etawa Conference
2011
Steven Kemp
The CAD & Foreign Liabilities
• The balance of payments is one of the key
sections of Unit 3A – Australia & the Global
Economy
• It is also one of the more difficult sections of the
syllabus that students find confusing, esp the link
between the CAD and foreign liabilities (incl.
foreign debt)
• External stability is specifically listed in Unit 3B (&
2B) dealing with economic policy objectives –
despite not being officially recognised as a
legitimate government policy objective
The balance of payments
Questions to ask your students
•
•
•
•
•
•
Are exports more important than imports?
Is it better to have a current account deficit or
a current account surplus?
Is it better to have a financial account deficit
or a financial account surplus?
Is it better to have a high $A or a low $A?
Are boys better than girls?
Are cats better than dogs?
The CAD & Foreign Liabilities
• Many media commentators & texts still allude to
misleading information concerning the balance of
payments & foreign debt
• Examples
Foreign debt – Australia’s black hole!
AUSTRALIA'S current account deficit improved
slightly in the first quarter following a blowout at the
end of last year, but the picture is marred by
ballooning foreign debt. “The fact that we are still
running a howler of a current account deficit looks
pretty bad,” JPMorgan's chief economist, said.
[smh, June 2007]
The CAD & Foreign Liabilities
• Examples
• AUSTRALIA'S foreign debt topped $1 trillion for the first
time . . . as the nation borrowed at record levels to finance
its spending habits. . . The nation's trade performance
also deteriorated significantly” [Brisbane Times June, 2008]
• “Increasing foreign ownership is creating a significant
drag on Australia's current account balance; Over the last
few years, Australia's net income balance has broken
below its long-term floor of -3% and is forecast to
deteriorate to -6% by 2013, worsening Australia's
current account deficit in years ahead” [Senator Bob Brown
June 29, 2011]
The CAD & Foreign Liabilities
Even the WACE exam last year
7. A worsening current account deficit is most likely to be
a result of
(a) a decrease in economic growth.
(b) capital expansion in domestic manufacturing plants.
(c) a positive gap between domestic savings and
domestic investment.
(d) an increase in exports.
19
6
19 0
6
19 2
6
19 4
6
19 6
6
19 8
7
19 0
7
19 2
7
19 4
7
19 6
7
19 8
8
19 0
8
19 2
8
19 4
8
19 6
8
19 8
9
19 0
9
19 2
9
19 4
9
19 6
9
20 8
0
20 0
0
20 2
0
20 4
0
20 6
08
Millions of dollars
Balance on goods and services
10 000
5 000
-5 000
-10 000
-15 000
-20 000
Balance on goods and
services
Balance on goods
-25 000
Source: Hubbard 2009
08
20
05
20
02
20
99
19
96
19
93
19
90
19
87
19
84
19
81
19
78
19
75
19
72
19
69
19
66
19
63
19
60
19
Billions of dollars
Net income, Australia
0
-5
-10
-15
-20
-25
-30
-35
-40
-45
-50
Source: Hubbard 2009
The CAD & Foreign Liabilities
• Both the RBA and Treasury now use the correct
terminology
• “The current account deficit is expected to narrow to 2
per cent of GDP in 2010-11, the smallest deficit as a share
of GDP since 1979-80. The trade balance is expected to
move from a deficit of 0.3 per cent of GDP in 2009-10 to a
surplus of 2 ½ per cent of GDP in 2010-11. . . . With a
large share of mining profits repatriated to overseas
investors, a wider net income deficit is expected to more
than offset the trade surplus, leaving the current account
in deficit”. Australian Treasury Budget Papers
A little bit of history
• Australia’s current account deficit (CAD) has
attracted considerable debate over the past three
decades.
• The rise in the CAD from the early 1980s became a
central focus for policymakers - high CADs were
seen as a source of macroeconomic vulnerability and
a constraint on economic growth.
• It was generally agreed that policy should & could do
something at reducing the CAD & foreign debt
• Why? A legacy of the previous fixed exchange rate
world
Long term view of the B of P
Sizeable current
account deficits have
been recorded in
Australia in almost
every decade for at
least 150 years
Source: RBA
Cumulative Current Account Deficits
Source: RBA
A little bit of history
• The abrupt rise in the CAD after the float of the dollar
combined with the rise in foreign debt led the
treasurer, Paul Keating to warn of the risk that
Australia could become a ‘banana republic’.
