U.S. international transactions in 1997.

Lois E. Stekler, of the Board's Division of International Finance, prepared this article. Virginia Carper and Clarke Fauver provided research assistance.

The U.S. current account deficit widened further in 1997, reaching $166 billion. U.S. imports of goods continued to exceed exports by a substantial margin (table 1). However, goods trade accounted for only a small part of the deterioration in the current account balance last year. The shift of investment income from positive to negative (the first time since 1914) was the major contributing factor; it reflected the cumulative effect of deficits in the current account that have persisted since 1982 and the balancing net capital inflows. The financial crises in Asia in the second half of 1997 visibly affected U.S. capital flows but influenced the U.S. current account in only a limited way in that year. Their effect on the U.S. current account is likely to be more apparent in 1998.

1. U.S. current account balance, 1992-97 Billions of dollars

      Item                      1992      1993      1994      1995

Current account balance         -56.4     -90.8    -133.5    -129.1

Trade in goods and services,
net                             -39.2     -72.3    -104.4    -101.9
   Goods, net                   -96.1    -132.6    -166.2    -173.6
   Services, net                 56.9      60.3      61.8      71.7

Investment income, net           18.0      19.7       9.7       6.8
   Portfolio investment, net    -33.6     -36.0     -41.0     -53.2
   Direct investment, net        51.6      55.7      50.8      60.0

Unilateral transfers, net       -35.2     -38.1     -38.8     -34.0

      Item                      1996      1997        Change,
                                                    1996 to 1997

Current account balance        -148.2    -166.4         -18.2

Trade in goods and services,
net                            -111.0    -113.6          -2.6
   Goods, net                  -191.2    -198.9          -7.7
   Services, net                 80.1      85.3           5.2

Investment income, net            2.8     -14.3         -17.1
   Portfolio investment, net    -63.9     -82.0         -18.1
   Direct investment, net        66.8      67.7            .9

Unilateral transfers, net       -40.0     -38.5           1.5

Note. In this and the tables that follow, components may not sum to totals because of rounding.

Source. U.S. Department of Commerce, Bureau of Economic Analysis, U.S. international transactions accounts.

The current account deficit in 1997 was almost as large as the record deficit in 1987; relative to the size of the U.S. economy, however, it was substantially smaller (2 percent of gross domestic product in 1997 versus 3.6 percent in 1987).

MAJOR ECONOMIC INFLUENCES ON U.S. INTERNATIONAL TRANSACTIONS

The U.S. current and capital accounts in 1997 were shaped by a wide variety of factors. These included U.S. economic growth and exchange rate developments, the financial crises affecting many developing economies in Asia, and rates of economic growth in other developing and industrial countries.

US. Economic Growth and Exchange Rate Developments

The U.S. economy grew at a robust pace in 1997 (table 2). Aggregate demand (including the demand for imports of goods and services) was strong, and corporate profits (including the profits of U.S. affiliates of foreign companies) were high. Inflation nonetheless remained subdued, partly because of decreases in the prices of imported goods as a result of the appreciation of the dollar against many currencies and because of declines in prices on international commodity markets.

2. Change in real GDP in the United States and abroad, 1995-97 Percentage change, year over year

      Country                     1995      1996      1997(1)

United States                      2.0       2.8       3.8

Total foreign                      2.7       3.6       4.2

Industrial countries' index(2)     2.3       2.2       2.9
   Canada                          2.2       1.2       3.8
   Western Europe                  2.7       2.2       2.9
   Japan                           1.4       4.1        .9

Developing countries' index(3)     3.5       6.0       6.2
   Asia                            7.7       6.9       6.0
   Latin America                  -3.4       4.5       6.4
     Mexico                       -6.2       5.1       7.0
     Other Latin America           2.4       3.2       5.0

Note. Aggregate measures are chain-weighted by moving bilateral shares in U.S. exports of nonagricultural merchandise.

(1.) Data for 1997 are partly estimated.

(2.) The industrial countries' index covers Australia and New Zealand in addition to Canada, Japan, and Western Europe. The index for Western Europe comprises Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, and the United Kingdom.

(3.) The developing countries in the index for Asia are the Peoples Republic of China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan, and Thailand. The countries in "Other Latin America" are Argentina, Brazil, Chile, and Venezuela.

Source. Various national sources.

From December 1996 to December 1997 the dollar gained 12 percent in nominal terms against an average (weighted by multilateral trade weights) of the currencies of the other Group of Ten (G-10) countries (chart 1). The dollar appreciated in terms of the other G-10 currencies during the first half of 1997, as the continuing strength of U.S. economic activity raised expectations of further tightening of U.S. monetary conditions. Also, the dollar tended to rise in terms of the German mark and other continental European currencies because of concerns about the implications of the transition to the European Economic and Monetary Union and perceptions that monetary policy was not likely to tighten significantly in prospective member countries. In the first half of the year, the dollar fluctuated against the Japanese yen in response to varying indicators of the strength of the Japanese expansion. But in the second half, the yen depreciated in response to evidence of faltering economic activity and perceptions of fragility in the Japanese financial sector. The perceptions of fragility were heightened by concerns about the negative effect on Japan of the financial crises elsewhere in Asia. As will be discussed in greater detail, the dollar also appreciated strongly against the currencies of developing countries in the second half of 1997.

