Home > Economic policy > Looking over the edge

Looking over the edge

November 30th, 2004

Another big blowout in the current account, the trade account and foreign debt. Costello is blaming it all on the appreciation of the dollar but the housing boom on which the government won re-election is at least as much to blame. Here’s my take, from the Fin a couple of weeks ago.

Although they are not particularly tightly linked with respect to trade and capital flows, the economies of English-speaking countries seem to share common characteristics, though not the same characteristics over time. In the 1970s, it was common to see reference to the ‘English disease’ referring to high levels of strike activity and cost-push inflation. More recently, most of the comparisons have been favourable, comparing dynamic English-speaking economies, with sclerotic Europe and chronically depressed Japan.

There is, however, a cloud on the horizon. With the exception of Canada, all the major English-speaking countries are running large trade and current account deficits, and most have done so consistently for a number of years. A deficit on the current account implies an equal and opposite surplus on the capital account, which in turn corresponds to an excess of national investment over national saving. A gap between investment and saving might arise from high imports of capital goods, reflecting the existence of more opportunities for profitable investment. The output produced by these investments would be expected to boost future exports, returning the trade balance to surplus, and thereby permitting the servicing of the debt created in the present deficit phase.

An important point, not sufficiently appreciated at present is that, while current account deficits may be sustained indefinitely, imports and exports of goods and services must balance out in the long run. Assuming, as is generally the case, that the rate of interest on foreign debt exceeds the nominal growth rate of the economy, consistent trade deficits imply explosive growth in the ratio of debt to GDP, which cannot be sustained indefinitely.

Those who regard the current account deficit as not being a matter of serious concern have commonly asserted, or assumed, that this is the case. In fact, however, business investment levels have not been particularly high. In Australia, a good deal of investment has gone into the housing sector, which does not produce tradeable outputs that can be used to service debt. Exports of manufactured goods have actually been declining in recent years.

The crucial fact explaining the large external deficits of the English-speaking countries is that all have experienced rapidly declining national savings, primarily as a result of declining household savings. Australia is in the almost unparalleled situation of having negative household savings. In the United States, household savings are a little above zero, but are cancelled out by large and growing government budget deficits.

The position of the US is bolstered by the fact that it is the world’s largest financial centre and the $US is a reserve currency. In fact, it’s hard to imagine that any other country could sustain such massive imbalances without running into a financial crisis.

The possession of a reserve currency is something of a double-edged sword, however. A shift from a dollar-based global economy to one in which either the euro or some sort of composite basket played the role of reserve currency would be hugely disruptive. Although the pain would be felt globally, the US would inevitably be most severely affected and the adjustment could take many years. Britain’s decades of malaise in the 20th century were in part an aftershock from the decline of the pound.

The other problem with possession of a reserve currency is that it reduces the pressure to resolve imbalances. Although President Bush has promised to cut the deficit in half, no one seriously believes that this goal can be achieved with his current policies. And the US Congress has passed a string of bills laden with pork barrel spending and targeted tax concessions, with more to come. The longer adjustment is delayed, the more painful it is likely to be.

Australia is, in important respects, in a stronger position than the US. Australian governments are generally running small surpluses, and the government balance sheet is strong, with substantial positive net worth for the government sector as a whole. Since our negative net saving is due primarily to borrowing against increased values, a soft landing for the housing sector would presumably imply a gradual increase in saving.

As the ‘Asian tigers’ learned, however, it’s easy for markets to change their views of an entire group of countries in a very short time. If the current relaxed view of US trade and current account deficits were to change, it is likely that all the English-speaking countries would face exchange rate pressure and a sharp increase in interest rates. Australia is not well-prepared for such a shock.

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  1. Giles
    November 30th, 2004 at 07:30 | #1

    “as is generally the case, that the rate of interest on foreign debt exceeds the nominal growth rate of the economy”

    I have thought that this observation only applies to countires with debt denominated in a foreign currency. In own currency terms interest is normally about equal to the rate of nominal GDP growth, excpet in recessions.

