Tag Archives: balance of payments

Spain’s Sectoral Balances

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The Banco de España released its Quarterly Economic Bulletin today and it had an interesting chart on the sectoral balances of the Spanish economy.

With a net indebtedness of €994.5bn – i.e., close to €1 trillion – as compared to the gross domestic product of €1.06tn (2010 figure) Spain has limited choices. Except via the possibility of expanding by another private sector led credit expansion which is highly unlikely, the Spanish economy faces the prospects of low output and demand. Increasing exports is another option but with all Euro Area nations’ governments being forced by a “fiscal compact” to contract, this is unlikely because of low demand in the rest of Europe.

The chart is really interesting as it illustrates some of the many causalities associated with the financial balances identity

NAFA = PSBR + BP

where NAFA is the Net Accumulation of Financial Assets of the domestic private sector, PSBR is the Public Sector Borrowing Requirement or the deficit and BP is the current balance of payments.

When the domestic private sector tries to increase its saving, there is a contraction of demand, income and output (unless exports increase). As a result imports too reduce (because income is lower). The higher propensity to save also leads to an increase in the government’s budget balance.

So in the chart you see a dramatic fall in the current account deficit and a huge increase in the government’s budget deficit. (The term “Nation” is used in the chart because the current balance of payments is the difference between the incomes and expenditures of all domestic sectors of a nation).

The situation is not atypical of recent (post crisis) behaviour of other nations’ sectoral balances but the fall in the external sector balance in this case is striking, though the same could be said for various deficit nations in the Euro Area.

The Banco de España – whose short-term projections are usually accurate – also said today that unemployment will hit 23.4% in 2012!

Z.1, Q3-2011

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The Federal Reserve released the Flow of Funds Accounts of the United States today.

The Flow of Funds Accounts provides one of the best snapshot of an economy. In an article appropriately titled ‘No one saw this coming’ – or did they? (see the full paper here), Dirk Bezemer correctly recognizes that the Economics profession’s ignorance of Flow of Funds had a big role to play in its inability to see a crisis coming. Bezemer says

We economists – and the policymakers who rely on us – ignore balance sheets and the flow of funds at our peril.

Of course, as Bezemer points out, there were exceptions. Post Keynesians were always aware of the flow of funds because monetary economy is a natural starting point in their theory. Wynne Godley and Marc Lavoie wrote a book (my favourite!) Monetary Economics: An Integrated Approach To Credit, Money, Income, Production and Wealth, Palgrave Macmillan, 2007, to unify Post Keynesian theory and the flow of funds approach, perhaps improving the presentation of the latter using something called the “transactions flow matrix”.

In my opinion, nobody even came close to Wynne Godley in not only predicting the crisis but the warning about the difficulties in resolving it.

One notable highlight of today’s Z.1 release was that

Household net worth—the difference between the value of assets and liabilities—was $57.4 trillion at the end of the third quarter, about $2.4 trillion less than at the end of the previous quarter.

A lot of readers will know about sectoral balances. How do we get that from Z.1? Table F.8 gives “Net Lending” of each sector of the economy. The difference in a sector’s income and expenditure is it’s “Net Lending”.

(click to expand, and click again to expand)

Before the crisis, the private sector had its income lower than expenditure and was financing the difference by borrowing from the other sectors. As the crisis hit, private sector expenditure retrenched – so you can see how the private sector has become a net lender from being a net borrower before the crisis. Because of this, the government’s borrowing increased from (line 49) $408.1bn in 2007 to $1,471.7bn in Q3 2011 (annualized). It was also due to a relaxation of fiscal policy during the crisis, in order to stimulate demand. The expenditure of the United States as a whole is higher than its income, and the difference is the current account deficit. This is financed by net borrowing from foreigners (line 42) – which was $446.7bn in Q3 2011 (annualized). This deficit was $715.9bn in 2007, bleeding demand at a massive scale from the US economy.

There are two more tables I see closely. The first is the net income payments from the rest of the world, which surprisingly remains positive, leading to a lot of literature about “dark matter”. (More on that some other time). This, according to the Z.1 is the “net receipts from foreigners of interest, corporate profits, and employee compensation”.

