Thursday, July 4, 2013

One Can't Talk About Current Accounts Often Enough!

I find it noteworthy that the issue of Greece's current account is being discussed more and more in other blogs. As I have argued for over 2 years now, of all the many issues, I consider the issue of Greece's current account probably the most important one! That's why I quote below a comment which I posted in the Ekathimerini today.

The current account relates to the whole country, the entire Greek economy (and not to the state only!). It records how much a country earns abroad  (exports, services like tourism, shipping, etc.) and how much it spends abroad (imports, services, etc.). Put differently, a negative current account means that a country is spending more abroad than it earns abroad out of its normal operations (not including financial activities, which are in the capital account). The current account plus the capital account make up the Balance of Payments which, for mathematical reasons, always has to balance. Thus, it is crucial to understand the following 2 formulas:

Current account deficit = surplus in capital account (capital imports; i. e. Greece)
Current account surplus = deficit in capital account (capital exports; i. e. Germany)

Capital imports/exports are typically loans and foreign investment. Greece could only accumulate a current account deficit of 199 BEUR from 2001-10 because it had such a huge surplus in the capital account (foreigners were throwing money at Greece like there was no tomorrow). Put differently, Greece spent 199 BEUR more abroad during this period than it earned abroad (that’s quite a lot of living beyond one’s means…) and it needed foreign capital to finance that. In fact, Greece not only got the 199 BEUR in foreign capital; it got as much as 283 BEUR of it! And almost all of it was in the form of interest-bearing loans. The excess of net capital inflows increased domestic money supply (asset values, wages, prices - everything goes up!) and facilitated foreign investment on the part of Greece.

The trade balance is typically the largest part of the total current account. A trade deficit (Greece had a gigantic one!!!) means that Greece imports more products than it exports. Here, the following is key to an understanding: when Greece needs certain medicines, it has no choice but to import. With toothpaste, for example, Greece would have a choice to import or to produce domestically. Thus, when Greece imports products which it could produce domestically, that is an ‘export’ of jobs to other countries. Every time Greeks import agricultural products, etc., it exports jobs to other countries. And: where the jobs are, there are the wage/income taxes, the social contributions and the revenue for the state. By importing so much which could have been produced domestically, Greece not only exported jobs (which jobs were presumably compensated for by the public sector) but also deprived the Greek state of revenues.

When Greece does nothing other than squeezing the current account into balance (as is happening right now), the result is unemployment. If Greece were to squeeze imports and substitute them with domestic production, it would be re-importing jobs. Why there hasn’t been a wave of ‘Buy Greek Products!’ so far escapes my imagination!!!

The comment was made that the US has had a current account deficit (a huge one!) for decades and it had no major problems. Right! Because the US is the US, the world’s largest economy and a great place for foreign investment. The US seems to have an infinite capacity for attracting foreign capital (loans AND investment) and this is why their current account deficit has not been a real problem so far. But remember: a current account deficit also means the transfer of domestic wealth to the rest of the world. In the very, very long run, half of Manhattan, all of Florida and the entire S&P 500 may be owned by foreigners. A problem? Not really, except that the return on those investments then flows abroad and not to Americans.

Incidentally, from 2001-10, Greece transferred 199 BEUR of domestic wealth to the rest of the world! The only trouble is that that ‘domestic wealth’ was, in the final analysis, money which had first been borrowed abroad. For those interested, I list a couple of links below which explain this in more detail.

A voice in the wilderness
Finally, the importance of current accounts has been discovered!
On the importance of current account balances
Greece's current account and foreign debt from 2001-10


  1. Addendum

    The political leadership (that is the PM) must think of a narrative which he can explain to all Greeks (as far as I am concerned, once a month on national TV). The Greek people must understand where they have been, how they got to where they are and why, and where the chosen road is leading. The problem is not so much that the Greek state overspent. That can be solved rather quickly through austerity. And, by the way, the state functions opposite to a family. The real problem is that Greece as a country overspent massively and the country, the entire economy functions exactly like a family. If it overspends, it has to go into debt and becomes poorer. And the drama is: you can repair a budget deficit rather quickly through austerity. A massive, chronic current account deficit destroys the domestic economic capacity which is very difficult and time consuming to rebuild..

    Obviously, Greece could never have overspent that much if lenders had not thrown all that money at it.

    That is what the Greek people, down to the last farmer, need to understand because then they will understand that the only solution is to reduce overspending by producing more domestically.

    Every Greek 'off the street' to whom I explained this has immediaterly grasped the issue. There is no reason why the entire population would not grasp the issue if the were told the narrative once a month. After 6 months, they would all have it memorized.

    And when the Greek people understand that running tavernas, cafés, restaurants, retail shops, etc. is fine and dandy but not enough to create domestic wealth and employment (in essence, it's just recyling money borrowed abroad), they will understand that they better think of what skills they have and need in order to produce more domestically and create jobs.

    And every time the PM tells his narrative, he could finish by saying: "This is why I have told the strong import lobby to go and fly a kite and why I am building up a strong export lobby!"