  2. John Quiggin
    November 30th, 2004 at 07:38 | #2

    The government bond rate is usually about equal to the rate of nominal GDP growth, but borrowers in general pay more than this and the expected return to equity investors is higher still.

    I agree that the phrasing is a bit stronger than it should be, but it’s difficult to fit the necessary qualifications into an Op-Ed piece.

  3. still working it out
    November 30th, 2004 at 08:14 | #3

    I was surprised to learn (although, i guess i shouldn’t be) the other day that Australia’s banks are sucking in huge amounts of capitol from overseas. It got me wondering if there is any layman’s explaination of the make up of Australia’s private foreign debt.

    Who is lending us the money? In what form? In which currencies is it denominated? What are the rates? and how much of it is fixed interest? Is it all going to the banks directly? Are the Asian central banks keeping an eye on our exchange rate or do they think it unimportant? It seems a readjustment is certainly coming and I think this information would be very useful in figuring out how we are going to be affected, but i don’t even know where to start looking for it.

  4. Tony Healy
    November 30th, 2004 at 08:26 | #4

    The Age’s Josh Gordon says:

    * The current account deficit is larger, as a percentage of the economy, than when Keating warned we were in danger of becoming a banana republic.

    * We owe the equivalent of more than $20,000 for every man, woman and child.

    * About 77 cents of every dollar of debt was borrowed by private-sector financial institutions, which have been using the money largely to finance the housing boom.

    * Australia’s current account deficit as a proportion of the economy is now higher than in the United States, where investors are offloading US dollars on concerns that the situation is not sustainable.

  5. Homer Paxton
    November 30th, 2004 at 08:46 | #5

    Lets put the current account into context.

    If the terms of trade were the same when the Banana republic statement was uttered then Keating would have been talking about a current account surplus!

    Instead today we have a currebt account deficit of 6.5% of GDP when out terms of trade are very very strong.

    We have wasted this on a housing bubble. The major problem is what happens after.

    history suggests a wee bit of pain is coming up.

    Like Keating in the 90′s costello has been asleep at the wheel.

    By the way if those LAW tax cuts had have gone to make a SGC of 15% most of the problem of an ageing population would have been ‘solved’.

  6. November 30th, 2004 at 10:05 | #6

    Australia has the wrong demographics for merely financial measures to “solve” the ageing population problem. With these demographics, measures that look like they would work would instead end up bidding up the prices of such things as doctors and nurses when the need falls due.

  7. observa
    November 30th, 2004 at 13:04 | #7

    Fallacies of composition aside, it is a no-brainer that generally the wealthier you are the more indebted you are. The sum of Aust individual’s situations could simply reflect this fact. ie we heard recently how Austns have increased their wealth dramatically over the last decade, albeit largely via RE values.

    Contributing to this growing wealth, apart from their willingness to lend to Austns, may be the trend for OS residents to invest in Aus RE also. To what extent has demand from wealthy SE Asians, Eastern Blockers and now perhaps Chinese, pushed up our RE prices? The truth is we will never know in a floating dollar economy, nor is there any forseeable cause to see this investment suddenly withdrawn. Where would it go? ME or African real estate? This sort of global investment cash has a simple rule to guide its destination- Position, position, position, unfortunately for our first home buyers. Fortunately for them, to help ameliorate the pain, there is an abundance of international cash about, if current prices are any guide.

  8. derrida derider
    November 30th, 2004 at 13:14 | #8

    PM Lawrence is right, Homer. And besides you shouldn’t believe all you read in the papers – Australia simply does not have a problem funding population ageing. Those saying otherwise often have an interest in scaring you into putting your money in their hands.

    The Intergenerational Report and the recent PC report both project the government share of GDP will rise by about 6 or 7 percentage points over a 40 year time frame (ie the rate of increase is a bit slower than in the last 40 years). But when you pick the details apart, less than half of this projected increase is a product of demographic change – the rest is driven by such things as ncreasing per-unit costs of health services (partly through PM Lawrence’s mechanism).

