At the moment our outrageoussly large current account deficit is ignored because of the terms of trade

Great to see you blogging. Welcome to Ozblogistan!

Cheers,

Some bloke you’ve never heard of

That we are still running a large deficit in these circumstances partly reflects the fact that (at least up to the March quarter of this year – the June quarter figures will be released in early September) there had not been any significant increase in the volume of exports (partly as a result of the capacity constraints noted in my original article); and partly because, since as a nation we are spending virtually all of the proceeds of the higher prices we’re now receiving for our resources exports, a proportion of that is spilling over into an increased volume of imports. In addition, foreign interest rates are now rising, increasing the cost of servicing the foreign debt; and, as a result of the growing foreign ownership of Australia’s resources industry, an increasing proportion of the profits earned by mining companies shows up as payments of equity income abroad.

At the risk of sounding simplistic, which I don’t mean to, the current account deficit is a problem in the short term only if the financial markets think it is. And in recent years, they haven’t thought it a problem: they’ve been willing, indeed (as evidence by the rise in the A$ over the past four years) more than willing, to finance it. This may be partly a result of the generally easy liquidity conditions in global financial markets in recent years – most countries running large deficits (most obviously the United States) have encountered much less difficulty financing them than even relatively sanguine observers had anticipated.

However there are two, and maybe three, longer-term problems or risks arising from Australia’s persistently large current account deficits.

The first is that Australian interest rates will almost always be higher than in major global financial centres (independently of whether our inflation rate is higher or lower than in other countries) in order to attract the capital we require to finance the deficit.

The second is that Australia will always be vulnerable to shifts in sentiment among foreign lenders (and financial markets more broadly) that may be entirely unrelated to developments in this country but which nonetheless make financing our deficit more onerous. Just as it was commonly said, after the recession of the early 1990s, that banks had become more cautious about financing viable businesses because of the credit losses they had incurred during that recession (I’m not affirming that, simply acknowledging that the charge was often levelled), it’s possible to contemplate circumstances in which countries running large surpluses (Japan, China, other Asian nations and oil-exporting nations) become much more reluctant to accumulate foreign assets (eg by lending to nations incurring deficits). In such circumstances, Australia could find itself confronting abruptly higher interest rates, or a sharply weaker exchange rate, with deleterious consequences for our ability to sustain the rates of economic growth to which we’ve become accustomed.

The third possibly disconcerting consequence of running persistent large current account deficits is that ownership of an increasing proportion of our assets may pass into foreign hands – to the extent that our deficits are financed by equity rather than debt inflows. Whether one views this as a problem is partly dependent on one’s views about the desirability or otherwise of foreign investment. But, as I noted earlier, one result of increasing levels of foreign ownership of Australia’s resources industry, a growing proportion of the fruits of the current resources boom is accruing to foreigners rather than Australians.

PS: I hope ‘fatfingers’ has observed with satisfaction that I’ve written the above without using any inverted commas at all. It’s true, I tend to use these when using a colloquial expression in a specific economic context, and perhaps I ‘over-did’ it (oops, there I go again!) in this article.

Gittins and Co criticise the government for wrongly taking credit for economic management that has led to the 15-year economic growth when it’s really the Reserve Bank that should get all the credit for the way in which it manages monetary policy. No credit is due to Howard and Costello, of course, for giving the Reserve Bank independence in the first place!

Managing an economy is a fine balancing act that most Australian governments prior to this one have failed in. Something’s being done right. If all we get in this monetary cycle is another two interest rate increases totalling 0.5% we’ll have done spectacularly well compared with every cycle since the sixties.