Understanding the Net International Investment Position

As the U.S. makes increasing use of tariffs in its trade policy, it is useful to consider how such measures might relate to the country’s external balance—typically reflected in the current account, which captures the net flow of goods, services, income and transfers between the U.S. and the rest of the world. One useful framework for this discussion is the net international investment position (NIIP), which measures the difference between U.S.-owned foreign assets and foreign-owned U.S. assets.

While the NIIP is often linked to cumulative trade imbalances, recent research points to a growing role for valuation effects—driven by asset price movements and exchange rates—in shaping the NIPP’s trajectory. Understanding these components can help clarify the channels through which trade policy, including tariffs, might affect the U.S. external position.

NIIP Accounting Framework

The U.S. NIIP has become more negative over the past two decades, reaching –88% of gross domestic product (GDP) by the fourth quarter of 2024. While this trend may suggest ongoing external borrowing, recent studies highlight that the underlying drivers are more nuanced.

A useful starting point is the accounting identity for the NIIP, which shows the change in NIIP from t-1 to t.

NIIPₜ - NIIPₜ₋₁ = CAₜ + ΔVAₜ + RESₜ

where CAₜ is the current account balance, ΔVAₜ captures valuation changes (due to asset price movements and exchange rates) and RESₜ is a residual term. This decomposition shows that the NIIP can evolve due to financial market dynamics as well as underlying trade flows.When a consumer purchases an imported good, such as a South Korean-made washing machine, this transaction is recorded as an import, contributing negatively to the current account. Since the balance of payments must always equal zero, a deficit in the current account is necessarily matched by a surplus in the financial account—implying that domestic assets (such as stocks, bonds or loans) are being sold to foreign investors. This means the current account deficit is effectively financed by foreign investors acquiring claims on domestic assets, increasing the economy’s external liabilities and thus making the net international investment position more negative.

In 2007, work by Philip R. Lane and Gian Maria Milesi-Ferretti and Pierre-Olivier Gourinchas and Hélène Rey emphasized that valuation changes—arising from exchange rate fluctuations and asset price movements—can significantly affect the NIIP independently of trade balances. Historically, these valuation effects often worked to the U.S.’s advantage because of the dollar’s unique status as the predominant international reserve currency (often described as the country’s “exorbitant privilege”).

For example, a weakening dollar and relatively strong returns on U.S. foreign investments have helped mitigate the buildup of external liabilities, as seen during most of the first decade in this century.

How does this work? Because global financial markets heavily rely on dollars, foreign investors are typically willing to hold dollar-denominated assets. When the dollar weakens, the value of U.S. foreign investments (denominated in other currencies) increases in dollar terms, boosting U.S. foreign asset valuations. Simultaneously, U.S. liabilities (largely denominated in dollars) remain unchanged in value from the perspective of U.S. borrowers’.

On top of all that, U.S. foreign investments historically yielded higher returns compared to what foreigners earned on their investments in the U.S. The combination of these two factors—exchange rate-driven valuation gains and superior returns—is what allowed the U.S. to partly offset its persistent trade deficits and moderate the deterioration of its NIIP.

Recent research suggests that this dynamic has shifted. In a 2023 working paper, Andrew Atkeson, Jonathan Heathcote and Fabrizio Perri documented that between 2007 and 2021, the U.S. NIIP declined by more than 60 percentage points of GDP, despite a narrowing current account deficit. Much of this change reflects valuation effects, particularly the rising value of U.S. equity markets—assets in which foreign investors hold substantial positions—while U.S.-owned foreign assets did not see equivalent gains. These findings are consistent with the broader observation by Gourinchas and Rey in 2007 that valuation effects account for roughly one-third of U.S. external adjustment over time.

Trade Policy and the Current Account

The current account (CAₜ) itself can be expressed as:

CAₜ = Exportsₜ − Importsₜ + Net Incomeₜ + Transfersₜ

Tariffs can influence this identity by affecting import demand or export competitiveness. In practice, however, studies such as the 2020 working paper by Pablo Fajgelbaum and others found that 2018 U.S. tariffs had limited impact on the trade balance, which was due in part to retaliation, supply chain adjustments and exchange rate movements.

Moreover, macroeconomic fundamentals place important constraints on the effectiveness of trade policy. The current account reflects the difference between national saving and investment, suggesting that durable improvements typically require shifts in underlying fiscal or private sector behavior. In addition, potential gains from tariffs may be offset by exchange rate movements. As Maurice Obstfeld and Kenneth Rogoff argued in a 2005 paper, narrowing a large current account deficit often requires a substantial depreciation of the real exchange rate—on the order of 20% to 30%—particularly when other countries do not allow their currencies to appreciate.The real exchange rate refers to the relative price of domestic goods compared with the price of foreign goods, adjusted for differences in price levels or inflation. This differs from the nominal exchange rate, which is simply the market price at which one currency is traded for another. Even if foreign governments intervene to prevent their currencies from appreciating in nominal terms against the dollar (e.g., accumulating dollar reserves), the U.S. dollar can still experience a real depreciation. This happens through adjustments in relative prices: Domestic inflation could be lower than abroad, or domestic wages and prices might rise more slowly compared with those in foreign countries. That is, the real depreciation needed to correct a large U.S. current account deficit can happen through relative price changes, not just movements in nominal exchange rates. They also cautioned that the U.S. historical advantage in financing deficits—given the dollar’s role as an international reserve currency—cannot eliminate the need for eventual adjustment.

Where the U.S. Is, and What Comes Next

In the past, the NIIP generally reflected the accumulated liabilities from past current account deficits. Yet as I noted earlier, valuation effects—such as changes in equity prices or exchange rates—have increasingly shaped the NIIP. If the valuation effects remain influential, short-term shifts in trade flows may not be enough to significantly alter the longer-term trajectory in the NIIP. However, the relative importance of these forces going forward remains uncertain.

Exchange rate movements could play a role in shaping the NIIP, particularly if changes in the value of the dollar affect the valuation of U.S. foreign assets and liabilities. While a depreciation of the dollar could improve the NIIP mechanically, the extent and durability of such effects would depend on global investor behavior and relative asset performance, which are difficult to predict.

In this context, strengthening the U.S. external position may involve a combination of factors. Policies that contribute to higher national saving, support investment in tradable sectors, or reduce sensitivity to valuation shocks could be helpful in some scenarios. At the same time, the outlook for the NIIP will also depend on broader global economic conditions and financial market developments, which introduce an additional layer of uncertainty.

Notes

1. When a consumer purchases an imported good, such as a South Korean-made washing machine, this transaction is recorded as an import, contributing negatively to the current account. Since the balance of payments must always equal zero, a deficit in the current account is necessarily matched by a surplus in the financial account—implying that domestic assets (such as stocks, bonds or loans) are being sold to foreign investors. This means the current account deficit is effectively financed by foreign investors acquiring claims on domestic assets, increasing the economy’s external liabilities and thus making the net international investment position more negative.
2. The real exchange rate refers to the relative price of domestic goods compared with the price of foreign goods, adjusted for differences in price levels or inflation. This differs from the nominal exchange rate, which is simply the market price at which one currency is traded for another. Even if foreign governments intervene to prevent their currencies from appreciating in nominal terms against the dollar (e.g., accumulating dollar reserves), the U.S. dollar can still experience a real depreciation. This happens through adjustments in relative prices: Domestic inflation could be lower than abroad, or domestic wages and prices might rise more slowly compared with those in foreign countries. That is, the real depreciation needed to correct a large U.S. current account deficit can happen through relative price changes, not just movements in nominal exchange rates.