Flow of Funds Washes Out Pessimists

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The U.S. reported third-quarter flow of funds Dec. 7. There are several points in the report that illustrate larger developments, but the key takeaway is that contrary to the take from the doom-and-gloom camp (one member, the economics editor of the Financial Times, sees the U.S. as being "comfortably on the road to ruin"), American prosperity continues unabated.

First, the flow of funds report shows that household net wealth in the U.S. rose by about $800 billion in the third quarter. To put this in perspective, it's roughly Canada's GDP; that is, U.S. household net worth increased by about the value of all the goods and services the Canadian economy produces in a year.

This is not a poke at Canada, a G7 economy. It's a way to point out that despite falling house prices and the current account deficit, which some pundits say is making the U.S. poorer, household net worth in the U.S. has never been higher.

This is also a timely reminder that stock terms, such as "household net worth," may be more important than flow terms. For example, even as the current account deficit is rising as a percentage of GDP, what is viewed from a stock perspective as a "net international investment position" has fallen in recent years as a percentage of GDP -- though there has been deterioration in Europe, and especially the U.K. Preliminary figures seem to suggest that the U.S. net international investment position is likely to have fallen this year as a fraction of GDP.

Another important takeaway from the flow of funds report is the still-unsated foreign appetite for U.S. securities. In dollar terms, foreign investors increased their debt holdings by $190.3 billion and equity holdings by $115.9 billion in the third quarter.

Of course, some will argue that when the U.S. current account deficit is increasing, foreigners by definition will buy more U.S. assets. However, the $300 billion foreigners bought in the third quarter is much larger than the U.S. current account deficit, and the prices foreigners paid do not appear lower but rather higher because the U.S. equity and bond markets advanced. The dollar was only slightly weaker in the third quarter. Last year, foreign investors bought $1.21 trillion of U.S. assets; the pace in the third quarter was similar.