[Chart 1 OMITTED]

Robust U.S. economic growth and tax collections moved the federal government budget close to balance in 1997. In general, reducing government dissaving would tend to move the current account toward balance as well; however, the current account deficit has been widening. In terms of national income accounting identities, the growing U.S. current account deficit (and the related national income concept, negative net foreign investment) must reflect a growing gap between domestic investment and saving (chart 2). However, the statistical discrepancy in the national income accounts has shifted from a large positive value to a large negative value in recent years, obscuring whether increases in investment, or reductions in private savings, or both have been the counterpart to the growing current account deficits. In any case, the inflow of foreign savings, which has financed part of U.S. investment over the past decade and a half, has raised productive capacity relative to what it would have been but has required ongoing payments of investment income to foreigners.

[Chart 2 OMITTED]

Asian Financial Crises

In July, strong downward pressure on the Thai baht marked the beginning of a series of Asian financial crises. Severe financial market pressures spread to other East Asian countries--most notably Indonesia and South Korea. These pressures appeared to have been triggered mainly by market concerns over substantial external deficits, possibly overvalued exchange rates, weak financial systems, sizable foreign-currency-denominated indebtedness, and government policy responses that were widely viewed as inadequate. The financial market pressures persisted despite the initiation of several financial assistance agreements led by the International Monetary Fund.

Several countries experienced sharp depreciations in their currencies. Between the end of June and the end of December, the Thai baht, Korean won, and Indonesian rupiah lost about half their value; the Indonesian rupiah continued to fall sharply in early 1998 (chart 3). The financial market turmoil in East Asia spread to Hong Kong and, to a lesser extent, Taiwan. However, the peg of the Hong Kong currency to the U.S. dollar has been successfully maintained, and the depreciation of the Taiwan dollar has been relatively small.

[Chart 3 OMITTED]

The turmoil in Asian financial markets was accompanied by sharp declines in stock prices, increases in interest rates, sharply reduced credit availability, heightened uncertainty, and, in some cases, somewhat tighter fiscal policies in connection with international support packages. As a consequence, economic activity slowed markedly in several Asian developing economies in the second half of 1997; growth between the second and fourth quarters of 1997 for these economies as a group averaged only about 2 3/4 percent at a seasonally adjusted annual rate, or less than half the 6 percent or more of earlier periods (table 2). This slowdown is expected to continue into 1998.

Economic Growth in Other Developing and Industrial Countries

Financial markets in some Latin American countries also came under pressure as the Asian crises led investors to reassess the riskiness of their exposures. However, despite considerable pressure, both the Brazilian exchange rate regime and the peg of the Argentine peso to the dollar held. In Brazil, high domestic interest rates and the tightening of macroeconomic policy to support the exchange rate weakened domestic demand toward the end of the year. In Mexico, the recovery of economic activity from the recession following the 1994-95 crisis continued, although the peso weakened. On average, economic growth in Latin America (weighted by shares in U.S. exports) was robust in 1997 (table 2).

Economic growth in the industrial countries firmed in 1997 (table 2). Growth in Canada was particularly robust, and most of the European countries also showed some improvement. Japan was a notable exception, as the growth of real GDP stalled partly in response to sizable fiscal contraction. In addition, as mentioned earlier, crises in many of Japan's Asian trading partners in the second half of the year weakened the outlook for external demand and heightened concerns about the fragility of Japan's financial sector.

DEVELOPMENTS IN TRADE IN GOODS AND SERVICES

In 1997 the overall U.S. trade deficit rose slightly in nominal terms from its 1996 level (table 1). A small increase in the deficit in trade in goods was almost matched by the increase in the surplus in services trade. However, because of differing price developments among the trade components, the trade deficit in terms of chained (1992) dollars continued to grow, and net exports subtracted about 0.6 percentage point from the growth of U.S. GDP between the fourth quarter of 1996 and the fourth quarter of 1997.

Exports

The value of U.S. exports of goods and services grew $83 billion in 1997, or about 10 percent, an acceleration from the 7 percent gain in 1996 (table 3). Exports of goods grew more rapidly than exports of services.

3. U.S. international trade in goods and services, 1995-97 Billions of dollars

      Item                               1995      1996      1997

Balance on goods and services            -102      -111      -114

Exports of goods and services             795       849       932
   Services                               219       237       253
   Goods                                  576       612       678
     Agricultural products                 57        62        58
     Nonagricultural goods                519       551       620
       Capital goods                      234       253       294
         Aircraft and parts                26        31        41
         Computers, peripherals,
         and parts                         40        44        49
         Semiconductors                    34        36        39
         Other capital goods              134       143       165
       Consumer goods                      64        70        77
       Automotive products                 62        65        73
       Industrial supplies                146       148       158
       Other nonagricultural exports       13        15        17

Imports of goods and services             897       960     1,045
   Services                               147       157       168
   Goods                                  749       803       877
     Oil and products                      56        73        72
     Non-oil goods                        693       731       805
       Capital goods                      221       229       254
         Aircraft and parts                11        13        17
         Computers, peripherals,
         and parts                         56        62        70
         Semiconductors                    39        37        37
         Other capital goods              115       117       131
       Consumer goods                     160       171       193
       Automotive products                124       129       141
       Industrial supplies                129       137       145
       Foods and other non-oil imports     59        64        72

