Transcript Macroeconomics, foreign trade and the European Union. Basics.

Balance of Payments.
Global imbalances and how they occur.
Theory and evidence from reality
Balance of payments. – Global imbalances
Today‘s topics
• Balance of payments; definitions
• Current Account and Capital account; definitions
• Imbalances of the partial balances
• Savings as determinant
• Types of foreign investment
• Case analysis: USA
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
05.04.2011
Balance of payments. – Global imbalances
Balance of payments – what is it?
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consists of two under balances: Current Account and Capital
account
is qua definition always balanced
illustrates how real economic activity is backed by financial
activity
In reality imbalances can occur. The so called “remainder” is
due to problems in accounting
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
05.04.2011
Balance of payments. – Global imbalances
Imbalances IN the Balance of payments?
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Global imbalances if the balance of payments is always
balanced?
Balance of payment can show clearly the competitiveness of
an economy and the results on the ownership of the stakes in
this economy.
it allows conclusions about the sustainability of the behavior
of the economic subjects (people) in an economy
All this we can see in having a look at the two under balances
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
The current account - definition
the current account shows the real economic balances of a
country with its foreign trade partners it consists of:
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foreign trade balance: goods traded between an economy and abroad
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services account: services traded between an economy and abroad
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balance of factor incomes: paid and received return on international investments,
earnings from international work
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transfer balance: transfers to/from a country without being backed by any
economical activity (we won’t focus on this part further, as it is raher influenced
by migrational issues than by economic ones)
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
The capital account - definition
the capital account shows the financial, monetary
transactions between a country and abroad. It consists of:
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Foreign direct investment: investments in production facilities as 1) investment
in existing firms or 2) greenflield investments
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balance of credits given and taken
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portfolio investment: investments in shares and bonds.
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change in Central Bank’s currency reserves
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Real vs. Financial transaction
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Balance of payments: balanced.
 Current account equals capital account.
Why is that?
we sell a product to the US (real economic transaction)
we accept US Dollar (financial transaction)
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Recieving foreign currency – a basic financial
transaction (1)
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Let’s have a look at the last point again, as it is not intuitive:
If you go to a shop in Russia, you can’t pay anything with a
Dollar bill. The US Dollar is NO MONEY in economical
definition in Russia (no accounting unit, no mean of exchange)
However the firm selling its goods to the US accepts a payment in
Dollars.
A one Dollar bill is a promise of payment of the Federal
Reserve Bank of the US
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Recieving foreign currency – a basic financial
transaction (2)
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so a one Dollar bill means that the FED owes the bearer of
the note the purchasing power of one Dollar.
as the Dollar is MONEY in the US, everybody there can use it
and use this promise to exchange this bill into goods in any
shop
If an American thus pays a Russian firm a Dollar bill, the
economy of the US (namely the FED) now owes Russia
GOODS in the purchasing value of one Dollar. (basic financial
transaction)
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Recieving foreign currency – a basic financial
transaction (3)
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so a non intuitive situation occurs: if we accept a dollar bill
as payment for exported goods, the US will be in debt with
our firm, and thus with Russia. In TAKING a Dollar bill TO
Russia, we EXPORTED capital!
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We used capital to produce this product and now accept a
promise of payment. As long as we don’t get the value of the
goods back, we give a loan to the US and thus export our
capital (we can use these Dollars in investments)
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Imbalances of the Current Account
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the current account is in deficit, when the sum of trade
balance, services account and balance of factor incomes is
below zero.
any partial balance can cause a deficit or a surplus, even if
two partial balances are in surplus, the overall balance can be
in deficit. (trivial)
Let’s have a look at the determinants!
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Balance of factor incomes
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Looking at the balance of factor incomes we can concentrate on
the income of the factor capital. The income of workers from
abroad is marginal in dimension.
If there is income from the factor capital which conclusion
about earlier current accounts can be made?
Only if we exported capital, we can receive returns on investment
from abroad. As we saw above, we export capital exactly then,
when we export goods or services. So we can conclude: we had
surpluses in current account in the past.
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
It‘s not unimportant! However we exclude it.
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we can thus conclude: The balance of factor incomes
depends on trade and services balances of the past. (as well
as the given yield on our investments.)
Knowing that and searching for reasons of imbalances in the
current account when can then exclude the balance of factor
income as an dynamic factor. However this factor can be
large in extend. We’ll focus on its origin: trade and
services balances.(assumption: balance of factor income = 0)
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Determinants of trade and services balances
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If the absorption of goods and services in a country is bigger
than its production, the current account is in deficit.
we know the classical equation Investment = Savings for a
balanced good’s marked in a closed economy.
For buying goods abroad, we need money. If buying from
abroad, the savings will decline, as we spend money there.
Leading to a new equation: Savings = Investment – Current
Account (S = I – CA)
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Determinants of the CA
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if in deficit S = I +CA mirrors as well the capital balance:
As the domestic savings are smaller than the demand for
investments, we need to import capital.
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So the two variables domestic savings and investment are the
real economic main determinants of the current account
balance.
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Savings and the current account
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why are the savings going up, once I have a CA in surplus?
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remember: I get paid in Dollar, but can’t spend them!
