Valuation Effects - Valuation Effects and The U.S. Current Account Deficits

Valuation Effects and The U.S. Current Account Deficits

Valuation effects have been increasingly important for the U.S. in the last two decades, given a dramatic, sharp rise in international cross-country portfolio holdings. For the U.S., valuation effects are partly compensating its current account deficits and therefore mitigating the decline of its net foreign assets.

During 1994-2007, the U.S. accumulated more than US$5 trillions in current account deficits. This figure will be rising at least in 2009 and 2010. The phenomenon understandably raises a lot of concerns about the size of the U.S. external debts, because a high, unsustainable external debt can result in painful debt service and/or sharp currency depreciation.

New evidence, however, suggests that while the U.S. has been experiencing large, persistent current account deficits, the assets U.S. investors hold overseas are gaining more in value compared to the value of U.S. assets held by foreign investors. These positive valuation effects represent financial gains for the U.S. (some attribute this phenomenon to exorbitant privilege). Economists at the Federal Reserve estimated that during 1994-2007, the U.S. valuation effects (in stocks and bonds) are about +$1.2 trillion, about 22% of the U.S. total current account deficits,.