Fool me once, shame on you; fool me twice, shame on you

Big valuation gains on US assets abroad (particularly US assets in Europe) have done wonders for the US net international investment position. Gains of X in 02, Y in 03, and maybe $400 billion in 04 have knocked over a trillion off our net external debt.

The counterpart of those valuation gains for Americans with investments abroad are big losses for most foreigners holding dollars -- or least for European, Canadian, Australian and to a lesser degree, Japanese investors. China keeps financing the US to avoid having to incur big valuation losses ...

Past performance, of course, is no guarantee of future results.

But financing the US current account deficit requires that US investors not chase after the big valuation gains that anyone with funds invested in Europe has enjoyed, and instead keep their accumulated savings in the US. And it requires that foreign investors not shy away from financing the US after experiencing large valuation losses because of currency moves (partially offset by falling interest rates and falling spreads). Investors in China and other countries that have yet to experience large valuation losses cannot learn from those who have experienced valuation losses; they have to keep dumping their savings into the US.

Rather than chasing past performance, investors have to chase past losses ...

Sometimes that might make sense. But with a current account deficit heading toward 7% of GDP, the US hardly looks like a country whose "fundamentals" have already turned around ...

Incidentally, the 5% or so rise in the dollar against the euro will generation valuation losses of about $200 billion, and thus add about about $200 billion to net external debt if the rise in the dollar is sustained. Since we are on pace to add another $800 billion to finance the current account deficit, our net debt, if nothing changes, will rise from about $3 trillion to around $4 trillion by end of 2005 -- pushing the net external debt to GDP ratio above 30% ... the euro/ $ gives, but the euro/$ also takes away.