I bring goods abroad and the foreigners are in dept with me
If doing so I can’t use the goods on my own, disclaim on
consume  I save.
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Capital account. – types of transactions
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As said above, there are different types of transactions in the
capital account. Through the balance of factor incomes they
have relevance for the current account as well.
We assume, that the basic transaction shown above is of
minor importance, as the opportunity costs of keeping
foreign currency in cash are to high. Even Central Banks will
only keep cash as reserves in very limited extend
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Foreign direct investments (FDI)
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FDI are investments to gain operative influence on an
existing firm or to found a new branch of foreign firm
(greenfield investment)
FDI are usually long run investments
Profits are partially reinvested, the rest flows abroad
FDI can help less developed countries to develop (spill over
effects)
In times of crisis they stabilize the situation
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Foreign credits
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foreign credits are often of medium term duration
as no sunk costs for building up a firm appear, they can be
retracted far easier than FDI and are thus of more risk for
the receiving country
due to insurances against currency fluctuations, the interest
rates can be quite high
in times of crisis they destabilize situation (will be retracted)
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Portfolio investments
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Portfolio investments can be strategic long term
participations in a firm or short term investments for
speculation.
Dividend payments flow abroad
Can be retracted easily
In times of crisis can destabilize situation, but help stabilizing
situation afterwards, as chance of buying shares of healthy
companies for low prices will be used
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Monetary reserves
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Currency reserves of the Central Bank appear once an
exporting firm exchanges its foreign currency in local
currency. Thus they are consequence of CA surpluses.
Currency reserves are usually not held in cash but in
conservative investments, being easily realizable
By using currency reserves Central Banks can try to avoid
crisis
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Example USA
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The savings quota in the US is usually very low. If not taking
companies treasured gainings into account even below zero
sometimes! Meaning: private Americans spend more money
for consummation than they earn. (unique situation in the
world)
This high demand for consummation leads to a high demand
for imports. Taking CA into deficit
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
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USA – Savings as a share of GDP
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Euro area EMU
United States USA
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5
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen
Source: www.worldbank.org
05.04.2011
Balance of payments. – Global imbalances
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1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
USA – Current Account as a share of GDP
France FRA
United States USA
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen
Germany DEU
Source: www.worldbank.org
05.04.2011
Balance of payments. – Global imbalances
Analysis
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we clearly see, that the described situation leads to long
term CA deficits of the USA
this means, the debt of the US economy is growing strong
over the time, leading to a situation, where many US firms
are owned by foreigners. Biggest shareholder: Chinese state
funds!
The situation can become then critical, once foreigners are not
willing anymore, to accept US Dollars as payment, or are not
interested anymore in investments in the US in fright of the non
sustainable situation
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Everlasting surplus – a gain?
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But is the “German way” the better one?
besides 1990-2001 (in consequence of the German
reunification) Germany always has vast CA surpluses.
This means Germans are disclaiming on vast amount of what
they are producing with their work and capital
The national wealth thus is at a lower level it could be
Danger of loosing foreign assets, in crisis dependent on
foreign economy, as domestic demand underdeveloped
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
Way out?
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Foreign assets gained through exports should be used
profitable and reduced again to spread the wealth in the
country of its origin.
In bad times of business cycle exports should stabilize local
production, in boom times imports should take place.
Over the time, the CA should be balanced.
In this respect France seems to do a rather good job.
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
US paradox. Balance of factor incomes
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One would expect to have the US big deficits in the balance
of factor incomes, as they seem to have everlasting CA
deficits.
In fact they have had SURPLUSES till the beginning of the
actual crisis.
So is the theory I talked about all the time just wrong? What
could be the reason for that?
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
US paradox. Reasons (1).
Reason one: the US Dollar.
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still leading currency in the world, so MAIN RESERVE currency of Central
Banks  as said before, these are investing money very conservative often in US
state bonds.
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Huge amounts of Dollars are in reserves in China, Russia, Japan. Absorbing the
foreign debt at large scale but at low return payments to foreign investors
The role of the US Dollar as No.1 currency reserve currency leads to a
situation, in which the return on invested capital in the US is low, due to the
large amount of Central Banks’ conservative investments.
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
US paradox. Reasons. (2)
Reason two: structure of US economy
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The US economy is dominated by huge scale companies. These companies are
easily able to invest in expensive and highly lucrative projects
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There are values of world brands like “Coca Cola”, “Microsoft”, “Apple” etc. By
exporting the “good” name the payback increases.
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Almost all the savings and thus the money available for foreign investment is on
the site of companies (priv. savings near 0), which increases the efficency.
The structure of the US foreign investments leads to an effective investment
with high returns on investment.
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011
Balance of payments. – Global imbalances
US paradox. conclusion
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to sum it up, we have a situation in which there is low return
of investment on average on capital invested in the US, and
high roi on US capital abroad
So even if LESS US capital invested abroad the returns are in
total higher, than of the capital invested in the US
The US are the only economy with this inverse structure.
However it gets less and less, as dept goes up. Although the
return on investment rate keeps higher.
Dipl.- Kfm. Thomas Stiegler, University of Göttingen
05.04.2011