ORIGINAL SIN AND DARK MATTER (STILL) MATTER: ASSET COMPOSITION AND SOLVENCY Ricardo Hausmann Harvard University & Santa Fe Institute Why do we care about deficits? • Because deficits determine the evolution of net financial assets • Surplus = ΔNet Financial Assets = ΔNFA • Financial income is a function of financial assets and liabilities • Fin.Income= i * NFA • The higher the debt, the higher the primary surplus needed to be solvent • Steady State Primary Surplus = (i - g) d • Where g is the nominal growth rate and d is the debt to GDP ratio • This is true both for fiscal dynamics as well as balance of payments dynamics For example, let us look at Japan Japan accumulated US$3TinCASand increased itsFin. IncomeinUS$B140 Cumulative Current Account, Billions 0 1000 2000 3000 1980 1990 Investment Income Net, Billions USD Cumulative Current Account, Billions year 2000 2010 0 50 100 150 Investment Income Net, Billions USD CAS and2.5%in netfinancialincome Japan accumulated ~50%ofGDPin Cumulative Current Account, % of GDP 0 .2 .4 .6 1980 Investment Income Net, % of GDP %of Net, Income Investment Cumulative Current Account, % ofGDP 1990 year 2000 2010 0 .01 .02 .03 Investment Income Net, % of GDP Japan: implied interest rate is reasonable .07 .06 Implied interest rate interest Implied .05 .04 1990 1995 2000 2005 2010 year But many countries do not look like Japan Let us look at the US but itsfin.income wentupbyUS$130B The USaccumulated US$8TinCAD, Cumulative Current Account, Billions -8000 -6000 -4000 -2000 0 1980 1990 Investment Income Net, Billions USD Cumulative Current Account, Billions year 2000 2010 0 50 100 150 200 Investment Income Net, Billions USD Financial income increased1%ofGDP The cumulative CADis50%ofGDP Cumulative Current Account, % of GDP -.5 -.4 -.3 -.2 -.1 0 1980 Investment Income Net, % of GDP %of Net, Income Investment Cumulative Current Account, % ofGDP 1990 year 2000 2010 0 .005 .01 .015 Investment Income Net, % of GDP The US pays a negative interest rate on its net financial position .02 .01 0 Implied interest rate interest Implied -.01 -.02 1990 1995 2000 2005 2010 year One accounting approach • Consider that all assets pay a benchmark rate – Say 5% • If you can invest and obtain a higher return, it is as if you own an asset that pays also pays 5% and that represents the difference • If you pay more than 5%, it is as if you borrowed a larger debt that also pays 5% but that represents the same interest payment • We call this asset “dark matter” – Hausmann and Sturzenegger (2006) (2007) US dark matter is 80 percent of GDP .8 .6 .4 .2 Cumulative Dark Matter, % of GDP GDP of % Dark Matter, Cumulative 0 1980 1990 2000 2010 year Japan’s dark matter is insignificant .1 .05 0 -.05 Cumulative Dark Matter, % of GDP GDP of % Dark Matter, Cumulative -.1 1980 1990 2000 2010 year How can the US do this? • Say the US borrowed US$ 8 trillion net • …but in fact it borrowed US$ 20 trillion gross • Say it pays 3% on its gross debt – US$ 600 billion • It uses the extra US$ 12 trillion to invest abroad • Say the return is 7% – US$ 840 billion • Net financial income would go up by US$ 240 billion Why don’t we all do this? • We can all ask Goldman Sachs or JP Morgan to manage our money • But US investments abroad are mostly FDI • They include productive knowledge • The apparent financial return incorporates payment for the use of productive knowledge • When China buys US treasuries, it does not add any knowledge to the investment • Differential returns are an equilibrium phenomenon • If some countries get excess returns, others pay excess returns (they must add to zero worldwide) Cumulative Current Account, Billions 0 500 1000 1500 2000 1980 Interest income atUS$20B China’s CADat US$2T 1990 Investment Income Net, Billions USD Cumulative Current Account, Billions year 2000 2010 -20 -10 0 10 20 Investment Income Net, Billions USD Cumulative Current Account, % of GDP -.1 0 .1 .2 .3 Interest income at0%ofGDP 1980 China’s CADat 30%ofGDP Investment Income Net, % of GDP %of Net, Income Investment Cumulative Current Account, % ofGDP 1990 year 2000 2010 -.015 -.01 -.005 0 .005 Investment Income Net, % of GDP China’s implied interest rate is negligible 0 -.2 -.4 -.6 Implied interest rate interest Implied -.8 -1 1990 1995 2000 2005 2010 year China imports dark matter to the tune of 30% of GDP .1 0 -.1 -.2 -.3 Cumulative Dark Matter, % of GDP GDP of % Dark Matter, Cumulative -.4 1980 1990 2000 2010 year Interpretation • China is running current account surpluses • But it has large FDI inflows – With their embedded knowledge • …and it is buying a lot of international securities – With their normal returns Chile Chile accumulated aCADofUS$15B, but paysasimilar amountdividends Cumulative Current Account, Billions -40 -30 -20 -10 0 1980 