Monday, 4 April 2016

A Current Account Surplus is Obviously a Good Thing. Isn't it?

After my recent Coppola Comment post on a theoretical framework for making the Eurozone a genuinely viable currency union, I received a number of interesting comments in opposition to the idea.

There were three main ideas in the criticisms. The first is that it is politically impossible. This, I am inclined to agree with although, as Frances says, we have to try. Germany would never agree to this because it goes against their idea of economics. In fact, I would say that the Germans don't actually consider there to be any problem with the structure of the Euro, only the irresponsibility of the debtors.

I suppose really the point of the post was trying to plot out a minimum required level of cooperation for the Euro to be viable. Otherwise, the structural problems are so severe the best option for everyone would be a break-up.

The second criticism was of the blank cheque that it gives to governments within the Eurozone. Here I argue that all it gives is the same blank cheque that every other sovereign government has. And it is a 'blank cheque' that is necesary for sustainable economic growth. However, in order to avoid abuse, then any plan of this nature would probably need synchronisation of certain tax and spending policies. This may be unpalatable, but still is preferable to the alternative.

The third criticism is similar to the the first, but differs on a key point. It says not just that Germany won't agree, but that they should not agree to give up their victory in attaining a current account surplus. The idea is that it is not in Germany's interest to run a current account deficit for a while. On this, I disagree completely. I actually don't believe that running a current account surplus is necessarily a victory at all.

There are some circumstances when a current account surplus is a good policy. One obvious one is for producers of natural resources, who wish to both prevent their domestic economy from over-heating as well as save up for the future some of the value of the extracted resources.

Another would be for a small state to build up some kind of buffer against future uncertainty. In this case, the effect of their policy is tiny compared to the size of the economy that they are building up savings in.

But for a state with the size and level of development of Germany it really gives no advantage whatsoever, and actually many disadvantages when it affects the economic growth of its neighbours so badly as I  discuss in the Coppola Comment article.

Persistently running a current account deficit in a fixed currency regime [edited; thanks Frances (in comments)] is clearly a bad thing, and I am not saying that it is OK to have a deficit. I am saying that there is no symmetry here. For the reason for this, we need to look at what actually happens to create a surplus. The wages/purchasing power of the surplus country is artificially kept low, either by currency manipulation, tariffs or (as in Germany's case) wage agreements. This makes the saving rate in the economy artificially high. And these excess savings must be invested somewhere, and this somewhere must be abroad. The surplus country thus creates savings in the deficit country.

There is no increase in demand in the surplus country as the increase in exports is counterbalanced by a decrease in domestic demand. But there is a reduction in demand in the deficit country. The net effect is a reduction in world demand. It is a negative sum game.

It is true that Germany is building up credits with the rest of the world. The claims of Germany on future production by the rest of the world are growing every year by a large amount. But the thing about these claims is that at some point they need to be spent. If not, they are worthless tokens.

When is Germany planning to spend these tokens? If never, then why are they working so hard and forgoing consumption now to build these piles of bonds and equities. This is even ignoring the fact that the less competitive parts of the Eurozone are suffering an economic strangulation in the collateral damage of this policy.

It's all very well talking theoretically about the effects of a current account surplus. I would argue that these are accounting identities, but nevertheless, people will still claim that running a current account surplus is good for growth. So I have looked at OECD data for developed economies for the past 18 years.

Below is the result for Current Account Balance plotted against RGDP growth for 423 country years. I have excluded a few large outliers on either side by limiting the deficit to -10% and surplus to +15% (the assymmetry is because there are fewer surplus countries). I have also provided best fit lines. I have divided the graph into two halves, surpluses and deficits.

This graph very clearly shows no correlation between surpluses and RGDP growth. This is exactly as the above argument suggests it should be. Saving in a foreign currency does not help your growth at all.

This is really the main point I am trying to make - that for Germany to run a deficit will not hurt their economic growth at all, just spend some of the many claims that they have on the rest of the world.

An (I think) interesting aside 

You can stop reading now, unless you, like me, are interested in the interaction between the current account and both private and public sector debt.

An interesting feature of this graph is that it shows that higher deficits are correlated with  higher economic growth. This would seem counter-intuitive because a deficit means that demand is taken from the domestic economy. Here, one probably needs to look at the line of causation. A booming economy will be more likely to receive investments from abroad and will pay higher returns on that investment. This means a large current account deficit. The effect of this confidence could well outweigh the negative demand impacts.

Looking at private sector credit growth gives more explanation. Here the same is plotted but on the y-axis is the change in private sector debt year on year, divided by GDP.

The higher deficit countries have the highest increase in private sector debt to GDP too. This is both a symptom of the confidence in the economy (/bubble) and a cause of greater GDP growth despite the deficit.

There also appears to be higher creation of private sector debt to GDP in the large surplus countries. Here it may be something about the investment led growth model being followed, and much of the increase may be for investment rather than bubble building or consumption.

For completeness, it is also interesting to look at how the current account balance affects public sector debt to GDP.


On the positive side of the graph, as one would expect given a current account surplus and higher private sector debt creation, we see a declining government deficit. More interesting is the negative side, which shows that government deficit actually reduces with a higher current account deficit. This could be due to the higher confidence and higher private sector debt creation that goes hand in hand with the type of high confidence (arguably misplaced) economy that runs large current account deficits.


  1. I quite recently published a piece about Ghana's trade deficit (link so I'm happy to see you take on the current account. It appears to me that the claims Germany has on the rest of the world due to its current account surplus would not be worth risking the stability of the eurozone for. I don't think that is a trade they really want to make.

    1. Nice post. It is true that Ghana's investment needs may mean it is better to run a deficit - although hopefully the investment is in the form of equity rather than debt ( in case things go wrong).

      I have voted for you for Ghana's best blog by the way. It is definitely the best blog I have read from Ghana.

    2. Thank you! I hope to get better as I read more from people like you.

  2. I don't agree that a current account deficit is "clearly" a bad thing. In fact your "aside" at the end gave the lie to this statement. Under some circumstances, a current account deficit is a strong statement of external confidence in the economy and in the currency. For example, the US's current account deficit is a necessary consequence of the fact that its currency is the worldwide settlement currency and its government debt is the premier risk-free asset. Have you heard of Triffin's Dilemma?

    1. My mind was in the Eurozone when writing the article; in a currency union the situation is very different and CA deficits are to be avoided at all costs.

      Overall though I am inclined to agree with you that it is not a big deal running a deficit as long as a) you have sovereign currency and b) the government borrows in that currency to fund the loss in demand. A problem arises if private sector debt fills this demand gap.

      In this case, a period of higher consumption now may be followed by a period of lower consumption later (if and when the deficit reverses) but the free floating currency prevents any particularly bad outcome.

      Really it was lazy writing on my part, as I was more concerned with the surplus than the deficit and didn't think beyond the Eurozone.

      Anyway, I look forward to your piece on the UK.


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