Any of our regular readers or longstanding investors will be familiar with our keen appreciation of the merits of Net Foreign Asset (NFA) analysis and our investment philosophy which prefers to divide the investable universe into creditors and debtors. The effects of a country’s NFA position on long term currency direction and creditworthiness was a central theme in the thesis of ours over two decades ago. We used it to identify the incoherent pricing of, for example, Greek debt in late 2009 when yields were at all-time lows of 1.34% while net foreign debts had deteriorated to exceed 100% of GDP (though the country was still A1 rated!).
Yet despite its usefulness and logic, NFA analysis, we believe, remains under-utilised in the investment world. Only in February 2012 did the European Commission include NFA related factors in their “Alert Mechanism Report”, a process to detect warning signs of “risky and harmful macroeconomic imbalances”. Ratings agencies were perhaps even slower with Moody’s only including it as a modest factor in their revised sovereign bond rating methodology of September 2013. Yet many still ambiguously refer to emerging market countries (though economically many emerged many years ago) while a lacuna persists for thinking in terms of creditors and debtor nations (e.g. Japan is a net foreign creditor nation). But perhaps this foundational methodology for viewing countries economic strength and the pressures on international flows of capital will become more recognised in the future. Especially if one of the chief architects of NFA continues to rise in influence.
In 2006 the IMF published a working paper by Philip R. Lane and Gian M Milesi-Ferretti on the External Wealth of Nations which took great effort to estimate countries’ historical net foreign assets. It aligned with our research and view of the world and provided further data to support our assessment. And although their data was once updated up to 2007 we have continued to maintain our country NFA estimates which attempt to adjust nations’ current account balances for valuation changes. One of the External Wealth of Nations authors Philip Lane is now the governor of the Central Bank of Ireland and a member of the European Central Bank’s governing council. According to the Financial Times today, Mr Lane is now one of the top contenders for the ECB vice-presidency this May, and failing this would also be a favourite for the ECB chief economist position when Peter Praet steps down in May next year. Needless to say, if the ECB was a democracy, Lane would get our vote in a hope that he would take seriously the persistent imbalances and lack of deleveraging since the crisis.