    Adding 15% to employer’s wage costs would really hurt either employment or current wages or both. Our children are going to be much richer than us – its unfair to cut low-income worker’s living standards now in order to ease their future tax burden (making high income people put money into super mainly just changes the form rather than the level of their saving – it’s low income people who wear the burden of compulsory super, especially as we rip most of it back from them in the form of fund fees, tax and a reduced age pension).

    From this POV we should be relaxed about our foreign indebtedness. But IMO the real issue with a big CAD is that we’re putting yourself at the mercy of markets that are prone to violent and unpredictable changes of sentiment through herd behaviour. That is, it is stability rather than level of future growth that is at risk.

  9. Homer Paxton
    November 30th, 2004 at 13:40 | #9

    sorry for my clumsy wording but yes Pm and DD you are right.

    however a 15% SGC would mean that excessive words on this topic would not be the case.

    to my mind that was the worst public policy decision made in the last 8 years.

  10. Razor
    November 30th, 2004 at 14:06 | #10

    If it is such a problem, how come all the economists I’ve heard (who are probably a lot smarter than I am and actually are fully utilising their economics degree, unlike me, with huge resources to conduct their analysis) aren’t predicting a fall in the value of the AUD in the near future??? It can’t be that bad can it.

    You wouldn’t be trying to make bad news just because it is a Howard Government, would you?

  11. Homer Paxton
    November 30th, 2004 at 14:13 | #11

    Razor, take a look at the $A against the current account deficit.
    You will see it follows a pattern.

  12. still working it out
    November 30th, 2004 at 14:41 | #12

    Razor,

    A lot of smart people did not predict the Mexican currency collapse, or the East Asian currency collapse, or Russia, or Argentina…

    There is a good reason for this. Confidence in a currency is in large part perception. Once some people’s confidence goes a little bit, other people’s will shortly follow. Hence a currency collapse.

  13. Razor
    November 30th, 2004 at 14:44 | #13

    still working it out

    So you believe that our economy and currency has the same fundamental problems as the examples you have given – I am all ears, please clarify.

  14. November 30th, 2004 at 15:19 | #14

    I celebrate the increase in our capital account surplus, and hope that we continue to attract foreign investment.

  15. November 30th, 2004 at 18:43 | #15

    Off topic but yeah…

    John, Im interested to hear your take on the issue with Kofi Annan and his son. Tim Blair is the only person who has addressed it so far.

  16. kyan gadac
    November 30th, 2004 at 20:14 | #16

    I think that we can confidently predict that we will in large part solve the ageing problem by importing cheap tax-earning labour from overseas – e.g se asia. This is a time honoured solution and is already in play in the skilled labour sector – it’s only a matter time before housemaids follow nurses follow the doctor’s so to speak.

    I was going to mention the current preciptious decline that is afflicting the UK housing market but observa pulled me up with his pungent observation about the impact of overseas buyers on our property market. But capital has fled to property markets everywhere it seems, to escape the perceived impending $US debacle, so even though Pt Piper or Toorak might not lose value the mortgage belt will probably get hit one way or another.

    Nevertheless the idea that Oz is economically well situated to ride out the storm of a US economic crash is worth considering. John Howard notwithstanding :-) , we may find ourselves in a much more powerful economic position relative to other countries (in particular ‘Western’ countries)than we have in the past.

    One of the consequences of the globalisation of technology is that ownership(as in location,location,location) of resources and raw material becomes the primary determinant of wealth. When our primary market becomes India and Indonesia then the average distance to our export market has fallen radically.

    Gee I’m not usually this optimistic?

  17. James Farrell
    November 30th, 2004 at 20:26 | #17

    John Humphreys

    You made exactly the same weird statement last time this topic came up. To say that foreign investment is good in and of itself is to say that having net liabilities is good in and of itself. You do understand, don’t you, that having foreign investment doesn’t tell us anything about how much investment in capital equipment is occurring. We could borrow ten times our GDP and spend the money on internet gambling, and it would still be ‘foreign investment’. Alternatively, you might be under the impression that you are a lonely beacon of wisdom in a sea of mercantilist ignorance. Well, trust me, we all know it can be appropriate for a country to incur foreign liabilites in some cricumstances. What’s being debated here is: are these such circumstances?

