World current account imbalances

I know that the theme of global imbalances has seen quite a bit of attention since the 2008 crisis but still I would like to stress the fact of how the Euro area is now the major contributor to current account imbalances in the world. According to the latest figures, the Euro area reported a 12-month cumulated current account of €244.5bn in March 2015 (2.4% of Euro GDP) which translates to roughly 0.40% of world GDP. This figure is substantially higher than the corresponding 2014 reading of €186.1bn (1.9% of Euro GDP).

If one takes a long-term look on country and country group current accounts a few major patterns will emerge:

1. The increase in the current account surplus for China between 2001 and 2008 and its large correction since then.
2. The corresponding increase of the German surplus which shows no signs of correcting.
3. The large surpluses of oil producing countries, dependent though on high oil prices (they are projected to be only marginally positive during 2015).
4. The US functioning as the world’s consumer up until the Great Recession and its strong correction since then (with the oil shale boom playing an important role).

One of the most important observations though is how the Euro area turned from a roughly balanced external balance (up until 2011) to a surplus larger than the combination of China and Japan for the 2013-2014 period. The result of this development, along with the US correction, is that the sum of the current account balances of this group of countries (Euro area, China+Japan, Russia + major Middle East oil producers and the USA) turned from a large negative value until 2006 to a surplus of over 0.55% of world GDP. The above are more easily illustrated in the following charts (based on the table data) for country

and country groups CA balances:

The above suggests that instead of a demand surplus in the 2001 – 2006 period (which could be tapped by the rest of the world), the world’s major countries now need the remaining (mostly emerging) part of the globe to run a current account deficit and borrow in order to maintain growth in the ‘first world’. In other words, the Euro area is now the group that fuels global imbalances and creates a ‘supply surplus’ which the world must consume if European countries will be able to emerge from their stagnation and large unemployment.

In order for the Euro area’s over -2.5% output gap to be lowered, surpluses of more than 0.4-0.5% of world GDP have to be maintained (under the current policy regime where Europe relies on external demand as a driver of its economic growth) in a world of deficient demand. Given the continuous slowdown of BRICS growth I wonder for how much longer this policy will remain successful.

Greek External Crisis Summary

Since I made a series of articles on the Greek external (im)balances I think it’s a nice idea to write a shorter summary on my main observations.

The basic method used is to examine fundamental macro identities:

• The external trade (goods and services) balance will be the outcome of two forces, relative prices and relative incomes. Relative prices can be represented by the Real Effective Exchange Rate (calculated using ULC or inflation indexes) and the relevant Nominal EER, while relative incomes reflect major differences on the growth paths of domestic demand between the country in question and its trade partners. In the case of Greece, since it is part of a monetary union (with nominal exchange rates not existent between union members) both the intra and extra-Euro trade must be examined (which can be proxied by intra and extra-EU trade for which detailed information is available).
• The external balance is the balancing factor of the difference between domestic saving and investment so one has to examine both variables in order to determine which was the driving factor.
• The annual current account deficit is reflected in the net international investment position. It is important to determine how the  external sector ‘invests’ its accumulated claims since that will determine both the stability of the external balance, as well as the annual income outflows that will be produced from this (negative) position.
• The structure of the current account with each factor playing a significant role on the long-term path and shifts of the external balance.

The main observations are as follows:

• Greece saw a relatively stable intra-EU trade balance with the extra-EU balance deteriorating significantly (from 4% GDP deficit up to 1999 to close to 10% in 2008). The trade balance excluding ships and fuel on the other hand shows a much milder increase of only 2% GDP and only for a shorter period.
• Both the REER towards EU and 35 industrial countries (based on ULC) appreciated significantly. In the case of extra-EU REER this was driven almost exclusively by the corresponding appreciation of the NEER. If Greece had maintained its own currency, such a large appreciation (+20%) would most probably not have happened (since it was followed by very large current account deficits).
• Structural reasons meant that Greek products had to compete with low-cost EMEs and East-Europe manufacturers, in contrast with German producers. High and Medium-High technology manufacturers account for 20% of manufacturing while in the case of Germany these reflect 55% of manufacturing. Manufacturing accounts for 55-60% of goods exports and food still accounts for 20%.
• Greek gross fixed capital formation was very stable during the Euro era, with construction dropping significantly from the drachma period highs. What did increase by almost 5% GDP was equipment investment which shows a very strong correlation with imports of goods. An increased production capacity investment cannot easily be regarded as an ‘unsustainable path’.
• Since mid-1990’s there was a large structural shift in household saving which went from 8% GDP to almost -4% GDP until 2004 and moved to 0% afterwards. This was reflected in total private sector saving which went from 24% GDP to 13% GDP (a shift of 11%). Annual private credit flows show a very strong correlation with current account deficits.
• Remittances and compensation of employees slowly moved to a negative position, shifting almost 1.5% GDP during the Euro area, most probably due to the large flow of immigrants in Greece.
• Since Greece adopted the Euro, the exchange rate would not adapt in order to maintain a roughly steady net international position (in dollar terms) but instead the external sector increased its outright claims and the NIIP moved from -25% to close to -100% GDP. As a result, property income shifted 3% GDP from -1% to -4% with most of the change accounted by interest payments.
• The increase in the negative investment position (in historical costs) was mainly accounted by accumulation of government securities by the external sector, mainly other Euro countries. As long as confidence in the bond market was maintained, Greece was in a position to increase its net debtor position in the same way that the United States were able to maintain large ca deficits. Government deficits could be considered a stabilizing factor since they allowed the external sector to acquire government bonds instead of claims on the domestic private sector (private securities and debts). If the latter had happened then a negative domestic macro shock (a recession) would have probably resulted in an external balance crisis, which could not have been averted by the ECB. Nevertheless, the ECB was not determined to keep Euro countries sovereign bonds as close substitutes to one another, thus actually allowing the external balance crisis to happen.

