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June 30, 2004

America: the world's biggest hedge fund

More Buttonwood analysis on the impact of interest rate rise -

The current account essentially comprises two things: the trade balance and overseas investment income. America’s trade deficit is bad and getting worse, even though the dollar has fallen by 23% from its recent high in February 2002. A $46.6 billion trade deficit in March had risen to $48.3 billion in April. In the absence of a net surplus from foreign investment, notes Jim O’Neill, the chief international economist at Goldman Sachs, this would mean a current-account deficit for the year of more than $600 billion, or getting on for 6% of GDP. No problem, say the more sanguine: America has long been able to finance its large and growing deficit because it is such a wonderful place in which to invest.

There are, however, a couple of snags with this argument. The first is that Americans find foreign climes more attractive to invest in than foreigners regard America: net foreign direct investment (FDI) has amounted to minus $155 billion over the last 12 months. And who can blame them? Returns on FDI into America were 5.5% in the first quarter, compared with returns of 11.7% on American firms’ foreign investment. Nor is this an aberration: the returns in America have been consistently lower for many years

..the United States is like a giant hedge fund, borrowing huge wodges of cheap money at home and then investing it in higher-yielding foreign assets.

Much of this money is now flowing into hot areas like India and China. Question is whether these newly emerging economies can survive a massive pullback of these American FDI or not. They will eventual survive but with some frequent hiccups like the one we saw right election results in India when FIIs pulled back strongly on the election surprise in the equity market.

June 30, 2004 in Dismal science | Permalink


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