  18. December 1st, 2004 at 01:53 | #18

    John,

    Canada’s anomalous status among the Consuming Anglosphere is only apparent, not actual. Canada’s economy is for all practical purposes an annex of the United States. The country runs a massive trade surplus with the US (+C$90.5bn in 2003) but a very large trade deficit with the rest of the world (-C$32.3bn in 2003).

    Gen’l Glut

  19. December 1st, 2004 at 09:48 | #19

    James — I don’t think my comment was weird. If there is an argument that capital in Australia is being misallocated, then make it. However, I think it is a very fair observation to note that the standard reporting of the CAD is that it is a problem. I think journalists should be required to report only the capital account so that they wont have to say the word “deficit” and then perhaps they won’t look so worried.

    As for the allocation of capital in Australia — I think it foolish for anybody to suggest that they know the correct distribution. I trust the market allocation of capital more than I trust a politicians allocation of capital (and yes, even more than I trust you or Q).

  20. still working it out
    December 1st, 2004 at 09:57 | #20

    Razor,

    I don’t know. All I know is that the conventional wisdom (ie. the experts) seem to be wrong about these things as often as they are right and we’ve got some pretty huge imbalances at the moment. Negative savings and just about the highest amount of personal debt in the world is not sustainable. I am no economist so I am not able to compare our current position with that of say pre-crisis Argentina. But its pretty clear that we are living beyond our means and that this will have to come back into balance somehow. What I really want to know is how? A currency crisis is one possibility, but I have no idea how likely this is. I would love to know.

    We feel that because our government has kept the budget in surplus we are in a good financial position and so are not vulnerable to the problems that the US looks like its got coming. But I don’t buy that. The private sector debt dwarfs government debt and we are not so big that, as is the case in the US, its problems are everyone’s problem. And what really worries me is that if/when the US dollar really starts to go that the “experts” will suddenly re-think their opinion on the Australian economy and our currency will get sucked down as well. In the East Asian currency crisis many genuinely sound currencies were hit very hard for no reason other than general panic. It is possible that something similar may happen to us, especially if foriegn investors have a closer look at our massive personal debt.

  21. still working it out
    December 1st, 2004 at 10:17 | #21

    John Humphreys,

    Foriegn investor’s do not care if the capital they lend to us is invested wisely or wasted on consumption. They only care about rate of return and likelihood of default.

    A bank issuing a credit card does not care if the money is blown on the pokies or invested in shares. It only cares about repayment.

    The question is how WE allocate the capital we have taken from overseas, not what the foriegn investors think. Capital can be blown on consumption as easily as it can be productively invested. Blind Freddy could see which of those two options we are putting our money into today.

    There is no rule which says borrowed money is can only be invested in productively in ways that will increase our GDP.

  22. still working it out
    December 1st, 2004 at 10:50 | #22

    Sorry. That last sentence sucked. Here it is again in English.

    There is no rule which says borrowed money can only be spent in ways that will increase our GDP.

  23. observa
    December 1st, 2004 at 13:56 | #23

    Compliments of commenter Stan over at CLs

    “Celebrating Two Centuries of Current Account Deficits. The further deterioration in Australia’s current account deficit in Q3 to test previous cyclical highs as a share of GDP has seen the usual doom-mongering, with predictions of a currency ‘crisis’ (the Australian dollar is in fact at historical highs on a trade-weighted basis) and claims foreigners will stop funding our supposedly excessive consumption. The fact that foreigners have been funding Australia’s economic growth in this way more or less continuously for 200 years perhaps makes predictions of this kind the single worst cumulative forecasting failure of any economic point of view, yet people never seem to tire of these predictions.”

    http://www.institutional-economics.com/

    A couple of observations I’d make about private debt spiralling out of control. Firstly almost all small/medium business loans nowadays are actually mortgage charges on the business owner’s home. The use of flexible mortgage drawdown facilities, ensures its widespread use for financing lumpy cash flow shortfalls. Secondly many of us particularly post GST, use credit cards for much incidental purchasing(particularly vehicle expenses where cheques are costly and problematic tender). In my case my business partner and I have a Mastercard each and these cannot exist solely under a corporate or business name, but must be issued to individuals under current banking laws. Ipso facto, there is no longer any way of accurateely determining private versus business financing debt.

