The Decline of American Global Dominance: A Look at the US International Investment Position
A quarter of a century ago, the United States was referred to as the world’s sole “hyperpower” by then-French Foreign Minister Hubert Védrine. It was seen as the guarantor of global security, the rule-maker for global trade, and the undisputed international hegemon. However, today the “Pax Americana” is in ruins, free trade is fading, and summits between other global leaders set the world agenda. The days of America’s unquestioned global dominance are over, and we now find ourselves in a multipolar world.
While geopolitically the world has shifted, the unipolar moment still persists in international finance. The US dollar remains the de facto global currency, and the United States stands alone as the world’s largest net debtor. The country’s net international investment position (NIIP), which measures its overall balance sheet by subtracting the claims of foreign investors on the US from its own investors’ claims abroad, stood at a staggering -$18 trillion in June 2023. This deficit is equivalent to 67% of the US economic output, more than double the deficit from a decade earlier, and over seven times larger than in 2007. No other economy comes close to matching the US in terms of attracting the world’s savings.
How did this disconnect between geopolitics and international financial flows develop, and how long can it last? The US NIIP provides some interesting and alarming insights.
Since 2016, the US fiscal deficit has nearly tripled, reaching $1.7 trillion in the most recent fiscal year. This has led to an expansion of the country’s current account deficit, which surpassed $925 billion in 2022, up from $400 billion six years earlier.
Financing these massive external deficits through government bond markets alone would have been challenging in a world that is becoming less globalized. However, the same fiscal recklessness that damaged the federal government’s balance sheet also created a golden age for US corporate earnings. President Donald Trump’s tax cuts boosted the profitability of American companies, and President Joe Biden’s spending boom further increased their revenue. As a result, US equity markets became a haven for foreign investors seeking returns.
This microeconomic revolution has had a macroeconomic effect, radically altering the composition of the US NIIP. Previously, the US remained a net investor in foreign equities, even as it sank deeper into debt. However, since 2016, the country has been funding its consumption by selling not only bonds but also equities in net terms. As a result, the US has gone from having a $2 trillion surplus in foreign equity investment a decade ago to a deficit of nearly $6 trillion today.
This new composition leaves the US more vulnerable to the whims of foreign investors. The old funding structure, dominated by Treasury bonds, was inherently resilient. In times of crisis, foreign investors would rush to buy even more US debt. However, equity financing is more speculative and prone to volatility. The recent extreme volatility in the US Treasury market is a warning sign that the country’s risk premium is rising. If the exceptionalism of US equity markets wanes and finance catches up with geopolitics, speculative capital flows could reverse dramatically.
This prospect is daunting for investors who have become accustomed to the idea that there is no alternative to US stocks. So, where should they allocate capital if markets become multipolar?
The most obvious candidates are major net international creditors, whose markets would likely benefit from the reversal of capital flows. China, in combination with Hong Kong, holds the largest positive net position of $4.5 trillion as of June 2023. However, given their involvement in the new Cold War, they are not necessarily a hedge against geostrategic risk. Japan ($3.3 trillion), Switzerland ($800 billion), and the Eurozone ($300 billion) are major savers and may be more popular options. However, except for Switzerland, these choices also align with specific geopolitical interests.
An alternative option would be to invest in emerging markets. Surprisingly, many emerging economies are now significant net creditors. Countries such as Singapore ($800 billion) and Saudi Arabia ($700 billion) are familiar, but others like South Africa and Argentina (both $100 billion) offer unexpected opportunities.
Geopolitical fragmentation is working in favor of many emerging economies. As the US encourages the diversification of supply chains away from China, countries like Mexico, Brazil, Vietnam, and India are stepping in. Additionally, as superpowers seek secure commodity supplies, countries from Chile to the Democratic Republic of the Congo have gained leverage. Several Gulf Cooperation Council countries are also capitalizing on their position as trade and finance hubs, accessible to both sides.
Furthermore, emerging market policymakers have outperformed their advanced economy counterparts in recent years. Their governments have embraced fiscal orthodoxy, and their central bankers have been more proactive. The Peterson Institute for International Economics even summarized this shift as “How emerging markets have outperformed the Fed and ECB.” The
More detail via Reuters here… ( Image via Reuters )