If you’re trying to reconcile unlimited wants with limited resources, and someone is willing to lend you the money, borrowing looks like a neat solution. For nations, collective borrowing is measured by the current account deficit[1]. Until quite recently, however, it seemed to be generally accepted that there was a limit beyond which such borrowing was imprudent and that the limit was around 5 per cent of GDP.
There are some good arguments against the traditional view, and we’d better all hope they are valid, though I fear they are not. I’m working on a big piece on this. More soon I hope.
fn1. More precisely, by the capital account surplus which is equal and opposite to the CAD.
John Quiggin 
The 7.1% figure is big. It was exceeded during the Depression (10%) and during the 1950s (up to 14%) and on a few occasions from 1886-1920 when on occasions massive capital flows poured into Australia. On my reckoning the ratio averaged about 3% from 1860-1990.
There is obviously no a priori upper bound — if there were enough strong resource and other projects being funded I guess it would not matter. But I assume concern is based on the fact that it is often seen as funding consumption and investment in housing.
I am puzzled by the strength of the Aussi dollar against the Greenback (though not against Euro) and, as a non-monetary specialist, would welcome insights from anyone on the reason for this if we (as some doomsayers suggest) are about to go bankrupt. Are these doomsayers underestimating the role of Australia as a major minerals and agricultural products supplier to Asia (and particularly China) over coming decades?
Do you have a handy online source of historical stats, Harry?
Not online but I have a graph from an article I wrote with Lee Smith, ‘Labor Migrations and Capital Flows: Long-Term Australian, Canadian and United States Experience’, International Migration Review, 30, 1996, pp. 925-949. You can click on this graph (its based on Excell) to get any values you want. I’ll email you.
An interesting thing is that historically the very high bouts of capital inflow were often associated with big labour immigrations so a past controversy was whether one input ‘dragged’ the other input in because of complementarities. Not true this time.
Presumably this is the second time that consumer debt is the major driver of capital inflows.
1. During the 1880s the linkage of British and colonial currencies and financial systems made notions of trans-political boundary flows somewhat academic.
2. The 1920s boom was driven by public sector borrowing during a period of high nett household saving.
3. The 1950s was a period of high corporate borrowing and portfolio investment during a period of high household nett saving.
4. The 1980s and 2000s current account deficits contain a large component of consumer debt during eras of dis-saving.
“Until quite recently, however, it seemed to be generally accepted that there was a limit beyond which such borrowing was imprudent and that the limit was around 5 per cent of GDP.”
Buggar it. In for a penny, in for a pound.
Anyway, it’s all for the fault of the Queensland Government, according to to Peter Costello, for not increasing the capacity of the Dalrymple Bay coal loader (even though it’s privately owned).
Yeah, right, Pete.
Ho, ho, ho.
Five per cent of what measure of GDP?
Another silly question: if the current account deficit is high, doesn’t this (in part) reflect the willingness of foreigners to invest in Australia? Why is this a Bad Thing? (Not wanting to preempt your “big piece”, JQ, but I’d appreciate some comment on this angle, from you or any of your learned readers.)
Alex, many of the issues were canvassed in this earlier discussion. I note that a certain Alex appeared in the comments box, but it might not have been you.
it’s all voodoo to me – but am waiting and hoping that JQ’s big piece will demolish the Smirk once and for all – Colebatch made a good start today in The Age
It’s also kinda amusing that we now have a conservative Federal Government and the big end of town egging on state Labor Governments to ramp up debt.
We’ll all be rooned.
Looking at the CAD you cannot help but wonder if we have the same problem as the US. ie High consumer spending driven in part by an articially high AUD relative to Asian currencies which is caused by Asian central banks buying AUD to keep their currencies artificially low. That does not seem to make sense in Australia’s case because they buy a lot of our natural resources, but you never know. I would love to know if Asian Central Banks are heavily intervening in the AUD market, but not being an economist I do not know where to look for this information and I cannot find anything on the net written about this. If the good Prof Q could address this in his upcoming post it would be much appreciated.
On the other hand maybe our continued high dollar is a side-effect of the Asian Central Bank efforts to maintain their low currencies relative to the US dollar. In which case when that ship sinks I guess our fate will be as unpleasant as the rest of the flotsam.
