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Previously, we talked a bit about the
"current account deficit." To refresh, an economic entity can have
a "current account deficit" or a "current account surplus,"
which, in the accounting terms used for individual entities, is analogous to
"generating cash" or "consuming cash." Neither is a good
or bad thing in all situations. While it may seem that "generating
cash" is a good thing, there are many "activist" investors who
are now pressuring corporate managements to "consume" their cash in
more productive ways! Indeed, high cash consumption is often a sign of a
plethora of investment opportunities, and thus of general good times.
That said, there is no "economy"
besides the activities of these economic entities, which we broadly
categorized as households, corporations and governments. An "economic
entity" is my term for an entity that is legally recognized to operate
as an economic unit, and has its own, unified assets and liabilities, inflows
and outflows, as represented for example in financial statements. This in
turn is defined by the legal status of ownership and obligation.
Assets are that which one owns; liabilities are obligations. Inflows involve
taking possession, and outflows involve relinquishing possession. Given that
one could have a lively debate (of the sort that goes on every day in
boardrooms) about whether a single economic entity should generate or consume
cash, once again consider the absurdity of trying to come to a meaningful
conclusion about whether the imaginary statistical abstraction known as a
"country" should, in aggregate, generate or consume cash!
All that one can really conclude is that, if a borrower decides to borrow,
and a lender decides to lend, then they do so because they see mutual benefit
in that arrangement. A "current account deficit" is merely a
situation in which the total amount of cash generated by those entities,
within a statistical area like a "country", is less than the total
amount of cash consumed by those entities which choose to be cash-consumers.
A "current account surplus" is the opposite condition.
I am painting a picture here of what the world
economy (there is only one economy) actually consists of, which is kazillions of economic entities, as opposed to the
metaphor you read about in the newspaper of this or that "national
economy" connected by some weird plumbing of "international
finance" with other "national economies." Each economic entity
may choose to operate on the basis of a certain currency, which is provided
by governments or government-sanctioned institutions such as central banks
(at the present time, though this was not the case in the past), or an entity
may operate on the basis of several currencies, as is common with
corporations and governments, and many households as well.
"Current accounts" are, as noted,
typically given for aggregates of individual entities. One can think of many
groups for which one can aggregate current account information. California
dentists have a current account surplus of $2.5 billion, while divorced real
estate agents living in New York City have a deficit of $1.75 billion.
Latinos in Los Angeles have a current account surplus of $5 billion, but
Latinos in Florida have a deficit of $2 billion. It may seem frivolous to
denote the "current account balance" for Latinos living in Los
Angeles, a group of perhaps 4 million people or so, but is it no less
frivolous to denote the "current account balance" of the 1.4 million
Estonians living in Estonia? What about Estonians that aren't living in
Estonia?
It can be observed that, among entities
sharing the same currency and general legal jurisdiction, such "current
account balances" are largely meaningless. Certainly Connecticut has
such a balance, as does Massachusetts. Official record may even be kept
somewhere, although I've never seen them. That's because I've never looked
for them, because they are irrelevant. This is interesting: we don't pay any
attention to the current account balance of California, for example, even
though, if it was a separate country, California would be one of the ten
largest countries in the world in terms of GDP.
That said, it is true that the effects of
certain trends appear in the current account information, and thus, to the
extent that a trend may portend something unfortunate, one can say that the
current account information portends something unfortunate. For example,
governments are often big borrowers, i.e., consumers of cash, and thus a
country whose government consumes a lot of cash will often tend to consume
cash on an aggregate basis, or in other words, run a "current account
deficit." Since governments today spend vast amounts of resources for
little or no gain whatsoever, financing such expenditures with debt
constitute "bad debt" (as described last week). When governments
are deeply in debt, or are running large budget deficits, they tend to do
things which are bad for all those living and operating within their jurisdiction,
such as raising taxes and playing games with the currency.
Likewise, the main generators of cash in any
economy tend to be households. Since, as noted, "bad debt" is the
rule rather than the exception with regard to household debt (the exception
being debt used to finance the purchase of reasonably priced shelter,
or to engage in cash-generating investments) low or no cash generation by
households may indicate the accumulation of large amounts of "bad
debt" or a low level of liquid assets in general. This also contributes
to a "current account deficit" on a country aggregate level. While
we noted earlier that, on the personal level, your neighbor's
financial problems do not affect you very much, when enough people do the
same thing that it shows up on the country-level aggregates such as the
"current accounts", it may result in an economic event such as a
recession that certainly does affect you.
Corporations mostly engage in "good
debt," with the amount of debt they take on often related to the
economic opportunities available. This "cash draw" also influences
the aggregate current accounts, but may indicate positive conditions.
To make a long story short(er),
"current accounts" begin to become meaningful when they describe
transactions that take place between parties whose accounts are based on
different currencies. Typically these entities are located (or affiliated)
with different countries, and thus the aggregate country current account
describes the amount of "cross border" (actually cross-currency) contracts
being created. Now this is the crux of the matter, for as noted previously,
net capital flows between countries create long-term relationships, which
simple trade does not. This relationship can be distorted in some pretty
awful ways by changes in currency value.
In no way does international investment (i.e.
"current account imbalances") inherently cause changes in currency
value. This is easy to see in the case of different countries that use the
same currency, such as the dollarized countries of Latin America or the
countries of the eurozone. No matter how big the
"current account imbalance" becomes between France and Germany, the
euro is not going to shatter into two separate currencies because of it, any
more than the "current account imbalance" between Arizona and New
Mexico, or El Salvador or Ecuador, is going to cause the dollar bills in
people's pockets to burst into confetti. The problem is, when currency values
change for some other reason, there can be a lot of people that get
into big trouble if they have lots of contracts denominated in foreign
currencies. Indeed, in the process of getting into trouble, within today's
chaotic environment of floating currencies, the problem can become even more
exacerbated. That is a second risk between such cross-currency interaction:
when more and more people are affected by a move in currencies (and there are
always moves in currencies in today's floating world), there is a
greater and greater likelihood that many people experiencing the same
stimulus will react in a similar fashion, causing a "stampede" of
one sort or another and generally making the situation more unstable.
This is not the fault of cross-currency
investing ("current account imbalances") per se, but the fault of
incompetent central banks that are not willing or able to manage their
currencies in a prudent manner.
Conclusion: A "current account
imbalance" does not inherently cause economies to implode or currencies
to collapse. The U.S. ran a "current account deficit" for well over
a hundred years, every year, from the colonial era to World War I, as
European capital flowed into the New World. The dollar was on a gold standard
for nearly all of the 19th century, and the economy flourished.
Today, the "current account deficit" is a reflection of wasteful
government spending, financed by debt, and a housing/consumer boom, also
financed by debt. These may cause problems later, although not because of the
"current account deficit." There is some risk, however, that because
so many people outside the United States now hold dollar-denominated paper,
and are thus exposed to the same stimulus of foreign exchange rates, that
they may all decide to do the same thing at the same time. Even this would
not be a problem if the Fed was a competent manager of currencies, but it is
not, and that, not "current account imbalances," is likely to be
the root cause of any economic instabilities going forward.
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United
States, Japan,
and the Middle East. About the Book: Gold:
The Once and Future Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is
available at bookstores nationwide, from all major online booksellers, and
direct from the publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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