      Item                                    Dollar change
                                        1995 to 1996   1996 to 1997

Balance on goods and services               -9.1           -2.7

Exports of goods and services               54.2           82.7
   Services                                 18.1           16.4
   Goods                                    36.2           66.2
     Agricultural products                   4.3           -3.1
     Nonagricultural goods                  31.9           69.3
       Capital goods                        19.0           41.1
         Aircraft and parts                  5.0           10.4
         Computers, peripherals,
         and parts                           4.0            5.6
         Semiconductors                      1.6            3.0
         Other capital goods                 8.4           22.1
       Consumer goods                        6.0            7.4
       Automotive products                   3.0            8.4
       Industrial supplies                   2.0           10.1
       Other nonagricultural exports         1.9            2.3

Imports of goods and services               63.4           85.3
   Services                                  9.6           11.3
   Goods                                    53.8           74.1
     Oil and products                       16.7            -.6
     Non-oil goods                          37.1           74.7
       Capital goods                         8.0           25.2
         Aircraft and parts                  2.0            3.6
         Computers, peripherals,
         and parts                           6.0            8.1
         Semiconductors                     -2.0            -.1
         Other capital goods                 2.0           13.6
       Consumer goods                       11.0           21.9
       Automotive products                   5.0           11.7
       Industrial supplies                   8.3            8.0
       Foods and other non-oil imports       4.8            7.9

Note. Changes in this and subsequent tables may differ from those calculated from the data shown in the tables because of rounding.

Source. U.S. Department of Commerce, Bureau of Economic Analysis, U.S. international transactions accounts.

Goods Exports

Exports of goods to Latin America rose more than 20 percent, and the growth to Canada and Western Europe was also strong (table 4). In contrast, exports to Japan declined slightly, and those to developing countries in Asia grew moderately, although more rapidly than in 1996. The financial crises in Asian developing economies had little noticeable effect on U.S. exports of goods in 1997.

4. U.S. exports of goods to its major trading partners, 1995-97 Billions of dollars

                                                     Percentage
    Importing region         1995    1996    1997      change,
                                                     1996 to 1997

Total                         576     612     678        10.8

Industrial countries(1)       335     351     383        9.1
   Canada                     128     135     152       12.8
   Western Europe             132     137     153       11.4
   Japan                       63      66      65       -2.0

Developing countries(2)       241     261     295       13.1
   Asia                       130     135     145        6.9
   Latin America               96     109     134       22.7
     Mexico                    46      57      71       25.6
     Other Latin America       50      52      62       19.8

(1.) The industrial countries include Australia and New Zealand in addition to Canada, Western Europe, and Japan.

(2.) The developing countries include Eastern Europe and Africa in addition to Asia and Latin America.

Source. U.S. Department of Commerce, Bureau of Economic Analysis, U.S. international transactions accounts.

Capital goods accounted for substantially more than half of the increase in the value of U.S. exports of goods in 1997 (table 3). Smaller increases were reported for a broad range of other products, including industrial supplies, automotive products, and consumer goods. Although the quantity of agricultural exports remained high, their value declined, as agricultural prices fell from elevated levels reached early in the year.

Given the loss of export price competitiveness associated with the appreciation of the dollar against many currencies over the past two years (chart 4), the strength of U.S. exports of goods in 1997 was somewhat surprising. Sustained economic growth in important U.S. export markets, particularly Latin America, Canada, and Western Europe, partly countered the loss of price competitiveness. However, even taking strong foreign economic growth into account, U.S. exports increased more than would have been expected based on estimated income and price elasticities. U.S. exporters probably benefited from the trend in Mexico and other Latin American countries away from policies that sheltered domestic producers from international competition.

[Chart 4 OMITTED]

The growth in the value of U.S. exports was largely the result of the rapid growth in the quantity of goods exported rather than increases in prices (table 5). Growth in quantity was rapid not just for computers and semiconductors (for which price indexes adjusted for technological change and quality improvements--hedonic price indexes--declined rapidly) but also for other nonagricultural exports.

5. Change in the quantity of U.S. exports and imports, 1995-97 Percentage change, year over year

   Type of export or import            1995      1996      1997

All exports                             11.1       8.3      12.4

Services                                 7.4       5.5       5.1
Goods                                   12.6       9.5      15.4
   Agricultural products                11.5      -1.8       1.6
   Nonagricultural goods                12.7      10.8      16.9
     Computers, peripherals, and parts  46.5      46.2      50.1
     Semiconductors                     76.8      47.1      40.5
     Other nonagricultural goods         6.7       5.7      12.7

All imports                              8.9       9.1      14.2

Services                                 6.1       5.5       9.5
Goods                                    9.5       9.9      15.1
   Oil and products                     -1.6       7.6       5.1
   Non-oil goods                        10.5      10.1      16.2
     Computers, peripherals, and parts  42.5      33.4      44.0
     Semiconductors                     74.4      63.5      57.1
     Other non-oil goods                 5.3       5.4      12.0

Note. Quantities are measured in chained (1992) dollars.