The CAD is a flow concept. GDP is also flow. I would have thought a ratio of flows is not the thing to focus on, and there would be no good or bad ratio. Should not one look at flow/stock ratios? eg CAD/net assets, CAD/’liquid’ net assets?. Also the CAD seems to be up and down, so I would have thought the medium term average CAD/net assets would be worth looking at too.
James Farrell – yes, it was me. My memory is not what it used to be! Although it is still slightly better than my knowledge of economics.
I would have thought it depended on what you spend the money on. 7% is nothing if you are using all the money to open a huge diamond mine. On the other hand, if you are using it to finance transfers to grandad so he can play golf it might not be such a good plan.
steve kyle,
That’s the problem. In seems that we are basically doing the latter.
Problem is you don’t know what proportion of this CAD is due to the myriad of small investment decisions that are mixed up with the obvious identifiable ones. A relation in the steel fabrication game tells me his firm has just commissioned a $1.4 million computer controlled sheetmetal, punching, folding, stamping machine in their factory. No doubt much imported small electrical switchgear, etc was used and as well last year the firm incurred 4 return tickets plus accomodation to a trade fair in Hanover, where the decision to order was made. Also the self employed tradeys I know have been buying up big on new utes, vans and 4WDs, as well as lots of tools and equipment. How would you know if a laptop, or PC purchase is for business or consumption too? Lots of small decisions that the ABS couldn’t hope to classify appropriately in their stats.(Trust me I know how we business types fudge those forms)
Forget the official stats and trust the Reserve I say. That’s because they have blokes on the board like fellow South Australian businessman Robert Gerrard. These sorts of blokes move in the upper circles of business and have their finger on the pulse. Eventually the ABS with all its revisions will catch up in a year or so’s time.
We already are all rooned. And as any debtor knows, the worst strategy possible is to start retrenching rather than keeping a high public spending profile while covertly looking for a solution. Anything else frightens the creditors and closes all doors.
We have to keep trading while insolvent. Variance is only a good proxy for genuine risk while you’re ahead of the game; if prudent policies merely guarantee a slow death, it makes sense to chase a few long shots on the off chance something will come right.
Well,well,well-time to start the old debt truck up again.
Oh,hang on,this is a blow out caused by the libs-put her back in the shed.
I well remember john howard speaking on perth radio on the day that we found out that many people had been paid their $600 per child, twice.
No worries said he,you can spend it on school fees or maybe a DVD player.Allied with this was costello having a laugh in parliament a few weeks ago about a local radio jock spending his $2400 on a greyhound and calling it lump sum.
What sort of serious drugs are the PM and the treasurer on?
Harry, It really isn’t fair to compare the current account these days to yesteryear.
Deregulation and all that.
Although your point is one reason why the depression ( ie the second worst depression we have experienced)was so bad. Indeed it was one of the reasons behind the worst depression ie in the 1890s.
Can I just say it AGAIN this current account has happened when Commodity prices are booming.
Context.
If commodity prices were at this level in the banana republic days there would have been a SURPLUS.
The last time Commodity prices were this high we did have a SURPLUS. Thit was when Whitlam was PM.
marklatham,
Are you saying Howard and Costello should be tutt tutting at how people spend their total incomes? Would you then be be happy if they and their critics began to tut tut over how Soc Sec recipients spend their incomes too? If not then perhaps you can see why they were poking fun at the wowsers and scoring political points that lump sums are indeed real dosh.
Homer, the price rises in resources are just beginning to come through the pipeline now, largely because of contractual lags. Also there are some large bottlenecks in shipping at present, which will not ameliorate until new ships come on stream. I think the international markets know this, which is why they are not discounting our dollar on the basis of the bad CAD news at present.
high commodity prices and no increased volumes means no capacity to mean Observa!