    As well my wife has our only VISA credit card, which by dint of rewards points and interest free period, she pays for everything from groceries to utilities bills, rates, etc. The maximum debt at the end of any month might frighten some, but has never incurred an interest payment for its owner. This type of credit card supposedly adds to the nation’s overall consumer debt levels, as well as the business cards. So what?

  24. Molly Rowan
    December 1st, 2004 at 14:13 | #24

    Dear J

    Thanks so much for your blog, I do so enjoy reading and learning from the threads of your economist types. Though some of your more esoteric modelling can be quite confusing at times. Especially when they are just as quickly countered.

    As SWIO writes, of course lenders (whoever and where-ever they are from) don’t mind what their money is spent on, as long as they get it back, on time and with the appropriate interest. However, I guess the $65,000 question is, with every Australian on average owing $20,000 (including all our children)- being 150% of what we earn, and mostly having been spent on real estate and consumerables – when and what will be the ‘tipping point’? And what price will we have to pay for their largesse and our naivity?

    I handed out ‘how to vote’ cards for the Independent Candidate, Brian Deegan, in Alexander Downer’s seat, and I know that the most compelling reason (obviously there were others) people voted for Ratty was the fear of the Coalition’s predicted interest rate rises if Labor got in. People are undoubtedly deeply overcommited debtwise.

    We just cannot go on spending such a % more than we earn for very much longer, surely even the most strident rightwing pundits must agree with that point.

    PS. My mum always used to pay cash immediately she received any bill, saying without fail, as she smilingly handed the money to the non-plussed cashier, ‘out of debt, out of danger’. Of course she had lived in London (and barely survived) through the The Depression and WW11.

    Regards

  25. ray
    December 1st, 2004 at 14:13 | #25

    After today’s GDP data you can bet with some confidence that Australian growth will be below trend for at least a few quarters. In the immediate term, unless our coal, other mineral and agricultural exports don’t pick up, we will probably get a more severe CAD as a % of GDP. The other wild card is the amount of Australian debt denominated in USD, which way are US interest rates going? In that environment our net income deficit will likely persist and possibly get worse. Extreme slowdown anyone??

    Ray

  26. Razor
    December 1st, 2004 at 16:43 | #26

    Not likely Ray. The current major restraint on our export performance is lack of infrastructure to export the commodities the world wants. Demand is strong and looks like remaining so. Hence, no slow down. As much as some people don’t like it, our comparative advantage in this world is in diggin up raw resources and shipping them out.

  27. Mark Upcher
    December 1st, 2004 at 17:33 | #27

    For all the doomsayers, our current experience is nothing new.
    (1) The current account deficit (CAD) is cyclical – it is high when the economy is growing strongly because this is when imports are particularly strong and there is some diversion of output to satisfy domestic demand rather than exports. Currently the CAD is at a cyclical peak.
    (2) This is not the highest peak CAD as a percentage of GDP – it was much higher in the 1980s and was higher at various times during the mid to late 1990s when the economy was growing strongly.
    (3) Typically, as the economy slows the current account deficit improves. With housing investment at its peak and signs of slowing in growth in retail sales, there is a reasonable expectation that growth in the Australian economy will slow over the next year or so. The current account deficit will then improve.
    (4) Interestingly, the markets reacted yesterday to news of slowing in growth by marking down the $A, when slower growth is likely to improve the CAD.
    (4)As John Humphries argues, Australia is still a good place to invest. Contrary to what has been said in some earlier posts, the level of investment in machinery and equipment and non-dwelling construction has been quite healthy in the last few years.
    (5)Does it matter if household savings is at an all time low if Government savings are at an all time high? The two are balancing each ther out. One could argue that the shift from public to private provision of health, education and other services might have at least some influence on this shift between public and private savings.