Spain balance of payments June 2012

The BdE (central bank of Spain) released data on the balance of payments till June 2012 today. The current account developments continue their previous positive trends.

Both the goods and services balance have improved significantly with the general current account deficit (Jan- June) shrinking from €24.57bn in 2011 to  €17.13bn in 2012 or around 1.6% of GDP. I still maintain my projection of an annual current account deficit of less than 3% of GDP during 2012.

On the other hand, the financial account continued its deterioration:

Compared with a positive figure of €22.46bn (excluding BdE) in 2011, the numbers so far show an exit of €219.82bn, or more than 20% of GDP. Portfolio investment is negative €77.49bn, while ‘Other investment’ (mainly loans) is negative by an alarming €154.29bn, marking the high risks of the Spanish banking system.

The detailed breakdown of foreign investment if Spain is as follows:

What is positive is the fact that portfolio investment outflows in government securities appear to have stopped, The main driver of outflows is the banking sector with both portfolio (bonds) and other investment being highly negative (-€14.22bn and -€22.77bn in June). A negative development is the fact that portfolio investment in ‘other resident sectors’ shows large negative outflows since March, with June posting the largest number for 2012, at -€7.15bn.

Recent monetary developments in Spain (for July) seem to suggest that retail investors have also started moving their deposits abroad. MFIs and other resident sectors still have very large foreign liabilities (in the form of bonds and deposits although available data are only available till 2012Q1) . Unless bank resolution (through the bad bank scheme and recapitalization) happens quickly, outflows will continue. The macro risk is quite significant (since Spain is in a deep recession) while bondholder involvement in recapitalizations obviously makes matters worse.

Overall, it looks like foreign investment is quickly replaced by Spanish banks using BdE funding to acquire government securities and pay their own debt with the former being supported by official loans through the EFSF.

Spanish Balance of Payments May 2012

The BdE (central bank of Spain) released data on the balance of payments till May 2012 today. The current account developments are actually quite positive:

Both the goods and services balance have improved significantly with the general current account deficit (Jan- May) shrinking from €23.25bn in 2011 to  €16.88bn in 2012 or around 1.6% of GDP. Given the current macro situation (shrinking domestic demand and wages), a yearly current account deficit of no more than 3% GDP is quite possible, levels that were not seen since the introduction of the Euro.

What is very worrying on the other hand is the financial account deficit:

Excluding BdE this one exploded from net positive €14.6bn in 2011 to -€163.2bn in 2012. Extrapolating the results, the yearly deficit might reach €350-400bn or 32-37% of GDP, a capital flight visible only in the most severe foreign exchange crises. Looking into the data, direct investment is still positive (€6.7bn) while portfolio investment is negative €65.5bn and other investment negative €108.9bn. Portfolio investment is related with shares and bonds while other investment with direct loans. The table below provides more detailed information on investment in Spain:

It is clear that:

1. Portfolio investment in MFIs is highly negative since February.
2. Portfolio investment in General Government (securities) was negative till April (with very large flows) but somewhat positive in May. If that is a structural change remains an open question.
3. Other investment in MFIs shows very large outflows which should probably be attributed to a large drop in loans (with MFIs having €446.82bn in foreign deposits in 2012Q1).
4. General government managed to maintain positive flows in the other investment category (although its loans were only €39.9bn in 2012Q1). Other resident sectors did not show any large changes.

The data are mixed in the case of Spanish investment abroad:

What mainly stands out is Other Investment with large outflows to MFIs. If the financial accounts of RoW for 2012Q1 are any guide (when Other investment abroad from Spain to MFIs was a bit more than €29bn) net issuance of liabilities was mostly towards MFIs (€29bn) while sectors such as non-financial corporations and households (which could have moved deposits abroad) were actually negative.