Source. U.S. Department of Commerce, national income and product accounts.

Services Exports

Exports of private services grew $16 billion, or about 7 percent (table 6). The largest dollar increase was in "other private services," a catchall category that included particularly large increases in U.S. receipts for business, professional, and technical services, and financial services. U.S. receipts of royalties and license fees and exports of "other private services" largely reflect the U.S. comparative advantage in services that depend heavily on technological expertise and contribute significantly to the net surplus in services trade enjoyed by the United States. Exports of traditional services like travel, passenger fares, and transportation continued to account for more than half of U.S. services exports in 1997, but the growth of these traditional exports was moderated by the appreciation of the dollar and the resulting decline in U.S. price competitiveness.

6. Service transactions, 1994-97 Billions of dollars

                                                         Change,
      Item                 1994   1995   1996   1997   1996 to 1997

Service transactions, net    62     72     80     85        5

   Exports of private
   services                 184    204    221    237       16
     Travel                  58     63     70     74        4
     Passenger fares         17     19     21     22        1
     Other transportation    25     27     27     28        1
     Royalties and license
     fees                    23     27     30     30        0
     Other private services  61     67     74     83        9

   Imports of private
   services                 123    135    143    154       11
     Travel                  44     46     49     52        3
     Passenger fares         13     14     16     17        1
     Other transportation    27     28     28     30        1
     Royalties and license
     fees                     6      7      7      8        0
     Other private services  33     39     43     48        5

   U.S. government and
   military services, net     0      2      2      2        0

Source. U.S. Department of Commerce, Bureau of Economic Analysis, U.S. international transactions accounts.

Imports

The value of U.S. imports of goods and services grew $85 billion in 1997 (about 9 percent), somewhat faster than the rate in 1996 (table 3). As on the export side, imports of goods grew more rapidly than imports of services. Imports were spurred by strong economic growth in the United States in 1997 together with a decline in the price competitiveness of U.S. goods (chart 4), largely as the result of the appreciation of the dollar against many currencies.

Oil Imports

Although the volume of oil imports increased about 5 percent from 1996 to 1997, their value fell slightly because of a 5 percent decline in the average price. Several factors contributed to the fall in oil prices and, at the time of this writing, have induced a further decline from levels prevailing at the end of 1997.

Changes in the prices of imported oil have tended to mirror changes in spot oil prices (West Texas intermediate) with a lag of several weeks (chart 5). Spot prices had risen quite sharply during the second half of 1996, from $18.54 per barrel in June to $25.39 in December. Refiners--uncertain about the availability of crude oil supplies from Iraq and concerned about the effect that such supplies might have on the price of oil--tended to keep their stocks low.

[Chart 5 OMITTED]

With the oil industry operating at minimal, just-in-time inventory levels, oil prices reacted quite strongly to unanticipated shocks. Two such events in 1996--the delay in the startup of several North Sea fields and economic activity in the United States that was stronger than anticipated--drove oil prices up. Once Iraq began producing oil for export at the beginning of 1997, spot oil prices fell sharply, from an average of $25.17 per barrel in January to $19.72 in April. Spot prices traded in a range of $19 to $20 per barrel during the remainder of the year. Oil import prices averaged about $18.63 per barrel in 1997, about a dollar below the average for 1996. Spot prices fell during January and February of 1998 as a result of several developments: Saudi Arabia, Kuwait, and the United Arab Emirates raised production in line with increases in their OPEC quota; warmer-than-normal weather from El Nino softened demand for home heating oil; and the economic turmoil in East Asia reduced shipments to those emerging economies.

The quantity of oil imports rose from an average of 9.4 million barrels per day in 1996 to 9.9 million in 1997 (table 7). An increase in U.S. consumption in the range of 0.4 million barrels per day accounted for most of the increase in the quantity of imports, as U.S. production has been little changed over the past four years.

7. U.S. oil consumption, production, and imports, selected years, 1980-97 Millions of barrels per day

      Item           1980    1985    1994    1995    1996    1997

Consumption          17.1    15.7    17.7    17.7    18.2    18.6
Production           10.8    11.2     9.4     9.4     9.5     9.4
Imports               6.9     5.1     9.0     8.8     9.4     9.9

Source. U.S. Department of Energy, Energy Information Administration.

Non-Oil Imports

The value of non-oil imports of goods increased $75 billion in 1997 (about 10 percent), up substantially substantially from 1996 (table 3). Large increases in imports of consumer goods as well as capital goods accounted for much of the increase; imports of automotive products also rose more than they had in 1996.

The industrial countries continued to account for more than half of U.S. non-oil imports in 1997. However, imports from developing countries continued to grow much faster than average (table 8). Growth of imports from Mexico was particularly strong, a development perhaps reflecting the continuing effect of the North American Free Trade Agreement on the pattern of U.S. trade.

