Does the current account deficit matter?

Will Hutton has, inadvertently, provided a case for fiscal austerity. He writes of our record external deficit and deficit on net investment income:

If these trends continue for another 10 or 15 years the interaction with our growing trading deficit – we import a great deal more than we export – will eventually make the scale of our international debts and income flows abroad insupportable. There will have to be a massive national belt-tightening along with the imposition of controls of capital to stop a runaway sell-off of what will be valueless pounds. The curtain will come down on an era of amazing economic fecklessness.

Before seeing why this claim might justify tighter fiscal policy, let's just strengthen Will's argument in three ways:

 - The UK's net foreign liabilities are now equivalent to 25% of GDP - their largest since records began in the 70s. Whilst this is roughly the same as Australia's, the US's or France's, the only major countries with significantly bigger liabilities are either those that ran into a big financial crisis because of their overseas debts (Greece, Spain) or poor countries for whom high liabilities represent FDI from overseas to take advantage of their decent long-term growth prospects. The UK is not in the latter category.

 - A current account deficit, by definition, means domestic investment exceeds domestic savings. This can be a sign that bank lending is growing faster than deposits - which might be a warning of an impending financial crisis. Is it really an accident that the countries which suffered most in the Great Financial Crisis all had big and persistent deficits - Greece, Spain, Ireland, US and UK?

 - We can't rely upon a fall in stering to eliminate the deficit: net exports just aren't very sensitive to exchange rate changes.

Herein, then, lies the case for austerity. A tighter fiscal policy would - in the absence of 100% crowding out - raise national savings and thus reduce the deficit. The bigger the fiscal multiplier, the more it does so - because there's a bigger drop in aggregate demand and hence imports. In this sense, fiscal austerity imposes hardship now in order to prevent a "massive national belt-tightening" in future.

I suspect Will does not want to reach this conclusion. And there's a good reason why he shouldn't. The UK's current account deficit is a symptom of the global savings glut and secular stagnation. By definition, the UK's deficit means that the rest of the world's domestic savings exceeds their investment. Foreigners are buying London houses and British businesses because they can't find sufficient productive investments at home.

One thing tells us this is a better way of regarding our deficit than the "amazing fecklessness" Will describes. It's that foreigners are happy to lend to us. Since early 2010 sterling's trade-weighted index has risen 15% and ten year gilt yields have fallen faster than US yields.Neither would have happened if the UK were in a desperate fire-sale of assets to fund profligacy.

Now, I don't say this to mean that the deficit is not a problem. Given the lack of global capital mobility, it is. As Sushil Wadhwani once said (pdf):

It is possible that the current account only matters some of the time. Casual observation suggests that countries with a current account deficit can have a currency that stays strong for a surprisingly long period, until, sometimes, there is an abrupt adjustment.

This might be an example of what Sornette and Cauwels call "creep": things can look robust until they suddenly collapse.

Instead, the question is: must we do something about the deficit now? I suspect perhaps not. Insofar as the deficit is partly the counterpart of high savings and weak demand in the euro area, we should wait until those problems are diminishing before trying to reduce it ourselves.

Comments

[TickyW]

Am fairly new to all this, but do sales of UK houses and businesses to foreigners show up in the current account? Are these not capital account movements? As follows in bookkeeping terms:

Dr Foreign currency reserves X
Cr Liabilities to foreigners X

[TickyW]

"A current account deficit, by definition, means domestic investment exceeds domestic savings."

Chris, is this correct? I suspect it's a typo and you meant to say,

"....domestic consumption exceeds domestic savings"

[Bob]

The problem with 'export led' growth is very simple.
It is an accounting equation.
Exports = Imports
Where every country implements austerity searching for exports is fool's gold.

[chris]

@TickyW: sales of assets don't show up in the current account, but in the capital account. I meant to say investment exceeds savings.
Think of national accounts identities:
Y = C + I + G + (X - M)
Y = C + S + T
A bit of rearranging gives us:
(S - I) + (T - G) = (X - M)
If you think of the government surplus (T-G) as the government's net saving, this tells us that the external deficit means that investment exceeds saving.
@ Bob - you're right at a global level. I'm not sure export-led growth is feasible at a national level either. This is because supply chains are globalized, so that exports have a high import content.

[TickyW]

Thanks Chris

[postkey]

"Do current account deficits matter?"

http://bilbo.economicoutlook.net/blog/?p=10389

[Gerardo Licandro]

Britain is no latin american country. Having said that, the experience in that part of the world tells you that debt busts might take a while but they happen. When they do, it is not a pretty sight. dirty Harry would say:"Are you feeling lucky Punk?"

[marcus nunes]

"Instead, the question is: must we do something about the deficit now? I suspect perhaps not. Insofar as the deficit is partly the counterpart of high savings and weak demand in the euro area, we should wait until those problems are diminishing before trying to reduce it ourselves."
The deficit in Spain was the counterpart of high saving in Germany. They waited (and are still waiting) for that to change. Time ran out and they to adjust on their own, with all the attending cost!

[marcus nunes]

On CA´s, there´s everyone and then there´s Australia:
https://thefaintofheart.wordpress.com/2014/07/25/a-useless-endeavor/

[Ari Andricopoulos]

Foreign buying of GBP is storing up a huge problem for the future. I have an alternative solution, though, that does not involve crushing domestic demand:

http://andricopoulos.blogspot.com/2015/02/why-bank-of-england-should-write-off.html

I would be very interested in any comments.

[Min]

A couple of what I hope are not too stupid questions.

Stumbling and Mumbling: "A current account deficit, by definition, means domestic investment exceeds domestic savings. This can be a sign that bank lending is growing faster than deposits"

Which means the pounds are accumulating in foreign accounts, right? Otherwise the growth of domestic lending would be matched by growth in domestic deposits. (And I suppose that foreign gov'ts are holding on to those pounds?)

S&M (Sorry, I couldn't resist. ;)): "- which might be a warning of an impending financial crisis."

Because of a shortage of money circulating in the domestic economy? Because of stockpiling of pounds by foreign gov'ts?

[Pension60]

Deficits are not a national debt. The UK has had a deficit for 300 years to no ill effect. And UK has no national debt as the OECD says UK debt is only a world average.

Austerity in a recession makes the nation worse off not better.

And anyway UK austerity has not happened.

The Tories are making the same mistake they did with the workhouse that killed 5 million at extra cost, when the Poor Law of old had worked fine without all the cost of staff and workhouse building to stave off starvation.

The cost of UK's welfare admin (both state and private contract) has gone up by the tens of billions each year, whilst the money to the starving has reduced by the billions.

Nowhere in history has an elite survived leaving its mass of poor to starve.

Universal Credit, replacing all other benefits, will inflict permanent sanctions off any food money by the Hardship Payments (hard enough to get so not standard) becoming recoverable loans from any future benefit or earned income.

This will afflict UK's working part time poor
(where most of the rise in employment has happened from 2008), who will be also permanently sanctioned under UC for not being able to do the unattainable of moving from part time to full time hours.

The working poor include the over 60s, who will also be denied Pension Credit benefit before state pension payout, payable even if remain in work.

The UK is predicted to have the most severe hung parliament in its history.

With an even more unelected Tory caretaker government far below anything like a majority, even if an MP loses his seat.

And so UK's poor will ever more fall into starvation, that include heavily pregnant mothers, mothers with new baby, families and poor pensioners denied state pension payout for life, also denied disability / chronic sick benefits.

See why under my petitition, in my
WHY IS THIS IMPORTANT section at:
https://you.38degrees.org.uk/petitions/state-pension-at-60-now