National Finances
March 27, 2013
Nations’ Financial Positions
A nation’s financial position can be understood both in absolute
terms and in terms relative to other countries. In both
dimensions, a country’s position may change over time, and do
so quite dramatically.
Sometimes, such shifts in financial position also signal changes
in wealth, but a nation’s financial position is not always equal to
its wealth.
For example, the US is now in a poor shape in terms of finances.
However, its wealth, as measured in annual terms and in terms
of its tangible and intangible wealth is still very, very large.
Measures of National Financial
Position
Balance of payments: the IMF definition of the summary financial
position of a nation, composed of the current account, capital flows
and changes in reserves.
Current account: mostly constituted by the balance of trade that
shows the relationship between the value of imports vs. the value of
exports. If the value of imports exceeds that of exports for a reporting
period, the current account will show a deficit, and if the reverse, it
will show a surplus.
Also part of the current account are the balance of government
transactions (the purchasing and selling of goods and services), foreign
aid grants, and remittances: funds sent to the home country by
corporations or individuals located outside the country.
Capital Flows
Total investments and loans foreigners citizens, corporations and
governments make in a country minus the investments and
loans that a nation’s citizens, government and corporations
make in other countries.
Made up of foreign direct investment: ownership of tangible
property, such as real estate, corporations or manufacturing
facilities, and indirect portfolio investment: holding of stocks,
bonds or the making of loans.
Thus, net capital flows can be made up in various ways,
depending on the balance of foreign investment in one’s country
and the amount of foreign investment one’s citizen’s make in
other countries.
Capital Flows
Impacts: it is generally good that a state has positive capital flows
because such flows tend to stimulate economic activity by making
capital available for start ups, expansion, research and development
and other uses.
However, a large proportion of foreign investment that constitutes a
positive capital flow will result in large going outside the country, thus
negatively impacting the current account. Large investments outside
the nation that would lead to a negative flow might starve a nation of
necessary capital, but help its current account.
Large, unregulated inflows of capital seeking high returns may also
have harmful effects, such as raising interests rates, the inflation of an
economic bubble, and the threat that such capital may suddenly be
pulled. Such large inflows are sometimes called hot money.
Financial Measures
The overall balance of payments is reflected in changes in
foreign exchange reserves. A negative balance of payments
results in a nation having to draw upon its reserves to make up
the difference by selling SDR’s or paying over hard currency.
A positive balance of payments will result in a nation adding to
its foreign exchange reserves.
Question: what is the balance of payments situations of:
The US?
Taiwan?
The PRC?
Wealth and Debt
Standing wealth: the amount of wealth a country possesses at any one
time:
• Foreign currency reserves
• Value of infrastructure
• Capital goods, such as factories and machinery
• Homes, cars and other items held by individuals
Countries can also, like individuals, accumulate debts by borrowing
money to:
• Pay for a trade deficit
• Pay the differences between citizens’ consumption and their income
• To finance government-sponsored economic stimulus programs by
means of Keynesian deficit spending in the national budget– spur
growth by stimulating demand in the economy.
International Debt
Sometimes countries borrow from their own citizens to pay for
national budget deficits or deficits in the balance of payments.
But more often they finance their debts internationally by
selling bonds on the international market or arranging loans
from consortia of banks or from the IMF.
If they are unable to meet the obligations of a loan, in the
form of interest and principal repayments, then they may
need to:
a)Refinance the debt: find some way of rolling it (negotiate a
new loan to pay off the old loan) over to ease current
payments in favor of higher payments in the future, or
perhaps at a lower rate of interest (the rates for borrowing
money).
International Debt
b) Default: acknowledgment that a country cannot repay debt and
therefore cannot make payments.
1) Lenders and investors settle for some fraction of the debt
(haircut)
2) Arrange for another institution to help with the debt by
negotiating with lenders and providing capital assistance in tandem
with efforts by the country to arrange financing through additional
taxation (bailout).
Why did the Eurozone countries and the IMF provide a bailout of
Greece and Cyprus?
Results in the inability to use the foreign financial markets for some
period of time because investors will not risk lending their money.
Relative Positions in the World
US:
• Militarily most powerful
• Largest economy in the world
• Hard currency
• Most technologically advanced in important areas
It is, therefore, in generally good shape. However, it is not as
powerful economically as it once was in terms of its relative
position in the world economy. That is, relatively speaking, it is a
declining power and has been since its peak in the early 1950s.
US
• Early 1950s: US economy twice as large as the next six largest
combined. Held half of the world’s financial reserves. Large trade
and balance of payments surplus.
• 1980: Share of world economy half that in 1950s. Held less than ten
percent of the world’s financial reserves. Beginning of long-term
trade and balance of payments deficits. Beginning of persistent
budget deficits
• 1990s, 2000s: did well immediately after the end of the Cold War,
but began experiencing economic problems in early 2000s that were
deepened by 9/11 and subsequent wars in Iraq and Afghanistan.
Banking sector failure in 2009, and consequent deeper budget
deficits.
National debt: the cumulative amount of debt a nation owes as a
result of deficit spending in the national budget: rose from $1 trillion
early 1980s, to $3 trillion by the end of the 1980s, to 15 trillion in
2012. GDP is about 15.8 trillion.
Current account deficit: about $450-500 billion annually
Source: Daniel Kurz, CFA
Institute
US vs. PRC, India, Germany, Russian Federation and
Brazil, GDP