International Investments and Current Account Imbalances: The Importance of Valuation Changes

The German Institute for Economic Research (DIW) has published a short round-up that I have written with Guido Baldi and Thore Schlaack. The round-up is available here. In the round-up we summarise the literature on international current account balances and international investments with a specific focus on Germany:

Global capital flows have strongly increased from the 1980s until the outbreak of the financial crisis. As a result of this development, Germany’s foreign investment has risen to around 250 percent of gross domestic product while foreign investments in Germany have increased to about 200 percent of Germany’s gross domestic product. This positive difference between Germany’s assets and liabilities is a result of the country’s continuous current account surpluses, which represent net financial flows – the difference between outflows and inflows. Investments abroad offer investors the opportunity to diversify their savings and possibly generate higher returns than in Germany. In return, however, foreign investment also entails risks; fluctuations in price and exchange rates can lead to high losses. Potential value fluctuations on international investments are relevant for Germany. German policy advisors controversially discuss whether additional investment in domestic infrastructure or research and development would yield higher and less volatile returns than some of Germany’s foreign investments.

In conclusion, we write that:

Against the backdrop of the sharp rise in foreign investment over the last forty years, valuation changes have become increasingly important for net foreign assets. Even if the global capital flows developed less dynamically since the financial crisis, the high foreign assets and liabilities are likely to persist in the future. Discussions about current account balances should, therefore, be conducted by taking into account the high levels of international investment positions and the associated valuation changes, which are potentially large. Against the backdrop of these value changes on foreign assets and liabilities, a discussion is being held in Germany as to whether additional investments - for example in domestic infrastructure or in research and development - could generate higher and less volatile returns than some of Germany’s foreign investments.