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autonomous movement of capital is apt to induce in the short run offsetting movements of other forms of capital, again with no net effect on the overall investment position of the country, but with possible effects on the composition of such investment. However, as just stated, under flexible exchange rates the possibility that a sustained capital flow in one direction will affect the current account of the balance of payments in the opposite direction is more likely than under fixed rates. Thus, an inflow of foreign capital would now tend, more than formerly, to change the international investment position of the United States, that is, to increase foreign investment here relative to U.S. investment abroad. However, the increase in net international indebtedness could well be offset by higher real investment at home.
the longer run, of course, foreign investment builds up an obligation for the payment of interest and dividends, and possibly amortization, that will have the opposite effect.
Foreign transactions in United States securities also provide a source of income to the brokerage community and others involved in the securities industry such as lawyers and investment advisers; it is estimated that in 1975 over $200 million of commissions were received by U.S. brokers from foreigners for transactions in U.S. stocks and some additional amount for bond transactions.
It is difficult to measure in any empirical way the effects on the balance of payments of portfolio capital inflows. During the period in which par values were maintained for most currencies, private capital flows were probably offset by official reserve movements, that is, if foreign private investors purchased U.S. securities, foreign central banks either lost reserves (and sold U.S. Government securities) or-given the fact that the U.S. balance of payments was in deficit over the period under consideration-they bought less U.S. Government securities than they otherwise would have. Nevertheless, there is also evidence that, at least over the past ten years, changes in the rate of inflow of foreign capital were accompanied by changes in the balance of merchandise trade and other current transactions which tended to be mutually offsetting.
Such an observed relationship need not mean, however, that the capital flows were themselves affecting trade, but merely that both were being affected by other forces (mainly cyclical conditions at home and abroad) in ways that led to the relationship observed.
Under the new system of flexible exchange rates, a large and continuous flow of capital in one directionsay large foreign purchases of U.S. securities over a considerable period of time-would tend to affect trade and other current account items more quickly than under a system of par values maintained by central bank intervention in exchange markets. This is because the resulting effect on exchange rates will change price relationships between U.S. and foreign goods, with an impact on both exports and imports. Even under flexible rates, however, the most immediate impact is likely to be on other capital items; changes in trade patterns require adjustments in production and distribution channels which cannot be instantaneously effected.
In summary, flows of foreign portfolio capital no longer affect the overall “surplus” or “deficit” in the balance of payments as they did in the pre-1973 period, but they can, and probably do, have a larger impact than before on other private international transactions, both in the capital and current accounts.
Effects on Financial Markets
The effect of foreign portfolio investment on U.S. financial markets may be discussed in somewhat the same terms as the effect on the balance of payments. Any additional demand for securities in any segment of a capital market tends to raise prices and reduce yields on the types of securities demanded. Thus, foreign purchases of U.S. stocks and bonds have a tendency to reduce yields and therefore make raising of capital relatively easier for domestic borrowers. This in turn will tend to stimulate real investment and increase the output and productivity of the economy. In actual fact, foreign portfolio capital inflows are relatively small in relation to total capital formation in the U.S. economy, which makes it difficult, if not impossible, to measure any such effects statistically. However, it seems quite likely that they have an impact on the structure of capital markets in the United States. Since foreign investors limit themselves mainly to stocks and bonds of fairly well known corporations, the result is presumably to reduce the cost of capital to those sectors relying on those forms of financing. However, arbitrage among various sections of the capital market is probably sufficient to ensure that any increase in the flow of funds to one market sector will have a tendency to ease conditions in all sectors, although relatively more so in the sectors where the new funds are immediately injected.
