Monday, 31 March 2014

The UK's Real Problem

The UK's current account deficit is a matter for some concern, as is its fiscal deficit, because both make it vulnerable to sudden reversal of capital flows. But these aren't its real problem....

More here (Forbes).


  1. Its confusing to picture currency moving out of, or into a currency zone, as that is not possible. Currency can't leave its own banking system. What happens is exporters either get paid in their own currency or have a bank balance in the importing countries banking system. Do pairs of cross border Currency traders achieve the role of go between by making reciprocal payments into bank accounts in their domestic banking system on each others behalf. The exchange rates are affected if the exporter then obtains a foreign currency for spending purposes or if a foreign currency needs to be obtained by the importer.

  2. Yes, I've simplified considerably. Explaining exactly how cross-border multi-currency trade works wasn't the point of the post.

  3. A current account deficit does not automatically result in an exchange rate neutral capital surplus. In the case of a current account deficit the exporter will wish to use the spending power in his own country thus calling on a currency trader’s services. This can effect the exchange rate as there is no demand for the importers currency as they have comparatively little exports.

    This video however does not explain the mechanics of currency traders activities or why sterling has not diminished in line with over the last decades current account deficit.
    How cross border multi- currency trade works would be an interesting topic for a post in itself.

    1. The relationship is not that simple. A trade deficit does not automatically result in an exchange rate fall if capital is simultaneously flowing INTO the country. Investors need the importer's currency to buy assets.

    2. I see so a upward or downward pressure on an exchange rate results from a nuanced weighting of the constituents of the "balance of payments" rather than one element.

    3. Exactly.

      We mistakenly ignore the role of capital controls during the Bretton Woods era in the balance of payments crises that characterised that period. When there are capital controls, a trade deficit necessarily causes the external value of the currency to fall. (This is why I argued that the imposition of capital controls in Cyprus in effect created two Euros.) But when there are free flows of capital, the effect of a trade deficit on the external value of the currency is as you say much more nuanced.

  4. "The bigger problem for the UK is what a large and rising current account deficit tells us about its international competitiveness."

    I read this all the time, and I think it is wrong. Imports and exports are not symmetrical. Exports tell you about a country's competitiveness, because you are exporting in competition with other exporting countries. And sure enough, the UK's exports have risen by 25% since 2009. The UK now exports L40bn or E50bn a month, compared to E38bn for France, E35bn for Italy and E20bn for Spain. So UK exports are not uncompetitive.

    Yet we still have a deficit in net exports, exports minus imports, which means that imports have risen as fast as exports, or even faster. So what does that tell you about competitiveness? Very little, since we don't even have a market presence in much of what we import. What it tells you instead is something about wage levels and domestic demand.

    The reason that Germany runs a persistent trade surplus has very little to do with "making things people want" or any of that tendentious nonsense. It is because the German economy is managed in a state of permanent mild austerity, real wage settlements are kept more or less flat, so domestic demand is suppressed. You can only generate a surplus for export if your consumers cannot buy all that they produce as a workforce.

    So a persistent trade deficit doesn't really tell you anything about the competitiveness of UK industry. It tells you that domestic wages are too high. And sure enough, Germany has a GDP/head roughly ten percent greater than the UK, but average German wages are roughly ten percent below UK wages. Through a combination of higher wages and easy credit, UK consumers can buy roughly twenty percent more than German consumers at the same GDP level. It would be a miracle if the UK could *not* run a trade deficit.

    People say the UK should be "more like Germany". That is simplicity itself. Just cut real wages by 20% and you are there. Osborne seems to have got us a percent or two on the way there. Only eighteen percent more real wage cuts to go.

  5. Jon, you have just repeated pretty much what I said in the post about Germany. You appear to have stopped reading at the phrase you quoted.

    I have never, ever suggested that the UK should be more like Germany. Indeed I said exactly the opposite here:

    What I am suggesting is that the UK needs higher business and public investment. You surely aren't arguing with that.