Tuesday, December 6, 2011

On the importance of current account balances

As long as today's Eurozone countries had their own currencies, the status of a country's current account balance was given high importance. Why? Because a country needed foreign currency to transact business outside its borders and if it didn't have foreign currency, it could not do that. What business does a country transact outside its borders? The most important item is imports. Other items would be foreign travel, investments outside the country, etc.

When Greece had the drachma, she could only import as much as she had foreign currency available for the simple reason that no one outside her borders had use for drachma outside Greece. In order to be able to import, Greece had to obtain foreign currency from abroad. She couldn't simply buy that foreign currency in FX markets because foreigners would only accept Greece's drachma if they had use for it. Typically, a country obtains foreign currency from abroad through exports, revenues from services like tourism, investment capital from abroad, grants from abroad like funds from EU Structural Funds, remittances of Greeks working abroad and, above all, loans from abroad.

Since the introduction of the Euro, countries' current account balances seemed to lose importance because now Greece and 16 other countries had the same currency. That was a big misjudgment because current account balances are important, whether it is 2 currencies or only one, as long as a country cannot print the currency which it needs to do business outside its borders.

Example: the Federal Republic of Germany consists of 16 Federal States, all of which share the same currency but none of them can print it. If a weak state has a deficit, it needs funding from the other states to stay in business. In Germany today, only 3 states have surpluses and the other 13 states have deficits. The 3 surplus states are: Bavaria, Baden-Wuerttemberg and Hesse. Once a year, there is a Financial Settlement among all states where these 3 states transfer their surpluses to the other 13 states which have deficits.

One of the reasons why Bavaria has surpluses is that the Bavarian government had implemented years ago austerity measures in order to balance the budget. Many social benefits had to be reduced or cut. Berlin, on the other hand, has significant deficits, among others because the Berlin government had even increased social benefits. That may work within one and the same country/nation although even Bavarians are starting to make noises that “they no longer want to live with their lower social benefits if that means that they have to finance higher benefits in Berlin”. Imagine how that would work between two different countries/nations in the long run.

The below table shows, for the years 2007-10, the current account balances of Greece as a country and between Greece and Germany.


Greece's current account balances 2007-10

Current account
Shares of current accounts


Greece Germany
Greece of

of Greece
Revenue from abroad

Exports 69.658 8.070

Services (e. g. tourism) 120.865 13.782

Other income 17.987 531

Current transfers 23.526 2.392

---------- ----------

Total revenue from abroad 232.036 24.775

Expenses abroad

Imports 214.253 28.597

Services (e. g. tourism) 61.249 3.927

Other expense (e. g. interest) 55.043 9.837

Current transfers 17.685 36

---------- ----------

Total expenses abroad 348.230 42.397

Net foreign deficit (current account) -116.194 -17.622

It is clear that Greece as a country/economy has enormous external deficits and Germany is one of the great beneficiaries thereof. Some people plead for a new local currency which could be printed and devalued and thus make Greece internationally more competitive (i. e. “cheaper”) again.

Devaluations certainly help to bring the current account into balance but social consciousness requires to consider who is actually paying the cost of inflation/devaluations. On one hand, inflation is the most wonderful tax of all because the tax payers don’t physically have to pay it. On the other hand, it is also the socially most unfair tax: the “clever ones” can protect against it and “the other ones” pay it in full.

Current account deficits mean essentially two things: import of capital and export of jobs. In the long run, this is not a good policy because it impoverishes a country and makes it dependent on subsidies from abroad (like Berlin is dependent on subsidies from other states). Also, the import of capital cannot go on forever.

Thus, it would appear that one of the most important issues for Greece to address as she makes economic plans for the future is how to get the current account deficit under control.

The Southern Periphery blames the North for not sharing in their economic pains. What the Southern Periphery (and the North as well) must understand is that the surplus countries will have to pay one way or another. Either because they have to make transfer payments to cover deficits in the South or, if they don’t want to make such transfer payments, because they reduce their current account surpluses with the South. It is like with inflation: the former is money actually transferred (and Northern tax payers have to pay it). The latter is wealth transferred (and Northern tax payers only “feel” it in the form of lower growth but they don’t actually pay it).

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