Homer,
Trust me there are large bottlenecks in international shipping at present as the Treasurer is alluding to. The Reserve would know it too. Current supply cannot meet demand and Oz exporters are continually getting their containers bumped. The main carriers have raised rates and charges some 25% recently and now want exporters to sign up to new 12 months forward shipping contracts for prices that are 25% higher. Some exporters are now 3 months behind with their orders and given the price hikes are reticent to commit to new contracts with the shipping lines. If you commit and don’t use the capacity you have to pay penalties. The shipping lines of course want to set long term contracts in place so that they can determine forward demand and decide whether to enter into new orders for ships. You can see the dilemma for the parties if the world economy goes pear shaped and the current demand subsides. New shipping and port handling require long lead and payback times and investors want certainty ie lengthy evidence of undercapacity.
Correction
“The main carriers have raised rates and charges some 25% recently and now want exporters to sign up to new 12 months forward shipping contracts for prices that are 25% higher AGAIN.”
Observa,
I’m not taking any issue with any of your observations, but the size of the trade deficit dwarfs any potential/probable discrepancies due to data errors or logistical bottlenecks with our exports. The cause is rampant import growth, funded by consumers binging on credit.
Homer’s (original) point is absolutely correct: it’s scary that we should have such a large trade deficit when the terms of trade have moved so far in our favour. The complacency of Howard/Costello on this issue shows how out of their depth they are.
observa,
I wasn’t trying to say you don’t have a valid point, you do.
I was merely saying the capacity constraints of our commodity producers is the greater problem at present.
The problem you allude to will be with us for a greater period.
OK Fyodor and Homer we are in agreement here and I accept that consumers have been on an overseas buying splurge, which IMO includes a fair bit of small capital item purchasing. The question is whether on balance this is a problem going forward. The evidence I (and the Reserve now)have that it isn’t, is simply because the AUD is holding up against foreign currencies. If the market believes that it is a problem then it should be heading south, back where it has come from in the past couple of years. At the moment the demand and supply of AUD are holding up at historical highs, despite all the gloom and doom surrounding past transactions(ie recent CAD statistics) If you believe the suppliers and demanders of AUD have their sums wrong, then feel free to go against the market as you wish ie sell down your dollars and make a killing buying them back cheap in future.
Or perhaps you believe that a .25% rise in Aussie interest rates is all that’s holding our badly leaking ship of state together?
I wonder why our ports, if true economic rationalism and price driven economics are paramount, are not being expanded?
The port costello refers to is a private port, no doubt he will blame the unions, the state and the greens, but at the end of the day private business is interested in profit, and that doesn’t always equate to what is good for the country.
alphacoward – the port Costello is referring to is privately owned, but the coal loading price is set by the State Government regulator. The regulator has set a very low price, both now and in the past, making expansion uneconomic. That is why Costello is having a go at the State Government – the socialists are limiting economic growth!
Fyodor comment #25 4/3/2005 @ 2:17 pm hits the nail on the head:
…………
I am delighted, for once, to agree wholeheartedly with Fyodor. Howard’s reputation as a great manager of economic prosperity, as opposed to his real skill in negotiating national security and cultural identity issues, is grossly overstated. Howard was given a high productivity economy by Keating and turned it over to realtors, with disastrous results for sci-tech investment.
Razor – if the “socialists” are limiting economic growth in Queensland, the mind boggles at the rate of growth the economy would have achieved over the past decade under a nonsocialist government.
As to an earrlier comment regarding the value of the Australian dollar, I’ve been lax in keeping track of this stuff lately – does anyone know how much we’ve appreciated on the trade-weighted index over the past year or so?
The US dollar itself has hardly been a tower of strength of late.
Ian, I usually keep track of the three way balance with a pair of other currencies, usually the pound and the US$. If you imagine plotting the log of these on a triangular graph as distances from each side, it will always fit since there is a mathematical constraint. But movements on this show roughly whether movement is being generated in this or that economy, unlike a single measure.
Dear Mr Gould
You take my comment completely out of context. I was commenting specifically on the case of the Dalrymple Bay Coal Loading Facility, which is privately owned by Prime Infrastructure Fund, but has it’s coal loading prices regulated by a government regulator. The Regulator has set the price too low to allow for the massive investment in infrastructure required to meet existing levels of demand. If the price was unregulated, this would not have been a problem and the facility would have been, or be well into the process of expanding. I say again, in this specific case, the socialists are restricting economic growth.
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