  28. observa
    December 1st, 2004 at 19:40 | #28

    Given the trends in business financing I outlined above, it is probably high time the ABS surveyed business proprietors to ascertain just how much business investment is really disguised as consumer debt. Economists might be in for a pleasant surprise, which probably shouldn’t really be a surprise, given the lowest unemployment rate for a generation.

    If you think ABS annual business surveys are of any real use in this regard, you’ve got to be joking. I always pull out last years Company return, as I’ve never got this years ready by Sept and attempt to fit some sort of coherent figures into their blessed forms, without it appearing not to add up. To properly survey business financing the ABS would need to use face to face surveys, but that’s probably cost prohibitive. Might be worth a once-off though, to get the big picture on the true state of business investment.

  29. James Farrell
    December 1st, 2004 at 22:34 | #29

    The optimistic analyses above all ignore – as far as I can see – John’s main point, that the trade balance can’t be negative forever. It has averaged about minus 1 percent of GDP for the last forty years, and has been positive very rarely. This pattern is quite unique in the OECD and if it continues indefinitely, then at some point we’re in a debt trap. One can make this point witout insisting that disaster is just around the corner, and no one in the above discussion is doing that.

    And as John also points out, a high rate of fixed capital accumulation is only an excuse, as it were, for a big debt, if that investment is in sectors producing tradable goods that will ultimately be used repay the debt. Australia does have a reasonably high investment rate – higher than the UK or the US, for example – but the proportion devoted to housing construction is much higher. This means that investment in plant and equipment, despite having risen in the last few years, is lower (in fact the two are about equal, at around 6-7 percent of GDP as I recall). And apart from a few flea-infested illegal backpacker flats in Bondi, there’s no way housing can be interpreted as a tradable good. The fact that people (including foreigners) are prepared to pay so much for real estate indicates, when all’s said and done, precisely that resources are expected to continue flowing toward non-traded goods and services, including accommodation.

  30. John Quiggin
    December 2nd, 2004 at 08:12 | #30

    Responding further to Mark, I don’t think the late 80s are a very appealing example for CAD optimists. The subsequent experience, including one of the deepest recessions in Australian history, certainly shows that current account deficits get stabilised in the end, but not necessarily in a comfortable fashion.

    The big question is whether this was entirely the fault of misconceived monetary policies or whether large imbalances always carry a substantial risk of painful adjustment like this. The successful management of the banana republic crisis in 1996 was taken as evidence that the policies adopted then, a short sharp shock in interest rates would work again next time. Similarly the macro policy successes of the mid-90s have produced a level of hubris which will now be tested (to be fair, the Reserve Bank has been consistently more concerned about risks to stability than has the government).

  31. December 2nd, 2004 at 09:53 | #31

    Still working it out — I know how capital is allocated, and still see no reason for believing it is being allocated worse than how you would allocate it.

    Consumption is not waste. Indeed… there would be little point investing and producing and never consuming. We do not consume for the purpose of making sure people can produce. We produce so that people can consume. There is necessarily nothing wrong with borrowing to consume.

    You’re correct that not all borrowed money will increase GDP. But there is more to life than GDP. If it was, then we would all be happier if we worked 22 hour days and never consumed. I know few people who believe that.

  32. December 2nd, 2004 at 09:55 | #32

    That should be: there is not necessarily anything wrong with borrowing to consume.

    Also, if there is a capital misallocation problem — then we should worry about that and not continue the myth of the ever-evil CAD.

    I wonder if this makes me a CAD-sceptic? :)

  33. James Farrell
    December 2nd, 2004 at 12:09 | #33

    A lot of consumption is waste, but you’re right in pointing out that the aim is to maximise utility, not output, over time.

    As for your second point, the capital misallocation problem and the CAD problem are just two ways of describing the same thing. The CAD is a problem if capital is misallocated, and the pessimists are saying that capital is indeed misallocated. To respond by invoking the invisible hand is just empty sloganeering.

