America risks financial credibility with payments deficit obsession

The writer is the Gregory and Ania Coffey professor of economics at Harvard University and formerly first deputy managing director and chief economist of the IMF

In February, President Donald Trump announced he was placing a new global tariff on US imports to “address fundamental international payments problems” and “stem the outflow” of American dollars to foreign producers. But despite warnings from the White House about a “large and serious balance of payments deficit”, global markets remained sanguine.

If it was not already obvious that there remains plenty of faith in the US’s ability to make its international payments, the events of the past week or so have made it abundantly clear.

The outbreak of the war in Iran and the risk of a broader conflict were accompanied by a stronger dollar and outperformance of the US stock market relative to other big competitors. The strength of its economy and institutions continues to make the US a highly desirable destination for capital in a risky world. There is no imminent payment threat that can be used to justify blanket tariffs for 150 days.

It is a fact that the US net international investment position, or NIIP, has deteriorated sharply in recent years. In the announcement declaring the imposition of tariffs under Section 122 of the Trade Act, the administration pointed to international liabilities exceeding international assets by $26tn in 2024 (which was 89 per cent of 2024 GDP) and stated that this “represents the most negative net international investment position of any country on Earth”.

It is important, however, to look a bit deeper here. The recent deterioration in the NIIP has little to do with persistent trade deficits and current account deficits, as claimed. Rather, it is a consequence of the much stronger gains in market value of US equities relative to foreign equities alongside a dollar appreciation over the past decade. Based solely on the US current account, the NIIP would be around a negative 50 per cent of GDP in 2024, only a few percentage points higher than in 2015. It is the differences in market valuation that get you close to 90 per cent.

The US used to be described as the banker to the world. Its international liabilities were mainly liquid low-return Treasuries, while its assets were more illiquid higher-earning assets through foreign direct investment.

That is no longer the case. US liabilities now include a large foreign holding of US equities, which is why valuation changes can have large effects on the NIIP.

This shift, along with the better performance of US equities over the past decade, explains why the income earned by foreign residents has exceeded that received from assets owned abroad (according to the Trump administration, for the first time).

The US is not immune to capital flow reversals simply because its liabilities are increasingly equity-denominated. But the nature of the stress is fundamentally different from a sovereign payments crisis. It looks like a market correction, not an inability to roll over obligations or service debts.

The notion, often cited as justification for the imposition of tariffs, that countries running large trade surpluses with the US are also responsible for buying up US assets is incorrect as well. Between 2015 and 2024, China had the largest trade surpluses with the US, yet this was the decade when China increasingly invested away from America. It was the small surplus countries in Europe and Japan that have been buying up US assets.

This is not to say that persistent US trade deficits and a large negative international investment position are never a problem. But the fix is not blanket tariffs. Lower US trade deficits will require two things: bringing fiscal deficits, currently projected at more than 6 per cent of GDP for the foreseeable future, back to more sustainable levels, and a serious pivot by China towards consumption-led growth. Neither is impossible. In Washington, the case for fiscal repair is gaining ground, while in Beijing, the language of “investing in people” is becoming more prominent.

The privileged position of US markets was built over decades. The dynamism of the US economy, the strength of its institutions, including central bank independence, the upholding of contracts and reliable policies have all been critical to cementing this privilege. Many more of these arbitrary tariffs that disrupt trade relationships, including with allies, threats to colonise friendly nations and attempts to impair central bank independence will only jeopardise this privilege. The payments deficit, in short, isn’t a problem — but the proposed cure might just create one.