Monday, November 11, 2013

"It's the Current Account, Stupid!"

These times are heyday for someone who has been arguing, intitially with no reaction, for over 3 years that 'it's the current account, stupid!'. Nowadays, no day passes without another contribution by learned people about this subject. The latest thought pieces on the subject which I have seen are from Olli Rehn and from Simon Nixon.

A very interesting thought piece was published by Prof. Marcel Fratzscher who is President of the German Institute for Economic Research (DIW Berlin) and Professor of Macroeconomics and Finance at the Humboldt University in Berlin. Of all the things I have read so far, this one really hits home with regard to the question of how strong the German economy really is.

Just picture that you own a domestic bank and you begin to realize that a huge portion of your assets, many times your equity, is invested in countries far away from home base. Wouldn't you start worrying? Wouldn't you start thinking that, perhaps, you don't want to have so much risk so far away?

Germany's gross foreign assets are approaching the level of 100% of GDP. Not a piece of cake, to say the least. Why does Germany have so many gross foreign assets? Well, current account surplusers have the jobs and the cash. The price they have to pay for that is having to make loans to the current account deficiters. That's mathematics and not economics!

Switzerland, as a micro-example, seems to have decided to put the whole country - financially speaking - outside of its borders. Their current account surpluses run around 11% of GDP!

I am no expert on Switzerland but I take it from the internet that its GDP is about 600 billion CHF. Well, do the Swiss know that they have about 3.600 billion CHF at risk in foreign countries?

Current account surpluses have net capital exports as a consequence. How much more capital do the current account surpluser want to export until they realize that there is quite a bit of risk involved in that strategy?


  1. The Euro is often compared as being equal to the gold standard. But it is nothing like the gold standard because of the way Target 2 works. Unlike the gold standard where imports stop when the gold is exported, in the Euro there is no limit to how much one euro member can buy from another Euro member because of the way the payments system works in the Euro. Do you concur.

    1. Yes, I concur with your description of the difference between a gold standard and the way the Euro works. Read below.

    2. "In the Euro there is no limit to how much one euro member can buy from another Euro member because of the way the payments system works in the Euro."

      Oh puh-lease!!!

      This myth is annoying to the extreme.

      If it was true, then Greece's current-account wouldn't have been scaled down to near balance.

      Here's a reality check. The reserve requirement, coupled with the eligibility for ECB liquidity, plus the haircut that the ECB imposes for said liquidity (and thus the need for the much more expensive ELA to be activated), put a severe strain on the Greek banking system, and as a result to the Greek economy.

      Credit collapsed, and as a result the Greek economy collapsed and bad loans soared (which was the result, and not the cause). Unemployment skyrocketed, and because the unemployed don't consume, the current-account became near balanced.

      So contrary to what Klaus says, the euro pretty much operates like the gold-standard, since it puts a real constraint to both fiscal and monetary policy.

    3. You quoted only half the sentence therefore loosing its meaning

      "Unlike the gold standard where imports stop when the gold is exported, in the Euro there is no limit to how much one euro member can buy from another Euro member because of the way the payments system works in the Euro."

      the pertinent point is that in the euro area importing things does not require exporting something.

      It only builds up an outstanding liability after the fact of the purchase

      The scenario you described illustrates that imports slowed because the home economy slowed , not because of a build up of previous imports which is unlike the gold standard.

      There are many ways relevant to trade in which the euro is unlike the gold standard.

      It is not required for surplus Countries to actively lend money to fund a trade deficit. The liabilities occur after the borrowing and purchase sing decisions have already been made .
      Therefore there is not a credit based or currency based way of controlling it.
      Higher interest rates would effect the whole economy not just the money to pay for imports.
      Unlike the gold standard there is the ECB to re-supply euros to the deficit country and so the trade deficit does not mean the deficit country is running out of money.The ECB is obliged to supply more euros to the deficit countries to use in there home economies ,otherwise they would have to leave the euro , and as long as there is euros in the deficit countries then the trade deficits can go on and on and the liabilities keep amounting .
      Therefore there is not a market based moderator of trade deficits, like there was with floating exchange rates or the Gold standard, and so a different way of balancing trade is required.

  2. Very good piece of Prof Marcel Fratzscher.
    But how differently the current account surpluser can use its surpluses?
    "Investment for More Growth" internally?

    And for Greece Conference Program 8-9 Nov

    - alternate options even a parallel currency you mention also!


  3. Thank you for the information. Could you please explain, how to arrive at your "about 3.600 billion CHF at risk in foreign countries".
    Best regards

    1. Gross foreign assets of Switzerland as per the Swiss National Bank: