Intro: Persistent current account deficits result in the build-up of net liabilities in the international investment account. NIIP deficits and surpluses tend to be self-reinforcing as the country earn less on its assets than it has to pay on its liabilities, resulting in an income account deficits. This in turn results in a further build-up of net external liabilities and so on.
Just as a companies’ profit and loss statement feeds through to its balance sheet, a country’s balance of payments statement feeds through to its net international investment position; the country’s external balance sheet. It shows all the foreign financial assets owned by a country’s citizens and all the liabilities that they owe. If a country runs a current account deficit it must borrow that money or draw down its assets and this translates directly into a deterioration in its NIIP.
NIIP surpluses also feed back through into the country’s current account. If a country has a large amount of external assets relative to liabilities, it will tend to generate large amounts of returns on these assets, which flow back in the form of income account inflows. This has the effect of providing further support to a country’s NIIP, allowing it to effectively live of the interest of its prior savings. In Japan, years of current account surpluses have allowed the country to build up large external assets that continue to generate huge amounts of interest payments that provides a great deal of support to Japan’s currency. NIIP and income account surpluses have shown to be correlated with stronger currencies and lower rates of inflation as the net inflows of dividends and interest payments increase demand for the country’s currency.
Safe Haven Currencies
Safe haven currencies tend to be defined as currencies which benefit in times of global risk aversion. With the exception of the US, as explained below, such currencies tend to be beneficiaries of net international investment surpluses. These currencies strengthen, in part, because domestic residents repatriate their overseas financial assets, putting upside pressure on the currency. Japan is a prime example of this dynamic, where the weaker the domestic economy becomes, the stronger the currency tends to be as declining risk appetite causes people to repatriate their overseas investments in favour of the yen.
The US Reserve Status
The US runs a large NIIP deficit owing to years of current account deficits which largely stem from the country’s low savings rate. Despite this, it still runs a financial account surplus as the money it earns on its overseas financial assets exceeds the money it pays to service its liabilities. In part this is due to the fact that a large share of the US’s external liabilities are in the form of low yielding US Treasuries, while a large share of its assets are in the form of foreign direct investments which generate in high returns. The US dollar still manages to benefit from safe haven flows in part because the repatriation of dollars from overseas tends to outweigh the impact of foreign countries repatriating their dollar investments for local currency.