1990 Investment Income Net, Billions USD Cumulative Current Account, Billions year 2000 2010 -20 -15 -10 -5 0 Investment Income Net, Billions USD Chile’s CADissmallbutitpays 8%in “debt service” (160%ofGDP at 5%) Cumulative Current Account, % of GDP -.8 -.6 -.4 -.2 0 1980 Investment Income Net, % of GDP %of Net, Income Investment Cumulative Current Account, % ofGDP 1990 year 2000 2010 -.12 -.1 -.08 -.06 -.04 -.02 Investment Income Net, % of GDP Chile’s implied interest rate is almost 80% of the cumulative CAD .8 .6 .4 Implied interest rate interest Implied .2 0 1990 1995 2000 2005 2010 year Chile’s dark matter amounts to 150% of GDP 0 -.5 -1 -1.5 -2 Cumulative Dark Matter, % of GDP GDP of % Dark Matter, Cumulative -2.5 1980 1990 2000 2010 year Interpretation • Chile has received significant FDI in mining and elsewhere • Good times have dramatically increased the returns on those investments • But the assets that Chile has invested abroad pay much less • The difference is equivalent to a very large external debt Colombia Colombia’s cum. CADatUS$60B Cumulative Current Account, Billions Interest payments atUS$12B -80 -60 -40 -20 0 1980 1990 Investment Income Net, Billions USD Cumulative Current Account, Billions year 2000 2010 -15 -10 -5 0 Investment Income Net, Billions USD Interest payments at3.5%ofGDP Colombia’s CADisat20%ofGDP Cumulative Current Account, % of GDP -.4 -.3 -.2 -.1 0 1980 (not 1percent at 5%) Investment Income Net, % of GDP % of Net, Income Investment Cumulative Current Account, % ofGDP 1990 year 2000 2010 -.06 -.05 -.04 -.03 -.02 -.01 Investment Income Net, % of GDP Colombia’s implied interest rates at ~20 percent .2 .15 .1 Implied interest rate interest Implied .05 0 1990 1995 2000 2005 2010 year Peru Peru accumulated CADofUS$40B Cumulative Current Account, Billions -40 -30 -20 -10 0 Interest payments atUS$10B 1980 1990 Investment Income Net, Billions USD Cumulative Current Account, Billions year 2000 2010 -10 -8 -6 -4 -2 0 Investment Income Net, Billions USD Peru’s CADat~30 percentofGDP Cumulative Current Account, % of GDP -.8 -.6 -.4 -.2 0 1980 Interest payments at6% Investment Income Net, % of GDP %of Net, Income Investment Cumulative Current Account, % ofGDP 1990 year 2000 2010 -.12 -.1 -.08 -.06 -.04 -.02 Investment Income Net, % of GDP Peru’s implied interest rate at 20% .2 .15 .1 Implied interest rate interest Implied .05 0 1990 1995 2000 2005 2010 year Peru’s dark matter is at ~100% of GDP .5 0 -.5 -1 Cumulative Dark Matter, % of GDP GDP of % Dark Matter, Cumulative -1.5 1980 1990 2000 2010 year Mexico Cumulative Current Account, Billions Interest payments atUS$18B -300 -200 -100 0 1980 Mexico’s CAD at US$270B 1990 Investment Income Net, Billions USD Cumulative Current Account, Billions year 2000 2010 -20 -15 -10 -5 Investment Income Net, Billions USD Interest payments atlessthan2% Cumulative Current Account, % of GDP -.4 -.3 -.2 -.1 0 Mexico’s CADat 25%ofGDP 1980 Investment Income Net, % of GDP %of Net, Income Investment Cumulative Current Account, % ofGDP 1990 year 2000 2010 -.08 -.06 -.04 -.02 0 Investment Income Net, % of GDP Mexico’s implied interest rate is reasonable .05 0 Implied interest rate interest Implied -.05 -.1 1990 1995 2000 2005 2010 year Mexico does not have much dark matter debt .2 0 -.2 -.4 -.6 Cumulative Dark Matter, % of GDP GDP of % Dark Matter, Cumulative -.8 1980 1990 2000 2010 year Brazil Cumulative Current Account, Billions Interest payments at~US$40B -300 -200 -100 0 1980 Brazil’s CADat ~US$280B 1990 Investment Income Net, Billions USD Cumulative Current Account, Billions year 2000 2010 -40 -30 -20 -10 Investment Income Net, Billions USD Cumulative Current Account, % of GDP Interest payments at2%ofGDP -.4 -.3 -.2 -.1 0 Brazil’s CADis at ~10%ofGDP 1980 Investment Income Net, % of GDP %of Net, Income Investment Cumulative Current Account, % ofGDP 1990 year 2000 2010 -.06 -.05 -.04 -.03 -.02 -.01 Investment Income Net, % of GDP Brazil’s implied interest at ~15% .2 .15 .1 .05 Implied interest rate interest Implied 0 -.05 1990 1995 2000 2005 2010 year Brazil’s dark matter at ~20% of GDP -.1 -.2 -.3 -.4 -.5 Cumulative Dark Matter, % of GDP GDP of % Dark Matter, Cumulative -.6 1980 1990 2000 2010 year IMPLIED INTEREST RATES - 2010 ImpliedImplied interestinterest raterate 20102010 (Investment income > 0) .6 FRA .4 .2 DNK CHE Implied interest rate interest Implied JPNDEUFINSWE CHN KOR HKG NLD NOR 0 JOR LBN BELUSA GBR MUS -.2 3.5 4 4.5 5 GDP per capita, logs ImpliedImplied interestinterest raterate (Investment income < 0) .8 CHL IRL .6 .4 ISR CZE PER .2 COL URY ARGBRA TUN PAN POLHRVESTSVK SVN EMU Implied interest rate interest Implied HUN MKD ZAFBLR SLV ALB BGR LTU PRT GRC ESPITA JAMBIH CRI ROMMEXTUR LVA 0 SRB VEN AUT RUS AZE NAM -.2 3.6 3.8 4 4.2 4.4 4.6 GDP per capita,