• In the 1988-89 Budget Speech, Paul Keating
reiterated that:
• “The balance of payments deficit is Australia’s
No.1 economic problem . . .”
• Policy was directed at reducing the CAD but despite
micro reform & fiscal consolidation, the CAD
remained high
A little bit of history
• By the late 1980s and early 1990s academics began to
debate whether the CAD should be a policy target
• The debate was led by John Pitchford & became known
as the ‘consenting adults’ view
• The ‘consenting adults’ view does not see the CAD as a
problem if it is based on private saving & investment
decisions
• The Pitchford view countered the more traditional view
that large CADs were unsustainable & imposed a
constraint on growth – on the contrary, a current account
deficit could promote economic growth through higher
foreign investment
A little bit of history
• By the early 1990s, both the Reserve Bank & the
Government changed their policy stance on the CAD
- monetary policy should not be used to target the
current account
• By 2004, Glenn Stevens firmly restated the RBA’s
view towards the CAD
• “Whether the current account position should be an
objective of any policy is not obvious . . . let me be clear
that the current account is not, and should not be,
an objective for monetary policy. We have had that
debate in Australia. It was settled more than a decade
ago, and I do not wish to re-open it”.
Balance of Payments - Definitions
1. Current account balance
= trade balance + net income balance
CAD occurs when
imports + income paid to foreign residents >
exports + income received from abroad
Expressed this way, a current account deficit often
upsets the protectionists, who – apparently forgetting
that a main reason to export is to be able to import –
think that exports are "good" and imports are "bad."
Balance of Payments - Definitions
2. Current account balance = Savings - Investment
The current account can be expressed as the
difference between national (both public and
private) savings and investment.
A current account deficit may therefore reflect a low
level of national savings relative to investment or a
high rate of investment – or both
CAD occurs when I > S
Balance of Payments - Definitions
The saving-investment perspective is more useful since it
provides a greater insight into the factors that cause the
CAD to change over time
e.g. A rise in the terms of trade may be expected to
increase exports & reduce the CAD, but it often does the
reverse!
Why? A rise in the terms of trade may lead to a surge in
investment which will increase the CAD
Australia’s CAD has been higher this decade as a result of
the mining boom
In June 2010 the CAD fell to 1% of GDP
Why??
Balance of Payments - Definitions
• The saving-investment perspective also emphasises
the role of the financial account – often forgotten in
the trade view of the CAD
• It is important to remember that with a floating
exchange rate, the current account & the financial
account balances must be equal & offsetting – both
being determined simultaneously
CAD = Financial Account Surplus
I - S = Financial Account Surplus
I = S + Net foreign investment
The Financial Account
• The financial account records a country’s net
foreign investment – the difference between
capital outflows from a country and capital
inflows
• Net foreign investment is the twin-side of the
CAD
• After the floating of the dollar in 1983, both
foreign investment in Australia and Australian
investment abroad increased sharply
How often is a graph like this published?
Net Foreign Liabilities
The increase in net
capital inflow meant
that the ratio of net
foreign liabilities to
GDP increased from
around 20% in 1980
to close to 60%
today.
Is this cause for
concern?
Net Foreign Liabilities
But foreign liabilities
can also be
measured relative to
i total financing &
ii total capital stock
Both of these ratios
have remained
relatively stable
The Financial Account
• Is there a risk that rising foreign liabilities
could undermine financial stability?
• In Australia’s case, virtually all foreign
liabilities are in Australian dollars
• Foreign capital inflow into Australia has been
used to fund high levels of investment & not
consumption
Note: Australia relies on foreign investment
not because its savings ratio is low but
because its investment ratio is high!
National Savings & Investment
Is Australia a low saving
nation?
No!
Australia’s saving ratio
is equal to OECD
average
Australia’s investment
ratio is well above
average
National
Saving
National
Investment
% of GDP 2000-10
Australia
22
27
Canada
23
21
Germany
22
18
UK
15
17
US
15
19
Japan
27
23
Comparing Australia & the US
Source: Australian Treasury
Net Foreign Liabilities &
Government Net Debt 2008
Source: Australian Treasury
Some Summary Points
• Australia’s high CADs/foreign liabilities are not a
cause for concern
• The CAD should be explained from the savingsinvestment perspective
• Higher CADS in Australia have been due to high
& rising investment rather than low or falling
saving
• The stock of foreign liabilities has increased over
time, but so has the stock of capital assets and
Australia’s wealth
•Questions