 The Levy Institute has been tracking this since 1994. Here’s a latest graph (from their March 2011 analysis)

There are discrepancies between BEA and Fed data. The other table which I rush to check, whenever the flow of funds data is released is the United States’ net indebtedness to the rest of the world – L.107:

which at the end of Q3 was $3,616bn, or 24% of GDP.

There’s a new table – L.108, Financial Business – which actually appeared first time in the previous release (Q2). This sector had $64,299bn in assets and $60,457bn of liabilities at the end of Q3!

Of course, I look at all the tables at some time or the other. Highly recommended.

The Eurosystem: Part 3

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In the previous post in this series The Eurosystem: Part 2, I discussed cross-border flows within the Euro Area. With exceptions, most of these flows are current balance of payments and balance of payments financing flows. Of course there are other flows with the world outside the EA17 and these flows flow via the correspondent banking arrangements banks have put in place and not the topic of discussion in this series.

The cross-border flows are important for the Euro Area since as a whole, the Euro Area’s balance of payments is almost in balance.

Source 

Source

So the Euro Area current account was in a deficit of €11.7bn in 2011Q3 and a net indebtedness of €1.35tn to the rest of the world at the end of Q3, or 14.5% of GDP. So most of external imbalances of the EA17 nations are within the Euro Area.

Back to TARGET2 flows: there was a debate among some economists on various matters related to these flows. Some even went on to suggest that these flow affect credit in Germany because the nation was financing the current account of the other nations. From an exogenous money viewpoint, this reduces banks’ ability to provide loans to their customers! (which is incorrect because money is not exogenous). The replies tried to disprove it by using the argument that attempted to prove that the NCBs were not financing the current account. Sorry no links.

This is a small post and my point is to show that since  TARGET2 is designed to automatically change the balance sheets of the NCBs, the debate whether the NCBs finance the flows or not is a bit counterproductive. Of course having said this, I wish to highlight the fact that the item “Claims within the Eurosystem” (in either assets or liabilities) is definitely recorded in the balance of payments and the international investment position as can be seen below for the case of Spain.

(Click to enlarge, Source)

(click to enlarge, Source)

Of course, the “Claims Within the Eurosystem” is just one item in the financial account and the international investment position, so not the whole of the current account deficit is financed this way. One minor advantage is that this part of the gross indebtedness of a whole deficit nation is at the ECB’s main refinancing rate, which is much lower than the effective interest rate deficit EA nations are paying on their gross liabilities to foreigners. This is not worthy of further attention, though.

How long can these flows continue? As long as the banks have sufficient collateral to provide to their home NCB. When banks run out of collateral (eligible for borrowing from the Eurosystem), emergency measures have to be taken and a future post in this series will discuss the Emergency Loan Assistance Program (ELA) used by NCBs.

[I welcome your comments. I have a “Zero Comments Policy” as opposed to a “No Comments Policy”. I like being notified of a comment.]

An Internal Balance Of Payments Crisis

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Economists are increasingly recognizing the Euro Area problems as a balance-of-payments crisis, in addition to realizing that the Euro Area national governments cannot finance their deficits by making a draft at the Eurosystem in extreme emergency.

The Economist has an article today Beware of falling masonry with the graph on the net asset position which I posted on several occasions in this blog.

With a few exceptions, the benchmark cost of credit in each euro-zone country is related to the balance of its international debts. Germany, which is owed more than it owes, still has low bond yields; Greece, which is heavily in debt to foreigners, has a high cost of borrowing (see chart 2). Portugal, Greece and (to a lesser extent) Spain still have big current-account deficits, and so are still adding to their already high foreign liabilities. Refinancing these is becoming harder and putting strain on local banks and credit availability.

The higher the cost of funding becomes, the more money flows out to foreigners to service these debts. This is why the issue of national solvency goes beyond what governments owe. The euro zone is showing the symptoms of an internal balance-of-payments crisis, with self-fulfilling runs on countries, because at bottom that is the nature of its troubles. And such crises put extraordinary pressure on exchange-rate pegs, no matter how permanent policymakers claim them to be.

The magazine also had another nice article recently: Is this really the end?. Here is a collection of covers from the magazine in recent times on the Euro.

Hungary?

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WSJ’s Marketbeat reports of troubles Hungary may be headed into. The blog post reports:

Hungary this morning had its own T-bill auction, just like Italy. It did not go so well!

