitors in all aspects
of operations. In Japanese, the word “keiretsu” stands for large, financially linked groups of com-
panies, but foreign critics translate it as meaning something else – an “economic barrier to non-
Japanese companies.” They wag their fingers at keiretsu as barriers to everything: trade, FDI in
Japan, and financing for Japanese firms in the USA. The relatively small amount of FDI in Japan
indicates that Japanese firms are more sheltered from foreign competition in their home market
than firms in other industrial countries.
Third, the USA’s other investment abroad accounts for nearly 30 percent of its total foreign
assets, while Japan’s amounts to more than 45 percent. Most of the other investments are short-
term capital flows such as trade credit, short-term bank loans, and currency. Moreover, portfo-
lio investments also include short-term capital flows such as short-term government securities
and money market funds. Apparently, Japan keeps most of its foreign assets in short-term capital
as compared with the USA and other industrial countries, which do not. No wonder, then, so
many Japanese banks are still suffering from bad short-term loans that they have made abroad
in the past.
Net international investment positions themselves are not particularly meaningful. This is why
many economists look at three broad categories of the international investment position: direct
investment, portfolio investment, and other investment. In other words, analysts break down
international investment holdings into several categories so that they can draw policy implica-
tions from each category about the liquidity status of a country.
Short-term foreign assets in the USA, such as bank deposits and government securities, are
meaningful because foreigners can withdraw these holdings on very short notice. For example,
if they fear capital losses from further depreciation of the dollar, or if interest rates decline, foreign
investors may turn away from dollar-denominated short-term assets. Such actions by foreign
investors may endanger the stability of the US financial system. Foreign official assets in the USA
are also significant. If foreign monetary authorities decide to liquidate their holdings of US gov-
ernment securities, the financial strength of the dollar will fall. Long-term investments, such as
long-term corporate securities and direct investment, are less important because they respond to
basic economic trends and are not subject to erratic withdrawals.
Table 3.3 shows the current-account balances of China, Germany, Japan, the UK, and the USA
from 1994 to 2001. Several inferences may be drawn from the table. First, the two largest
economies in the world – the USA and Japan – have incurred massive current-account imbal-
ances since 1994. Second, the British current-account balance has been in large deficit since 1999.
Third, the Chinese current-account balance has increased sharply since 1994.
The current-account balances of China, Japan, and the USA since 1995 largely reflect the
Asian financial crisis of 1997–8. Several factors have been singled out as leading causes of a huge
rise in the US deficit for current-account balance from 1998 to 2002: faster economic growth
in the USA than in its major trading partners, the strong US dollar, and reduced US exports to
those Asian countries hit hard by the Asian crisis.
Table 3.4 shows the financial-account balances of China, Germany, Japan, the UK, and the
USA from 1994 to 2002. Apparently, the US current-account deficit was largely offset by massive
inflows of capital (the financial account). On the other hand, the financial account of Japan,
which reflects the net financial outflow from the trade surplus, has been systematically negative.
China had mostly maintained surpluses in both the current account and the financial account
until 1996, thereby increasing its reserve assets. After 1996, however, China’s current-account
surplus declined until 2001 and its financial-account balance had reversed as it entered the WTO
in 2001.
The world balance of payments
Table 3.5 shows that the expansion of world trade averaged 6.4 percent per year between 1991
and 1999, while the growth of global output averaged only 2.4 percent per year during the same
period. As a result of the 1997–8 Asian crisis, world output grew 1.9 percent in 1998 and 2.9percent in 1999. With such a slow output growth, world trade growth fell from 1997’s excep-
tional 9.5 percent, but maintained a 4–5 percent pace in 1998 and 1999. These statistics indi-
cate that the share of production traded increased substantially during the 1990s; this reflects the
re lative openness of markets and the ongoing integration of the global economy.