Effects on Investment Position
Legal Aspects It appears that there are very few negative factors affecting foreign investment in this country. The withholding tax on interest and dividends paid to foreigners was the most frequently cited impediment to foreign investment in the United States. The provisions of the Securities and Exchange Commission legislation are generally seen as a positive factor favoring foreign investment in the United States over other countries because of the amount of information that has to be furnished to shareholders and the protection from inside manipulation provided by these laws. However, some reservations were expressed with respect to the possible deterrent effect of provisions in the SEC laws regarding disclosure of ownership of securities by persons owning more than a specified amount of stock of a particular
The effect on the international investment position of the United States is also somewhat ambiguous. Under the par value system, as already indicated, a movement of private capital in one direction was apt to be offset, at least in the short run, by movements of official capital in the opposite direction, with no net change in our international investment position. Even under flexible rates, an
Adequacy of Information
company. There also seems to be strong view in the securities industry that the provisions in reciprocal tax treaties with other countries providing for disclosure to the government of the investor's country of his ownership of U.S. securities has a deterrent effect, although it was generally recognized that this risk could be fairly easily avoided by using foreign banks and brokers as nominees. Recent trends in the United States toward making private financial records more readily available to government agencies, notably the so-called Bank Secrecy Act of 1970, was also regarded by some foreign investors as at least a potential negative factor.
Other aspects of U.S. legislation do not seem to be regarded as having significant adverse effects on foreign portfolio investment. Legal limitations exist on foreign ownership in certain sensitive industries, such as commercial aviation, shipping, communications and atomic energy, but the restrictions do ņot inhibit portfolio investment holdings.
Freedom from arbitrary expropriation or nationalization of foreign investment is widely regarded as being more complete in the United States than almost anywhere else in the world, in spite of past U.S. actions taken to vest enemy property in time of war or to control the assets of certain foreign nationals in time of extreme national emergency.
An examination of the legal environment in most other countries that might be considered potential competitors with the United States for foreign portfolio investment show that their taxation policies are generally similar (e.g. withholding tax on interest and dividends, exemption from capital gains tax). Other controls and limitations are seldom, if ever, less restrictive than in the United States; some countries still place difficulties in the way of repatriation of foreign capital invested in them. Only in the area of protection of privacy do investors regard other foreign countries—notably Switzerland-preferable to the United States from a foreign investor's point of view.
The survey revealed that foreign portfolio holdings of U.S. stocks were about 37 per cent higher than previously estimated. This underestimation could have resulted from a combination of the following factors: 1. Failure of current reporting systems to cover all
purchases of U.S. stocks by nonresidents. 2. Changes in the residence of existing holders of
securities, e.g., the outward migration of U.S.
citizens. 3. Failure to estimate correctly the effect of price
changes on the value of the foreign portfolio. Considering the long period of time—33 years since the previous benchmark, the differences between the survey results and the previous estimates suggest that the conceptual and institutional structures of our current reporting systems are adequate. Nevertheless, it will be necessary to monitor constantly the reports and to maintain close communication with the reporting firms to ensure that no major gaps develop in our reporting network. The benchmark survey results have given us some indications of avenues which can usefully be explored for this purpose.
Implications for Future Patterns
Comparison with U.S. Portfolio Investment
In interpreting the data on foreign portfolio investment in the United States, consideration must be given to recent trends in new investment, as well as the stock of investment on a particular date; the latter, of course, reflects the net result of activity over a considerable period of time. Taking both sets of data into account, the following observations can be made. 1. The shift to a regime of greater exchange rate flex
ibility makes it likely that foreign official holdings of U.S. assets will not increase as rapidly in the future as in recent years. On the other hand, the greater freedom that foreign monetary authorities now have to decide when to use their reserves might lead to proportionately more official holdings being placed in "portfolio" assets and less in short-term
than has been the practice in the past. 2. There seems to be no reason to expect any large
foreign investment in U.S. corporate bonds. U.S. long-term interest rates tend to be lower, most of the time, than those in other countries; thus there is usually no interest incentive to induce such purchases. Portfolio diversification objectives could lead to some capital inflow through this channel, but probably only on a small scale. Abolition of the withholding tax on corporate (and U.S. Government) bond interest could stimulate foreign purchases and, possibly, some shifts from time deposits at banks (the interest on which is already
exempt from the U.S. withholding tax) to bonds. 3. In all probability, investment in stocks will con.
tinue to be the predominant part of private foreign portfolio investment in the United States, although
U.S. portfolio investment abroad is relatively less important than foreign portfolio investment in the United States, and consists chiefly of bonds of foreign issuers (mainly Canada and the international lending institutions) originally placed in U.S. markets by the borrowers, mostly because of interest rate advantages. U.S. portfolio investment in foreign stocks is relatively less important than investment in foreign bonds, and probably is confined mainly to issues listed on U.S. stock ex. changes. Estimated holdings—$9.0 billion at the end of 1974-were equal in value to less than 2 percent of publicly traded U.S. stocks. Apparently, U.S. investors find that domestic markets provide sufficient opportunity for risk diversion and adequate returns. Of course, many of the reasons why foreigners invest in the United States apply to domestic investors as well.