  34. Homer Paxton
    December 2nd, 2004 at 12:37 | #34

    I was told this was the worst deficit on record.
    At least in the 80′s we had the excuse of a the terms of trade falling like a WMD however we now have the strongest Terms of trade in 30 years.
    not something I would normally associate with a record current account deficit.

    I must say talk of all this productive investment reminds my of the old 80′s days when the same reasons were given.

  35. still working it out
    December 2nd, 2004 at 13:44 | #35

    John Humphreys,

    I agree with both the points that you make

    there is not necessarily anything wrong with borrowing to consume

    if there is a capital misallocation problem — then we should worry about that and not continue the myth of the ever-evil CAD.

    I feel that there has been a capital misallocation, mainly because of the housing boom. Basically my point is that we are not investing productively enough to justify our high CAD, and the simple evidence of this is as John Quiggin points out “that the rate of interest on foreign debt exceeds the nominal growth rate of the economy”. If we were growing rapidly I would seen no problem with the high CAD. It would mean we are able to afford it.

    In other words, the return we are getting on our investments (our rate of growth) is less than the interest we have to pay on the money we borrowed (the CAD) to make those investments. The difference will have to come from somewhere.

    The analogy is borrowing $200k to buy a property at 7% and getting a total yield (rent + capital growth) of 5% and then constantly increasing the size of the loan to cover the shortfall. At some point it becomes unsustainable.

  36. Alex
    December 2nd, 2004 at 17:01 | #36

    I can’t see that it is valid to look at the debt issue without also looking at the asset question. This also applies to Jeremiah Quiggin’s comment in his initial post “while current account deficits may be sustained indefinitely, imports and exports of goods and services must balance out in the long run”. If the excess of imports over exports results in the accumulation of an equivalent value of assets, surely the books are balanced?

  37. Mark Upcher
    December 2nd, 2004 at 17:20 | #37

    John

    All I was saying was that CADs are cyclical and so while we are at a peak in the current CAD cycle, the economy will slow and the CAD will improve – a fairly obvious point, I agree, but seemiongly overlooked by other commenters. Over the last 45 years the average for the CAD has been a 3.5 per cent deficit. When growth is above average the CAD is higher, when it is below average it is lower.

    The late 1980s was driven by strong investment in both dwellings and office blocks. The subsequent slowdown was an extreme example. It would have happened anyway but was then exacerbated by draconian and, in my view, misguided monetary policy. Since then we have had successive peaks and troughs in the CAD (with a 3.5 per cent average) primarily associated with peaks and troughs in the dwelling cycle. However, in the current cycle while dwelling invesmtent is extremely strong machinery and equipment investment is also at an all time high. This should make some of the pessimists less concerned.

    To summarise, we should not be so worried whether the current level of the CAD is sustainable (it is not) but whether the average over the economic cycle is sustainable (echos of the Federal Government’s sustainable fiscal policy mantra).

  38. John Quiggin
    December 2nd, 2004 at 20:57 | #38

    Alex, a couple of points of rhetorical advice.
    (1) Don’t mix serious requests for clarification with sarcastic epithets
    (2) The term ‘surely’, usually indicates ‘I’m not sure but I want this to be right’.

    Coming to substance, your claim is either tautologically true, but irrelevant, if you are deriving asset values as the present value of the flow of services they generate, or relevant and false, if you ae valuing assets at cost.

  39. James Farrell
    December 2nd, 2004 at 21:24 | #39

    Yikes! I bet I use ‘surely’ too much. Better attend to that. I wish Word would challenge one on such things, instead of complaining about the passive voice in situations where it’s obvious to anyone but a machine that the active is unworkable.

  40. Alex
    December 3rd, 2004 at 10:17 | #40

    Sorry, JQ, wasn’t intending to cause offence, just picking up on the pessimistic tone of your post. I’d appreciate it if you could elaborate slightly more on your comments. Particularly as to why what I said is “tautologically true, but irrelevant”.