8. U.S. imports of non-oil goods from its major trading partners, 1995-97 Billions of dollars

                                                  Percentage
   Exporting region         1995   1996   1997      change
                                                 1996 to 1997
Total                       693    731    805        10.2

Industrial countries(1)     408    421    456         8.2
   Canada                   137    146    159         8.5
   Western Europe           142    155    170         9.7
   Japan                    123    115    121         5.5

Developing countries(2)     286    309    349        12.9
   Asia                     189    199    222        11.5
   Latin America             87     99    115        15.6
      Mexico                 57     67     78        16.7
      Other Latin America    30     32     36        13.0

(1.) See table 4, note 1.

(2.) See table 4, note 2.

Source. U.S. Department of Commerce, Bureau of Economics Analysis, U.S. international transactions accounts.

As with exports, the increase in the value of non-oil imports largely reflected growth in quantity rather than higher prices (table 5). Rapid quality improvements in computers and semiconductors continued to push down their hedonic price indexes. However, the prices of core imports (goods imports excluding oil, computers, and semiconductors) also fell--about 3/4 percent between the fourth quarter of 1996 and the fourth quarter of 1997; declines in world commodity prices played a role, but appreciation of the dollar was also a factor. The nominal exchange rate of the dollar against the currencies of thirteen developing economies (weighted by bilateral import shares excluding oil, computers, and semiconductors) appreciated 14 percent between the fourth quarter of 1996 and the fourth quarter of 1997; against the currencies of sixteen industrial countries, the dollar appreciated almost 9 percent during the same period (chart 6).

[Chart 6 OMITTED]

Services Imports

Imports of private services rose $11 billion in 1997, an increase of more than 7 percent (table 6). Although imports of services that depend on technical expertise are much smaller than exports of such services, "other private services" accounted for about half the increase in value of service imports. U.S. expenditures on travel abroad also increased.

DEVELOPMENTS IN THE NONTRADE CURRENT ACCOUNT

The two major components of the current account other than trade in goods and services are net unilateral transfers and net investment income (table 1).

Net Unilateral Transfers

Net unilateral transfers include government grant and pension payments as well as net private transfers to foreigners. The deficit on unilateral transfers fell slightly from the 1996 level, to $39 billion. The 1996 level had been unusually large because of the deferring of transfers to 1996 during the budget impasse and government shutdown at the end of 1995 (table 1).

Net Investment Income

Net investment income is the difference between the amount that U.S. residents earn on their direct and portfolio investments abroad (receipts) and the amount that foreigners earn on their direct and portfolio investments in the United States (payments).(1) Revised data indicate that net investment income turned negative in 1997 for the first time since 1914 (table 9). The data on investment income were revised in light of the results of the Benchmark Survey of U.S. Ownership of Foreign Long-Term Securities, discussed later. As a result of large and persistent U.S. current account deficits over the past decade and a half, foreign assets in the United States have grown more rapidly than U.S. assets abroad. However, net investment income remained positive (chart 7) long after the net investment position became negative because foreign direct investment in the United States has earned a far lower rate of return than U.S. direct investment abroad.

[Chart 7 OMITTED]

9. U.S. investment income, 1994-97 Billion of dollars

            Item                1994   1995   1996   1997

Investment income, net            10      7      3    -14

Direct investment income, net     51     60     67     68
   Receipts                       71     90     99    109
   Payments                       20     30     32     42

Portfolio income, net            -41    -53    -64    -82
   Receipts                       84    107    108    127
   Payments                      125    160    171    209

Source. U.S. Department of Commerce, Bureau of Economic Analysis, U.S. international transactions accounts.

Net Direct Investment Income

Net direct investment income reported by U.S. and foreign corporations on Department of Commerce surveys rose little in 1997, as the dollar increase in payments about matched the increase in receipts (table 9).

The growth of income on U.S. direct investment abroad in 1997 was the product of both strong economic growth in many of the countries where the United States has substantial investments and continued large additions to holdings by U.S. investors. Direct investment receipts have tended to increase along with the growth of U.S. investments (chart 8), although they have varied with economic conditions abroad. Economic growth was strong in Latin America, Canada, and Western Europe in 1997, areas that account for the largest shares of U.S. direct investment abroad (table 10). In contrast, economic growth in Japan was anemic, and growth in the Asian developing economies fell sharply toward the end of the year. However, these Asian economies (including Japan) accounted for less than 15 percent of the stock of U.S. direct investment abroad at the end of 1996. Whereas income on investments in these Asian economies declined, particularly in the last half of 1997, favorable developments in the rest of the world kept receipts on direct investment up for the year.

[Chart 8 OMITTED]

10. U.S. direct investment position abroad, by area, year-end 1996

                            Billions of
      Item                  U.S. dollars    Percent

Total                          796.5          100

Canada                          91.6           11
Europe                         399.6           50
   United Kingdom              142.6           18

Latin America and
   the Caribbean               144.2           18

Asia                           106.1           13
   Japan                        39.6            5
   Other Asia                   66.5            8

Australia and New Zealand       34.5            4

Other                           20.7            3

Note: Valued at historical cost.

Source. Department of Commerce, Bureau of Economic Analysis.

Payments on foreign direct investment in the United States also increased substantially in 1997 as a result of strong U.S. growth and high corporate profits. Direct investment payments have not always kept pace with the growth of foreign direct investment in the United States; between 1980 and 1993 the direct investment position increased sharply, but payments showed no upward trend (chart 9).