there may well be substantial variations in such investment from year to year. The recent interest in U.S. stocks on the part of official, or quasi-official, institutions in certain OPEC countries has added a new dimension; such purchases may remain at
substantial levels for at least a few years. 4. Foreign net purchases of U.S. stocks have over the
past 5 years represented a higher proportion of net
new funds entering the market for U.S. stocks (as measured by new issues, see Chapter V) than foreign holdings represent of total stock outstanding. A continuation of this trend would mean that the ratio of foreign-held stocks to the total outstanding will rise, but since new issues normally amount to only one to two percent of outstanding stock, any such rise would be extremely slow.
Section 6 of Public Law 93-479 directs the Secretary of the Treasury to "investigate and review the nature, scope, and magnitude of foreign portfolio investment activities in the United States” and to “study and analyze the concentration and distribution of foreign portfolio investment in specific United States economic sectors." This chapter presents the statistical data arising from the survey of foreign portfolio investment as of the end of 1974, together with estimates of such investment as of the end of March 1976.
Definitions and Methods
A detailed methodology of the survey together with copies of the reporting forms and instructions appear in the appendixes. Some of the basic aspects are summarized below.
First, the term “foreigner" includes all persons residing in foreign countries, both foreign and U.S. nationals, except U.S. nationals with U.S. Government (APO and FPO) addresses. The term also includes foreign banks, brokers and other business firms, including foreign branches and subsidiaries of U.S. firms (but excludes U.S. branches or affiliates of foreign entities); all foreign governments, national and local, and their agencies, and foreign pension funds and non-profit institutions. Reporters were allowed to use post office addresses to determine place of residence. While this definition of a foreign "person" (as opposed to foreign "national") was appropriate for the survey, U.S. nationals residing abroad were identified as a separate group.
U.S. assets required to be reported were corporate stocks and long-term debt obligations of all types of U.S. issuers. The term “stocks” (or "equities”') includes common stocks, both voting and non-voting, preferred stocks, warrants and rights to stocks, and ownership interests in non-corporate business firms, including limited partnership accounts.
Long-term debt obligations are basically of two types, marketable securities and other debt. Marketable securities consist of bonds and debentures with an original maturity of more than one year, both in registered and bearer form, including convertible debentures. Other debt includes all other long-term obligations with an original maturity of more than one year. Both private and Government obligations are included.
Foreign portfolio investment does not include any investment in a U.S. company held by a “directo investor, that is, a foreigner or affiliated group of foreigners owning 10 percent or more of the voting stock of a U.S. enterprise. However, a foreign investment in either stock or long-term debt of such a company by a person who is not affiliated with the foreign parent interest is considered to be a portfolio investment.
Foreign persons can hold U.S. equities or debt obligations in two ways, either directly registered to them on the books of the “issuing' person (or its transfer agent), or held for them by a U.S. nominee or custodian who acts as the “holder of record.” Accordingly, information had to be collected from two sets of reporters. The first set was the “issuers" themselves—U.S. corporations, investment companies, partnerships, and other organizations and persons resident in the United States. These persons were required to provide, on the basis of their own records and those of their transfer agents, information regarding foreign ownership of each of their securities or
long-term debt, by country of residence and type of foreign-resident owner. (See Form FPI-1, reproduced in Appendix C.)
The second set of reporters consisted of persons acting as nominees or custodians for foreign owners. Such persons were required to provide similar information, that is, countries of residence and types of holder for each security issue held for foreign persons. (See Form FPI-2, reproduced in Appendix C.)
The information provided by both sets of reporters was aggregated by the use of the CUSIP numbering system (Committee on Uniform Security Identification Procedures), which provides for unique identification of most securities issued and traded in the United States.
The following standard notations have been used in the tables:
Less than one-half million dollars
Zero n.a. Not available Note: detail may not add to totals because of round. ing.
Enterprise Standard Industrial Classifications 13, Oil and Gas Extraction, and 29, Petroleum and Coal Products (Manufacturing), were not uniformly applied by