  2. Herr Klaus some observations. Current account is of great importance as you mention.
    However we have to see the data of economic efforts the last 3-4y very carefully and make evaluations.
    We didn't pay the necessary attention to improve competitive advantages setting
    quality targets in the liberalization of internal markets, professions, and areas such land registry or a system to record the income-fortune of every individual.
    Those are important because Greece is not Germany. We have doctors and in Germany there are, but we haven't exporting structure in fields of equipment, tech, or medicine. Our economy products are limited, not expanding in various fields, as in Austria- Germany we have tourism, shipping and services, but all these are few. Even in tourism were we have advantages we do not emphasize in quality.
    These are important to differentiate a relatively small economy, to create new industries , however we need a specific culture, from school, country targeting, people orientation and years of planning.
    School must build from 0.
    The easing of doing business in Gr is not related only with bad legislation, mentalities or unseen reforms.
    There are practical issues. When energy for small-medium sized companies are more expensive 30-40% than competitors countries or the cost of a self employed to hold an office, pay insurance etc force him to tax evade as IMF said before few days these are problems. The most expensive diesel gas prices in an economy with no innovation, as mention, no new industries and basically NEGATIVE banking funding every year, NEGATIVE imports of industrial equipment and NEGATIVE retail sales will create new problems.
    If the income elasticity of demand remain the same possibly we would have again recession.
    My suggestion: Current account is vital, but the depth of recession in an economy we not sufficient not diversified industrial production, no innovation, no good funding is THE issue.
    By reducing taxes in specific limited areas and in independently implementing quality reforms we might tackle hard recession of 5,5%- March 2013.
    Question, by reducing taxes in eg diesel or energy of companies we will deteriorate current account?
    Possibly yes but previous experience have shown that in countries with small industries underdeveloped less diversified compared to others, no business interest, possibly internal demand is a solution to change something.
    If you don't pay eg 2000E for heating but instead1000E or 14000 for transportation but 10000 the remain money can be used by people more wisely to increase business sentiment.
    The opportunities created will improve negative business climate.


  3. "Why there hasn’t been a wave of ‘Buy Greek Products!’ so far escapes my imagination!!!"

    This is because the fugitive of your imagination doesn't speak german or english...

    Google for "αγοράζω ελληνικά".


    Moreover, nowdays it is a bit complicated as to what is really greek and what seems greek but it isn't.

    1. Yes, I know that Greeks are engaged and do things like buying more Greek products and/or starting a potato movement, etc. on their own.

      What I am talking about is not individual actions by individual Greeks. I am talking about a government plan which includes a narrative of what should be done to turn the Greek economy around. Individual actions are great but without leadership, individuals alone won't accomplish all that much.

    2. If you refer to a state campaign, i don't know how accurate this is, but about a year or so, i remember an MP on tv, saying that they can't restore the old tv commercial of the 80s, because they would breach EU competition rules...

      A few days ago, i read that one minister is working to find a way to label at least some products with a sign that will make it more clear that are greek.

      If you refer to a greater plan about the economy, it's a bit hard to make it trustworthy. For example. You have Samaras and Stournaras, that for months talk about some measures. Then the troika comes and says "no". This makes anything the goverment say, not credible.

      Also, "MS", correctly talked about business climate.

      An economy, to move forward, needs banks. Greece is still with no banks really. Even if banks suddenly found liquidity, there are other problems. Many if not most of the businesses are now in the bank's "black list" system (Teiresias).

      The deposits don't return to the banks. The 100.000 EU guarantee, is good on paper. But, what happens if the deposits above 100.000 are not enough? In Greece nowdays, only a 0,40% or 4% (i don't remember) of deposits is above 100.000. According to some articles, there is a small legal window in the EU agreement, where indirectly, they can force haircut below 100.000 too.

      The tax law is yet again changed. Every year, new tax law.

      In general, the economic climate won't return to normal, until there is uncertainty about the debt and a sort of regularity in taxation. Given that at least the primary deficit is more or less under control. Because the uncertainty, also means, political instability.

      Even a businessman that does have money, right now he is in "wait and see" posture.

      Where are goverments have failed, is in the communication sector, trying to explain why they are doing things. But, the problem is, that at the end, you fall under massive fire by the opposition and you are labeled as "memorandum party" and "troika's servant". So, you become easy target, once something goes wrong in the program. Lately for example, the goverment is taking heavy fire from Tsipras and the rest of opposition, first because of the "multiplier" mistake of the IMF (that underestimated the recession) and second about the latest report.

      Now, after all this, imagine Samaras, trying to "sell" "his plan". When everyone knows that his plan is good, only in the degree that the troika will approve it...

      Mr. Kastner, the troika must leave. This finally will clear things for everyone. Each party will have to present its own story and be judged according to it. If that means, returning to the drachma, then so be it. The country can't go on forever as foreign protectorate, pretending to have sovereignty, the greek population doesn't react well to it, given a long history of foreign intervention in politics, the picture of the economy needs to be cleared out soon and move on from there, knowing where you stand. This is also a way to avoid further increase of extremist parties. You know, we will sooner or later run out of "memorandum parties". And the more the people see that this isn't succeeding, the more they will seek a "radical" change in policy.

      Greece must seek soon a final settlement on debt, stop troika's intervention or else go to the drachma and end the madness. Blanchard in a interesting comparison of Latvia, underlined, that one of the advantages of Latvia's recovery, was the low debt and that it was clear where the country was standing. In Greece nobody knows what happens. And when you don't know, you don't invest, you don't buy, you sit on your money.