  41. Alex
    December 3rd, 2004 at 10:34 | #41

    BTW, on an issue slightly related to this thread, there’s a theory (I believe associated with Schumpeter) that one of the weaknesses of capitalism is that it is prone to overproduction and underconsumption, which gives rise to periodic recessions. Interested to hear your comments on this, JQ. If you agree with this thesis (or even if you don’t) I wonder if you’d like to comment on the proposition that the current consumption orgy by Australia and the US in particular may be a good thing because it counterbalances the underconsumption/overproduction of a number of other economies.

  42. Homer Paxton
    December 3rd, 2004 at 10:43 | #42

    I just found out that again costeelo beats Keating and this current account deficit as a % of GDP is larger then in the bananna republic days or in the days it casued Cozzy anger!

    Mark,
    Yes it is cyclical ( it used to be called a restraain on growth when I was young) but why does the economy slow after this ?

  43. Mark Upcher
    December 4th, 2004 at 14:18 | #43

    Homer

    Don’t quite understand your point/question. The cyclical behaviour of the CAD coincides with the cyclical behaviour of housing investment. So because housing investment is at a cyclical peak, we can expect that it will begin to decline and the CAD will improve.

  44. Splat Guy
    December 5th, 2004 at 02:34 | #44

    I’ll agree with a lot of the comments on here regarding unproductive consumption – I still can’t believe how many people have bought $4,000 plasma TVs. But if it makes people happy, then why shouldn’t they?

    Firms presumably know that they’ll need to produce goods/services in the future, so they must have been investing in capital; I doubt the entire productive side of the economy is expecting just to use up existing capital stock and then go broke. A *lot* of investment has been happening.

    Just on a side note, Razor mentioned that our comparative advantage is digging stuff up. While true, I wonder if a lot of recent investment hasn’t been in human capital? Certainly a lot of investment done through my own business and that of the firm I work for (to supplement my income) has been in skills and technology, which have a tendency to (1) increase consumption and (2) exaggerate the CAD.

  45. thersites
    December 5th, 2004 at 21:23 | #45

    “In fact, however, business investment levels have not been particularly high. In Australia, a good deal of investment has gone into the housing sector, which does not produce tradeable outputs that can be used to service debt. Exports of manufactured goods have actually been declining in recent years.”

    That concurs with what i thought was the case but ive been scratching my head since Alan Kohler wrote in the SMH last week:

    “The current account deficit is 6 per cent of GDP because there is an
    extraordinary investment boom going on. As HSBC’s John Edwards points out,
    investment is a record 25 per cent of GDP, domestic savings are steady at 19
    per cent and the difference (6 per cent) comes from offshore. Edwards says
    Australia’s investment boom is almost as big as China’s (proportionately) -
    the greatest in 40 years, and it’s why we have a high current account
    deficit despite very good terms of trade.”

    Huh? Last time i looked at the RBA chartpack business investment was around 12% which is around the long term norm except for recessions & the savings rate had fallen below zero. Or has Kohler included housing investment in the numbers?

    Kohler also refers to a double counting problem with housing expenditure that technically eludes me at the moment? I came here as a potential source of explanation?

  46. Alex
    December 5th, 2004 at 21:31 | #46

    thersites, the difficulty is that a lot of small to medium businesses are now required by the banks to use their homes as collateral when borrowing for business purposes. Thus a good deal of what is actually borrowing for investment gets counted in official statistics as borrowing for housing.

  47. Mark Upcher
    December 5th, 2004 at 22:00 | #47

    Alex

    I would be suprised if this miscounting of business investment were the case. Even if homes were being used as collateral, the statistics would be based on the purpose of the loan.

  48. John Quiggin
    December 5th, 2004 at 22:24 | #48

    Thersites, Kohler has included dwelling investment in the numbers, and his whole position is based on the premise that current house values are sustainable.

    The double counting problem refers to the fact that maintenance expenditure on housing (and other capital goods) is treated as a current cost rather than an investment. If I understand correctly, substantial renovations are treated as investment. All this is standard, and doesn’t go far to allay concern about a negative savings rate.

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