Hungary’s auction had a bid-to-cover ratio of just 1.0, and it had to pay a 6.79% yield to move the debt.

I decided to do some basic analysis of what is going on. The Annual Report On Exchange Arrangements And Exchange Restrictions 2010 reports that

and also that:

FT provides the chart of EURHUF:

The depreciation got me even more curious. More screenshots from data sources below. The first one is Hungary’s current account balance as a percentage of GDP, courtesy IMF’s World Economic Outlook, Sep 2011.

(Click to enlarge)

So Hungary has been running a huge current account deficits since many years. A current account deficit means that a nation’s expenditure is higher than income and the difference has to be financed by net borrowing from abroad. During boom times, this may not be problematic but the accumulated debt has to be rolled by attracting foreigners by hook or crook. The route most chosen to prevent getting things out of control is be deflating demand. Only in a Mundell-Fleming fantasy world does the nation’s currency depreciate to bring the current balance of payments to zero and an equilibrium with respect to the external world.

Hungary is a small nation with GDP equivalent of €97b (in 2010, using an approximate average 2010 exchange rate of HUFEUR=0.0036. Note to self: This needs more correction). Due to deficits in the international current balance of payments, the nation has accumulated a debt equivalent of €113.59b (the negative of NIIP) according to the the release Hungary’s balance of payments: 2011 Q2 from Magyar Nemzeti Bank – Hungary’s central bank. With net foreign asset position worse than -100% of GDP, this puts Hungary’s economy in a terrible position. Recent data suggests an improvement in external trade but the international currency markets are not impressed.

According to this Wikipedia Map, Hungary is obliged to join the Eurozone, and has no opt-out option like UK. However, it has not satisfied the Maastricht criteria, and hence the Eurozone won’t let it in yet. Better not! As long as Hungary has its own currency, its government can make a draft at the central bank to finance a portion of its deficit and gives it a tool to protect itself in the short term. So Hungary is protected from being Greece as long as it is not in the Eurozone. But in the long run, Hungary’s growth will be constrained by its balance of payments.

Severe Imbalances Within EA17

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In a recent post Chart: Euro Zone Indebtedness, I graphed the Net International Investment Position (the negative of “external debt”) for EA17 nations to highlight the severity of internal imbalances within the Euro Area. I found a source of data for the current account balance as a percentage of GDP in the IMF’s latest World Economic Outlook and am posting a screenshot below of the table I am talking about.

(It’s a bit of hard work to get this otherwise). Click the image to enlarge. You can see that around 2007, the imbalances grew out of control but continued to grow in 2008.

The Eurozone And Current Account Imbalances

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There’s a new article from the Federal Reserve Bank of New York – Saving Imbalances and the Euro Area Sovereign Debt Crisis by Matthew Higgins and Thomas Klitgaard.

The abstract

For several years prior to 2010, countries in the euro area periphery engaged in heavy borrowing from foreign private investors, allowing domestic spending to outpace incomes. Now these countries face debt crises reflecting a loss of investor confidence in the sustainability of their finances. The result has been an abrupt halt in private foreign lending to these economies. This study explains how the periphery countries became dependent on foreign borrowing and considers the challenges they face reigniting growth while adjusting to greatly reduced access to foreign capital.

which is almost right.

The Euro Zone nations have run massive current account deficits and foreigners allowed this game to go on. The deficit nations became more and more indebted to the rest of the Euro Zone. This process can go on as long as foreigners allow it but with rising negative net asset position relative to gdp, the processes have to stop somewhere leading to a collapse in demand.

The authors point out how yields on government bonds of various nations were close to each other before crisis hit. This is consistent with Wynne Godley’s stand that there is no signal that something is wrong or can go wrong when unsustainable processes are building up, until something goes awfully wrong.

The article also has a section on the TARGET2 payment and settlement system. TARGET2 flows is one of my favourite topic. I will write about it sometime in the same spirit as my previous post on domestic payments.

The article however puts the blame on deficit countries which is inaccurate from a Post-Keynesian perspective. The problem was with the design of the Euro Zone itself. The problem was also the ideology that “market forces” work to achieve results which is best for everyone.

There are some behavioural hypothesis/assumptions used in the article which are not quite right, but I won’t go into them.

There are some interesting charts in the article, for example