[Chart 9 OMITTED]

The rate of return on foreign direct investment in the United States remains low by any measure--far below the rate of return earned by U.S. direct investors abroad. Three measures of rates of return can be calculated. In each measure (shown in table 11), receipts or payments reported by direct investors are divided by estimates of the value of direct investment assets outstanding during the year. Historical cost is the price at which the assets were purchased; current cost adjusts the historical accounting values for inventories and plant and equipment to reflect movements in current replacement cost indexes; and market value adjusts the ownership position using general indexes of stock market prices. All attempts to estimate changes in the value of assets are imprecise and do not take into account developments that may be important to the value of specific investments.

11.Rates of return on direct investment, 1990-97 Percent

Measure used in
calculating the
rate of return           1990   1991   1992   1993   1994   1995

U.S. investment abroad

Historical cost          14.5   11.6   10.7   11.5   11.8   13.3
Current cost             10.0    8.3    8.0    8.9    9.4   10.7
Market value              7.5    6.7    6.4    6.7    6.7    7.6

Foreign investment in
the United States

Historical cost            .8    -.8     .1    1.3    4.2    5.7
Current cost               .6    -.7     .1    1.1    3.5    4.9
Market value               .5    -.6     .0     .8    2.6    3.4

Measure used in
calculating the
rate of return           1996   1997

U.S. investment abroad

Historical cost          13.1   12.8
Current cost             10.7   10.6
Market value              6.9    6.9

Foreign investment in
the United States

Historical cost           5.4    6.1
Current cost              4.6    5.3
Market value              2.8    3.2

Note. The rates of return are calculated as follows: The numerator is direct investment receipt or payments, from the U.S. international transactions accounts. The denominator is the average of year-end figures for the current and previous year for the particular measure of the value of direct investment position shown. The positions for year-end 1997 are constructed by adding the recorded direct investment flows during 1997 to the recorded year-end positions for 1996.

For a discussion of the BEA's measure of "current cost" and "market value," see J. Steven Landefeld and Ann M. Lawson, "Valuation of the U.S. Net International Investment Position," Survey of Current Business, vol. 71 (May 1991), pp. 40-49.

Source. U.S. Department of Commerce, Bureau of Economic Analysis, U.S. international transactions accounts and U.S. international investment position.

As noted previously, the differential in rates of return between U.S. direct investment abroad and foreign direct investment in the United States has mitigated the effect of the negative U.S. net investment position on net investment income. Two important issues are whether these reported differentials are accurate and whether they are likely to persist. Numerous factors have probably contributed to the differential in reported rates of return. First, investments in many places overseas are more risky than investments in the United States, so some differential in rates of return should be expected. Moreover, many foreign investors who participated in the rapid increase in direct investment in the United States in the late 1980s had limited experience with foreign investments and made serious errors of judgment. Particularly ill-fated were Japanese investments in U.S. commercial real estate. In addition, both U.S. and foreign corporations may succeed in using transfer prices to shift reported profits to countries with lower tax rates despite efforts by the Internal Revenue Service to limit this practice.

Net Portfolio Investment Income

Portfolio investment income consists of dividends and interest paid on a wide range of claims and liabilities. Receipts and payments are estimated by the Bureau of Economic Analysis (BEA) of the Department of Commerce based on estimates of holdings, dividend-payout ratios, and interest rates. Net portfolio income fell sharply in 1997, largely because of growing U.S. net international indebtedness (table 9). Over the past decade, the decline of net income has closely mirrored the growth of the negative net portfolio investment position (chart 10).

[Chart 10 OMITTED]

Results of the Benchmark Survey of US. Ownership of Foreign Long-Term Securities

The data on net portfolio investment income were revised in 1997 to take into account the newly available results of the Treasury Department's Benchmark Survey of U.S. Ownership of Foreign Long-Term Securities. These results indicated that official statistics had been significantly underestimating U.S. portfolio holdings of foreign equities and debt instruments with maturities longer than one year. As a result, the US. net international investment position was correspondingly less negative, and U.S. investment income slightly larger, than previously indicated.

The survey was long overdue. The previous survey of U.S. holdings of foreign securities was conducted during World War II. The data on international capital flows that are gathered regularly by the Treasury International Capital (or TIC) Reports cover only purchases and sales of securities, not holdings. For the past fifty years, the BEA has had to rely on estimates of the value of U.S. holdings based on cumulative capital flows since World War II and estimates of changes in values. Estimates of holdings made by this method are likely to be increasingly inaccurate as time elapses.

The results of the recent survey indicate that, at the end of March 1994, U.S. residents held $304 billion in foreign bonds and $567 billion in foreign equities (table 12). Issuers from Canada and the other industrial countries accounted for most of the bonds held by U.S. residents. Holdings of bonds issued by developing countries were very small, except for those issued by four Latin American countries: Mexico, Argentina, Venezuela, and Brazil. About half of the long-term debt securities were denominated in U.S. dollars. Much smaller shares were accounted for by the yen, deutsche mark, and Canadian dollar, and the rest was spread across a wide variety of currencies. However, these results are of limited use in assessing the exchange rate exposure of U.S. investors because exposures may be hedged. Analysis of bond holdings by sector of issuer indicates that governments and international organizations constituted the largest category by far, accounting for more than 60 percent of the total. About one-third of reported holdings involved bonds issued by foreigners in the United States.

