Tag Archives | balance of payments

Balance of Payments Disequilibrium

Readers Question: Explain what is meant by a balance of payments disequilibrium?

The Balance of Payments is comprised of two main components:

  • The Current Account (trade in goods, services + investment incomes)
  • The Financial Account (used to be called capital account; this is capital flows such as foreign direct investment)

If the UK imports more goods and services than we export – then we have a deficit on the current account. A significant deficit on the current account is generally referred to as disequilibrium. It will be matched by a surplus on the financial account.

In the post war period, the UK has usually had a current account deficit, apart from a brief surplus in the early 1980s and 2000s. The UK currently has a deficit on the current account.

Deficit in current account as % of GDP

current-account-quarterly-1980-2012

See also ONS – balance of payments Continue Reading →

UK Balance of Payments

The Balance of Payments is the record of a country’s transactions / trade with the rest of the world.

The balance of payments consists of:

  1. Current Account (trade in goods, services + investment incomes + transfers)
  2. Capital Account / Financial Account (capital and financial flows, net investment, portfolio investment)
  3. Errors and omissions. It is hard to collect all data so some is missed out.

In theory there should be a balancing between capital and current / financial account. If there is a current account deficit, there should be a surplus on the capital / financial account.

UK Current Account

The UK current account deficit wa s£20.7 billion in Quarter 3 2013, up from a revised deficit of £6.2 billion in Quarter 2 2013. The deficit in Quarter 3 2013 equated to 5.1% of GDP at current market prices, up from 1.5% in Quarter 2 2013 (page updated 8th Jan. 2014)

In 2012, the UK’s current account deficit was £59.8 billion.

current-account-quarterly-2000-2012

Source: ONS Balance of Payments Current account as % of GDP

This shows a deterioration in the current account. The current account deficit for Q3 2012 was over £12bn (Seasonally adjusted measure). Q3 2012 as a % of GDP 3.2%

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How does a current account surplus affect demand?

Readers Question: How does a current account surplus change demand in an economy?

A current account surplus means that the value of exports is greater than the value of imports (of goods and services).

Net exports is a component of Aggregate demand.  (AD) = C+I+G+(X-M).

Therefore a current account surplus means that the net exports is contributing to higher domestic demand. For example, China has had a significant current account surplus over the past few years. This high demand for exports is contributing to the high level of Chinese economic growth.

If the UK has a current account deficit, this represents a net leakage from the economy. Aggregate demand will be lower than if we had a surplus.

Evaluation

It could be the situation that a current account surplus is the result of a recession and low consumer spending. In a recession, we would expect to see a fall in consumer spending; therefore, we will see lower spending on imports. This will cause a current account surplus. In this case, the low aggregate demand is causing a current account surplus.

A current account surplus is not necessarily a good thing. For example, some criticise Germany for pursuing policies, which lead to a very large current account surplus. They argue that this is leading to lower demand in other European countries. Some economists argue, Germany should seek to boost domestic demand; this will lead to higher import spending and benefit other European countries with a large current account deficit and weak domestic demand.

On the positive side, a current account surplus is an indicator that Germany are very competitive, and this will help them to create jobs and economic growth.

Current account surplus and exchange rate

Another factor to consider is the impact of a current account on the exchange rate. In 2006, China was running a large current account surplus. However, in the past few years, the Chinese currency has steadily appreciated. This increase in value has reduced their current account surplus, and limited the growth in Chinese exports and domestic demand.

If the UK moved from a deficit to a surplus, we might expect to see an appreciation in the Pound (this is due to greater demand for Pounds as people buy more UK exports). The appreciation in the currency will tend to reduce demand (assuming relatively elastic demand)

Related

How Did Portugal Reduce Current Account Deficit?

Readers Question: Can you tell what Portugal has done to reduce the Current Account GDP deficit so steeply?

portugal-current-account-deficit

The reduction in the Portuguese deficit is quite striking. In researching the answer to this question, I came up with a different post – The Portuguese Economic crisis

From what I can gather, essentially, the rapid reduction in the current account is due to a sharp fall in consumer spending on imports, combined with some growth in exports – helped by improvements in unit labour costs. However, bear in mind, I may have missed out a few other reasons due to lack of data.

Likely Reasons for Reduction in Current account deficit

1. Fall in consumer spending on imports.

portugal-germany

Portuguese economic growth compared to Germany

As mentioned in The Portuguese Economic crisis Portugal has seen the biggest fall in real GDP (apart from Greece) in the Eurozone. Portuguese consumers have seen a rapid fall in disposable income due to a combination of tax rises and public spending cuts. With lower income, Portugal is simply buying less imports – this improves the current account.

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Germany’s Current Account Surplus

A few years ago, global trade imbalances were dominated by China and the US. At its peak, China’s current account surplus reached over 10% of GDP. By contrast, the US current account deficit reached over 6% of GDP. The classic image was of China manufacturing goods, selling them to the US  consumer.

Then with this export revenue, China bought US Treasuries to keep the Chinese Yuan permanently undervalued. Many in the US criticised China for this ‘currency manipulation‘ – In fact, Mitt Romney, the 2012 Republican Presidential candidate, promised to label China a currency manipulator from day one. However, Romney was really a couple of years behind reality.

 

currency
China still has a current account surplus, but it has fallen from 10% of GDP to 2.6% of GDP in 2012. China’s currency is no longer chronically undervalued, and the Yuan has appreciated 40% in real terms against the Dollar since 2005. Although China’s economy is still reliant on exports and investment, it has begun a process of rebalancing the economy. It is not the same source of global imbalances that it was five years ago,

The biggest global imbalances, in absolute terms, now come from Germany, who have seen their current account surplus to continue to increase. In Q3 2012, their current account surplus widened to $58 211 million (equivalent to an annualised surplus of  $ 232,844 million – (7.0% of GDP) OECD)

Current Account Deficits

oecd-current-acccounts-q2-2012

The largest current account surplus is in Switzerland (13.1% of GDP) though this reflects the unique challenges Switzerland faces as a safe haven resort (investors trying to save money in a safe currency are pushing up the Swiss Franc causing an appreciation.)

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