The value of world merchandise trade reached a new record of $6 trillion in 2002. Table 3.5
shows that world trade had grown about 2.7 times as fast as world output in the 1990s. In 2001,
world merchandise grew slower than world output for the first time in modern history, perhaps
due to the September 11, 2001, attacks. However, the World Bank forecasts that world mer-
chandise trade will grow two or three times as fast as world output from 2002 through 2005
again. It seems that the excess of trade over output in the twenty-first century will be as great as
that in the 1990s. The head of economic research at the World Trade Organization has said that
the gap between exports and output “is the handiest practical measurement of the pace of glob-
alization” of manufacturing.
Globalization represents a huge opportunity for countries at all levels of development. The
rapid increase in trade volume over the past 30 years has been one of the most important factors
in the rise of living standards across the globe. Because a fresh wave of market-opening initia-
tives alters economies, many forecasts predict an annual global-trade growth of 10 percent for
the next two decades.
The international investment position
Trade balance is a flow concept because it measures the economic activities of a country over a
1-year period. The international investment position is a stock concept because it summarizes
a country’s assets and liabilities on a given date. Tables 3.6 and 3.7 show the international invest-ment position of the USA and of Japan from 1994 to 2002.
These two tables reveal striking differences in the international investment position between
the two countries. First, the USA is the largest net debtor nation in the world, while Japan is the
largest net creditor nation. For the USA and Japan over the same period, a largely reciprocal rela-
tionship is evident. Growth in the net international investment position of the USA coincided
with the rapid increase of Japan’s net investment position during the 1990s. The US net over-
seas investment evolved steadily from $6 billion in 1919 to $358 billion in 1983. This long-term
increase in the US net investment position has decreased dramatically since 1983. In 1987, the
USA became a net debtor nation for the first time since World War I. As shown in table 3.7, its
foreign debt reached $2.6 trillion in 2002. This is about 60 percent of the combined total debt
of some 140 developing countries. Huge trade and budget deficits, caused by major shifts in
macroeconomic policy in the first half of the 1980s, turned the USA from creditor to debtor.
Persistent trade and budget deficits, along with more foreign acquisitions of US assets than US
acquisitions of foreign assets, caused US foreign debt to grow continually.
Second, FDI in the US accounts for approximately 35 percent of foreign assets in the USA,
but FDI in Japan amounts to about 10 percent of foreign assets in Japan. Critics charge that
Japanese firms participate in keiretsu to insulate themselves from outside competitors in all aspects
of operations. In Japanese, the word “keiretsu” stands for large, financially linked groups of com-
panies, but foreign critics translate it as meaning something else – an “economic barrier to non-
Japanese companies.” They wag their fingers at keiretsu as barriers to everything: trade, FDI in
Japan, and financing for Japanese firms in the USA. The relatively small amount of FDI in Japan
indicates that Japanese firms are more sheltered from foreign competition in their home market
than firms in other industrial countries.
Third, the USA’s other investment abroad accounts for nearly 30 percent of its total foreign
assets, while Japan’s amounts to more than 45 percent. Most of the other investments are short-
term capital flows such as trade credit, short-term bank loans, and currency. Moreover, portfo-
lio investments also include short-term capital flows such as short-term government securities
and money market funds. Apparently, Japan keeps most of its foreign assets in short-term capital
as compared with the USA and other industrial countries, which do not. No wonder, then, so
many Japanese banks are still suffering from bad short-term loans that they have made abroad
in the past.
Net international investment positions themselves are not particularly meaningful. This is why
many economists look at three broad categories of the international investment position: direct
investment, portfolio investment, and other investment. In other words, analysts break down
international investment holdings into several categories so that they can draw policy implica-
tions from each category about the liquidity status of a country.
Short-term foreign assets in the USA, such as bank deposits and government securities, are
meaningful because foreigners can withdraw these holdings on very short notice. For example,
if they fear capital losses from further depreciation of the dollar, or if interest rates decline, foreign
investors may turn away from dollar-denominated short-term assets. Such actions by foreign
investors may endanger the stability of the US financial system. Foreign official assets in the USA
are also significant. If foreign monetary authorities decide to liquidate their holdings of US gov-
ernment securities, the financial strength of the dollar will fall. Long-term investments, such as
long-term corporate securities and direct investment, are less important because they respond to
basic economic trends and are not subject to erratic withdrawals.