12. U.S. long-term securities, by country of issuer, March 31, 1994

                                     Bonds
   Country or area         Billions of
                           U.S. dollars     Percent

Total                         304             100

Canada                         68              23
Europe                        129              42
   United Kingdom              20               7

Latin America                  34              11
Caribbean                       8               3

Asia                           40              13
   Japan                       32              10
   Other Asia                   9               3

Australia                      10               3
Other                          14               4

                                    Equities
   Country or area         Billions of
                           U.S. dollars     Percent

Total                         567             100

Canada                         40               7
Europe                        270              48
   United Kingdom             100              18

Latin America                  57              10
Caribbean                      23               4

Asia                          151              27
   Japan                       99              18
   Other Asia                  51               9

Australia                      17               3
Other                           9               2

                                   All securities
   Country or area         Billions of
                           U.S. dollars     Percent

Total                         870             100

Canada                        108              12
Europe                        399              46
   United Kingdom             120              14

Latin America                  92              11
Caribbean                      31               4

Asia                          191              22
   Japan                      131              15
   Other Asia                  60               7

Australia                      27               3
Other                          23               3

Source. U.S. Department of the Treasury.

Industrial countries also accounted for the bulk of U.S. holdings of foreign equities. Two countries, the United Kingdom and Japan, together accounted for more than one-third of total U.S. holdings. However, holdings of equities issued by entities in developing economies were not negligible. Both Mexico and Hong Kong were among the top ten issuers. More than one-fourth of US. holdings was accounted for by American Depository Receipts (ADRs)--stocks that were specifically marketed to U.S. investors.

Comparison of the benchmark survey results for the end of March 1994 with the BEA's earlier end-of-year estimates for 1993 and 1994 indicate that the BEA had been underestimating U.S. holdings by substantial amounts (table 13). Possible explanations for these errors are numerous. First, TIC reporting of purchases and sales of securities may have contained errors and omissions. Over time, U.S. investors and their fund managers have increasingly transacted directly in foreign markets, thus bypassing the U.S. financial intermediaries that form the core of the TIC reporting system. To ensure adequate coverage, the TIC reporting system has had to continually expand its list of reporters, and at times, Treasury has been slow to do so. Even if the TIC Reports covered 95 percent of net purchases, the omitted investments would cumulate to substantial sums over an extended period.

13. U.S. holdings of foreign securities: Earlier BEA estimates and benchmark survey results, 1993-94 Billions of dollars

                         Earlier BEA estimates,     Benchmark
                               year-end            survey results,
      Item                                            end of
                           1993         1994        March 1994

All foreign securities      551          556            870

Bonds                       248          232            304
Equities                    303          324            567

Source. U.S. Department of Commerce and Department of the Treasury.

Second, the BEA's estimate of price changes may be inaccurate because the TIC Reports do not provide adequate information to identify with certainty the country of issue, currency, or term of the securities purchased. Moreover, the weights of various equities in U.S. portfolios may not mirror stock market price indexes that are readily available and used by the BEA.

The BEA raised its estimates of U.S. holdings of foreign securities at the end of 1994 more than $330 billion (about 60 percent) in light of the results of the benchmark survey. The BEA also revised its estimates of U.S. holdings from 1985 forward. The revisions to holdings of equities were much larger (both in dollar and percentage terms) than the revisions to holdings of bonds. Moreover, the benchmark survey results indicate that the BEA's methodology had produced large errors in the estimated distribution of bond holdings by country and currency. In particular, holdings of Japanese bonds were much larger than estimated, as were holdings of foreign-currency-denominated bonds.

Both the revision to the level of holdings and the change in composition had implications for the BEA's estimates of investment income for the period 1985 to the present. The BEA's revisions to investment income receipts in 1994 as a result of the benchmark survey amounted to an increase of about $10 billion. The revision to income was small relative to the revision to holdings for two reasons. First, the bulk of the revision in the estimated position involved estimated holdings of equities, and dividend-payout ratios for foreign stocks tend to be low. (Capital gains are excluded from investment income in these accounts.) Second, the survey indicated larger holdings of foreign-currency-denominated bonds than the BEA had previously estimated, particularly low-yielding, yen-denominated bonds.

The BEA made no revisions to the published data on capital flows as a result of the benchmark survey. The BEA could not determine whether the errors in the estimates of holdings were the result of unreported net purchases of foreign securities or errors in its estimates of valuation changes over the previous half a century; moreover, the BEA had no basis for determining the dates of unreported securities transactions.

CAPITAL ACCOUNT TRANSACTIONS

Foreign ownership of assets in the United States and U.S. ownership of assets abroad both rose significantly in 1997, an increase reflecting the continuing trend toward the globalization of financial markets as well as goods markets. Direct investment flows (both inward and outward) and private purchases of U.S. securities were particularly strong. Evidence of the gathering financial storm in Asia was apparent in U.S. capital flows mainly during the last quarter.

