Why do Foreigners Invest in the United States?

Why do Foreigners Invest in the United States?
Kristin J. Forbes

Abstract: Why are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less developed financial markets. The magnitude of this effect decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and foreign investors “chase returns” in their purchases of U.S. equities (although not bonds). The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances.

Assorted on Capital Controls

Have capital controls helped or hindered Asian financial markets?

There are volumes of academic research on this topic, which one can find easily online, and much of the academic literature on capital controls concludes that capital controls are indeed generally bad for financial market development. To summarize, this research finds that despite the possibility for short-run volatility in financial markets after liberalization (i.e., elimination of capital controls), in the long-run such liberalization results in larger, more stable financial markets with greater liquidity.

However, looking across the horizon at Asia, where most countries have some form of capital controls, it’s difficult to draw the conclusion that capital controls have hindered the (recent) development of the financial markets. Such a broad conclusion would be supported by the school of thought that supports the use of capital controls. In Asia, Malaysia is held up as the example (pdf) to show that the controls the country put into place in 1998 in the aftermath of the Asian financial crisis helped to produce faster economic recovery and turn around of the stock market as compared to other countries in the region (i.e., Thailand and Korea) that did not impose controls. Of course, there are also counter-arguments to this conclusion with some (pdf) research pointing to strong fundamentals in Malaysia being the driving recovery factor.

So, after all of the years of experience and reams of paper used in the research of topic of capital controls, what can policy makers across Asia make of all of this in terms of financial sector development policy? Are there any specific lessons that can be applied across countries in Asia or is issue this simply too complex to be dealt with on a regional or multilateral basis?

Managing Capital Flows: Search for a Model - High-Level Conference


Managing Capital Flows: The Case of Thailand

Managing Large Capital Inflows: Taking Stock of International Experiences

Managing Capital Flows: The Case of Malaysia

Managing Capital Flows: The Case of the People’s Republic of China

Managing Recent Hot Money Inflows in Asia

NIPFP-DEA Program on Capital Flows- (India)

Nonsensical arguments against capital controls

We must curb international flows of capital

Futility of capital controls?

Capital Controls In Argentina -- On Inflows!

Capital controls impeding trade

Collateral Damage: Exchange Controls and International Trade

Reaping the Benefits of Financial Globalization

China, Asia, and the New World Economy- Book recommendation

China, Asia, and the New World Economy
Edited by Barry Eichengreen, Yung Chul Park, and Charles Wyplosz

China and Global Issues
1. China's Coming Demand for Energy , Richard N. Cooper
2. China and the Global Environment , Warwick J. McKibbin

Trade Issues
3. The Spoke Trap: Hub and Spoke Bilateralism in East Asia , Richard E. Baldwin
4. Proliferation of FTAs and Prospects for Trade Liberalization in East Asia , Yung Chul Park and Inkyo Cheong
5. Containing the PTA Wildfire , Cédric Dupont and David Huang
6. China and the Multilateral Trading System , Robert Z. Lawrence

Financial Issues
7. Regional and Global Financial Integration in East Asia , Soyoung Kim, Jong-Wha Lee and Kwanho Shin
8. The Main Determinants of Liquidity in the Thai Bond Market , Akkharaphol Chabchitchaidol and Sakkapop Panyanukul
9. Is East Asia Safe from Financial Crises? , Charles Wyplosz

Chinese Macroeconomic Management
10. Chinese Macroeconomic Management: Issues and Prospects , Yu Yondgding
11. The Chinese Approach to Capital Inflows: Patterns and Possible Explanations , Eswar Prasad and Shang-Jin Wei
12. Do China's Capital Controls Still Bind? , Guonan Ma and Robert N. McCauley
13. Impact of Financial Services Trade Liberalisation on Capital Flows: The Case of China's Banking Sector , Li-Gang Liu and Elvira Kurmanalieva
14. Why Does China Save So Much ? , Charles Y. Horioka and Junmin Wan

Assorted on Capital Flows, etc

International Financial Integration through the Law of One Price: The Role of Liquidity and Capital Controls

Managing Capital Flows: The Case of Indonesia

Managing Capital Flows: The Case of Malaysia

Managing Capital Flows: The Case of the Philippines

Nonsensical arguments against capital controls

On global cash flows issue you can jump in without drowning

Reaping the Benefits of Financial Globalization

Cost of India’s Burgeoning Foreign Exchange Reserves: What to Do With So Many Reserves?

Looking at some of the domestic and external economic indicators, India seems to have come a long way since the 1991 balance of payment crisis. The liberalization process started in the 1980s giving an impetus to exports and oil imports. This lead to trade and current account deficits which were mainly financed by high-cost short-term external commercial loans. Medium and long-term external commercial loans also rose. By 1990, the debt-service ratio rose to 35.3% while the ratios of short-term debt to forex reserves and debt to current receipts reached highs of 382.1% and 328.9%. In 1991, political instability at home and a global oil price spike led to further deterioration in the trade and current account deficits, falling to -3% and -3.1% of GDP, even as export growth and remittances declined. Downgraded credit ratings harmed investor sentiment as short-term investors and Non-Resident Indians (NRI) withdrew money from the country and foreign banks were reluctant to roll-over debt. Trying to defend the currency, the Reserve Bank of India’s (RBI) foreign currency assets fell from $3.1 bn in August 1990 to $975 mn in July 1991, inadequate to fund even three weeks of imports. Economic growth and industrial output slowed and inflation surged. India pledged gold to the Bank of England to finance its imports and also sought bilateral and IMF assistance to repay its debt to avoid rescheduling.

However, the crisis paved way for further liberalization of the economy and since then trade, foreign investment and exchange rate reforms have been undertaken. Post-2002, booming economic growth, domestic investment activity, eased restrictions on capital flows and interest rate differentials have led to a rise in FDI, portfolio investment, NRI deposits and external commercial borrowings (ECBs) by domestic firms, leading to a surplus on capital account. However, the country runs trade and current account deficits due to oil and non-oil imports, not withstanding the growth in exports (esp. in services) and remittances. Apart from the surge in these capital inflows, RBI has been resistant to exchange rate appreciation to protect exports, though India is a domestic demand driven economy, and structural factors more than currency value constrain export growth. This has resulted in the rapid growth in forex reserves from a mere $5.8 bn in 1991 (Fiscal Year in India is from April-March) to $76 bn in 2002, $141 bn in 2004, $199 bn in 2006 to close to $290 bn by Feb 2008. Foreign investment followed by External Commercial Borrowings by domestic firms have accounted for this rise in forex reserves.

Are Capital Controls in the Foreign Exchange Market Effective?

Thaksin, Capital Controls, and the Reserve Bank

Has the strategy of bringing back capital controls worked?

Foreign Direct Investment in South Asia

A recent publication from ADB- South Asia Economic Report-Foreign Direct Investment in South Asia

Managing Capital Flows in Korea

Managing Capital Flows: The Case of the Republic of Korea

The Republic of Korea has recently experienced: (i) large capital inflows, in particular a surge in portfolio inflows, and (ii) an appreciation of asset prices, including stock prices, land prices, and nominal and real exchange rates. We first document the recent trend in capital inflows and asset prices in Korea, and review how a surge in capital inflows can increase asset prices. Then, we empirically investigate the effects of capital inflows on asset prices using a VAR model. The empirical results suggest that capital inflows shocks increased the stock prices but not land prices. The effects on the nominal and real exchange rates are limited, and this is related to the accumulation of foreign exchange reserves. A catch-all solution to the problems that capital inflows present does not seem to exist. Therefore, the most should be made of the available instruments at hand.