In 1997, in contrast to earlier years, increases in foreign official holdings in the United States did not play a major role in the capital flows that are the counterpart to the current account deficit (table 14). Foreign official assets in the United States rose $45 billion in the first three quarters of 1997, below the pace for 1996; the increases were concentrated in the assets of certain industrial countries and members of OPEC. In the fourth quarter, foreign official assets declined sharply; the declines were concentrated in assets of Asian countries and of several developing countries outside Asia that were experiencing exchange market pressures. For the year as a whole, foreign official holdings in the United States rose only $18 billion.

14. Composition of U.S. capital flows, 1993-97 Billions of dollars

      Item                          1993     1994     1995     1996

Current account balance              -91     -134     -129     -148

Official capital, net                 70       45      100      128
   Foreign official assets in
   the United States                  72       40      111      122
   U.S. official reserve assets       -1        5      -10        7
   Other U.S. government assets        0        0       -1       -1

Private capital, net                  15       91       44       67
   Net inflows reported by U.S.
   banking offices                    56      100      -45      -88
   Securities transactions, net      -44       31       95      181
     Private foreign net purchases
     of U.S. securities              102       91      196      290
       Treasury securities            24       34      100      156
       Corporate and other bonds      59       54       82      121
       Corporate stocks               19        3       14       13
     U.S. net purchases of foreign
     securities                     -146      -60     -100     -108
       Stocks                        -63      -48      -50      -59
       Bonds                         -83      -12      -50      -49
   Direct investment, net            -27      -24      -19      -11
     Foreign direct investment in
     the United States                49       46       68       77
     U.S. direct investment abroad   -76      -69      -87      -88
   Foreign holdings of U.S.
   currency                           19       23       12       17
   Other                              11      -39        0      -32

Statistical discrepancy                6       -3      -15      -47

      Item                          1997        Change,
                                             1996 to 1997

Current account balance             -166         -18

Official capital, net                 17        -111
   Foreign official assets in
   the United States                  18        -104
   U.S. official reserve assets       -1          -8
   Other U.S. government assets        0           1

Private capital, net                 246         179
   Net inflows reported by U.S.
   banking offices                    -9          79
   Securities transactions, net      273          92
     Private foreign net purchases
     of U.S. securities              352          62
       Treasury securities           163           7
       Corporate and other bonds     122           1
       Corporate stocks               67          54
     U.S. net purchases of foreign
     securities                      -79          29
       Stocks                        -38          21
       Bonds                         -41           8
   Direct investment, net            -12          -1
     Foreign direct investment in
     the United States               108          31
     U.S. direct investment abroad  -119         -31
   Foreign holdings of U.S.
   currency                           25           7
   Other                             -32           0

Statistical discrepancy              -97         -50

Source. U.S. Department of Commerce, Bureau of Economic Analysis, U.S. international transactions accounts.

In contrast, increases in the assets of other foreigners in the United States in 1997 about equaled or surpassed previous records. Net purchases of U.S. stocks were particularly strong--a record $67 billion. Net purchases of U.S. Treasury bonds by private foreigners remained robust; more than $30 billion of U.S. Treasury securities were purchased in October alone, when developments in Asia led to a flight to quality. As the end of the year approached, however, some foreign private holdings of U.S. Treasury securities were liquidated. In addition, foreign direct investment in the United States amounted to a new high of $108 billion, as the strong pace of mergers and acquisitions across national borders continued.

U.S. direct investment abroad in 1997 also reached a record net outflow--$119 billion. U.S. net purchases of foreign securities in the first three quarters were $76 billion, a little below the pace for 1996; however, net purchases fell sharply in the fourth quarter, probably in reaction to the perceptions of higher risk arising from financial turmoil in Asia. Banks in the United States reported a large increase in net claims on foreigners in the first three quarters of the year, but these outflows were largely reversed toward the end of the year.

With net recorded capital inflows to the United States exceeding the large U.S. current account deficit in 1997, the U.S. international accounts recorded a large negative statistical discrepancy for the second year in a row (table 14). This negative discrepancy indicates that net payments in the current account or net outflows in the capital account have been unrecorded. For example, illegal drug imports would contribute to a negative discrepancy, as would unrecorded investments abroad by U.S. residents or overstated capital inflows. Although the statistical discrepancy in the U.S. accounts tended to be positive in the years before 1990, large negative discrepancies have become more common since then for reasons that are not well understood.

PROSPECTS FOR 1998

The fallout from the Asian crises is likely to have further consequences for U.S. international transactions in 1998. Until the economies of the countries directly affected begin to rebound, U.S. transactions with them, including exports of goods and services and the profits of direct investors, are likely to be depressed. The negative ramifications of the Asian crises for other trading partners may depress their demand for U.S. exports as well. The recent appreciation of the dollar and the associated loss in competitiveness of U.S. goods and services is also likely to continue to have a negative effect on the U.S. trade balance in 1998. On the other hand, continued strong growth in Latin America, Canada, and Western Europe, which account for the bulk of U.S. exports and direct investment, would tend to counteract the negative repercussions of Asian developments.

(1.) An investment is considered direct if a single owner acquires 10 percent or more of the voting equity in a company. All other U.S. claims on foreigners or foreign claims on the United States are included in the other category--portfolio investment.