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Balance Of Payments

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I'm reading this book at the moment:

Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics

http://www.amazon.co.uk/gp/product/B003XT60KO

Seems a great book, really learning a lot of stuff that I didn't realise before.

One very good point made is that imports and exports are two sides of the same thing. If we import something, they then have £s which they use to buy something of us. They have to balance out. I get that each year there's some fluctuation, but how do we run a deficit for so many years?

I'm thinking one of the following

- Countries are lending us the money back? (possible, but they say we owe most of our money to ourselves)

- Countries holding many £s

- We're just printing more (unlikely, other than recent)

- The BoP calculations are not correct

- The BoP calculations don't include foreign people buying property here

But really not sure and hoping someone clever on here can shine some light?

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What would happen in your example (trade balance wise) if one country kept on expanding their money supply and the other country kept on taking it and giving them real goods in return?

You end up with China holding a mountain of cash, and Britain holding a rubbish dump full of stuff.

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What you say might happen if there was a fixed (finite) amount of £'s in the world but there isn't. The BoE and the UK banks can magic more out of thin air, within some made-up rules about what is 'fiscally responsible'.

Best example is the recent QE. £'s were magicked out of thin air and given to the banks to pay off their debts. The problem for the rest of us is it reduces the value of a £, hence the price of food rising being one example, the drop in the exchange rate against just about any other currency another.

The question you have to ask is who makes up the rules for how many £'s there should be in circulation?

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I'm reading this book at the moment:

Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics

http://www.amazon.co...duct/B003XT60KO

Seems a great book, really learning a lot of stuff that I didn't realise before.

One very good point made is that imports and exports are two sides of the same thing. If we import something, they then have £s which they use to buy something of us. They have to balance out. I get that each year there's some fluctuation, but how do we run a deficit for so many years?

I'm thinking one of the following

- Countries are lending us the money back? (possible, but they say we owe most of our money to ourselves)

- Countries holding many £s

- We're just printing more (unlikely, other than recent)

- The BoP calculations are not correct

- The BoP calculations don't include foreign people buying property here

But really not sure and hoping someone clever on here can shine some light?

I suspect this is what is known as a 'Eureka' moment.

China and Germany have decided they wish to run export surpluses to support their manufacturing model.

China does it by fixing it's currency against the dollar. This generates a trade surplus with the US. The trade surplus generates a capital account deficit which means they recycle capital back to the US. They do this by buying (in the main) US treasury debt. This forces the US to (effectively) run govt deficits by creating US Treasury debt to satisfy this demand for capital inflows. In essence China is financing the US to continue to purchase their crap to support their manufacturing export model.

Germany does similar by also fixing their currency. In this case by the fixed currency mechanism of the Euro.

Both China and Germany ought to have free floating currencies, which would then (largely) appreciate until the balance of payments corrects itself.

Many would argue that this demand for US debt that China led to artificially low interest rates which was recycled into the US economy in the form of a credit boom. In other words it is fundamental to the personal credit and housing booms. Similarly those money flows into the UK via US banks pumped up the UK credit and housing booms.

These imbalances need to be rebalanced either by China and Germany stimulating domestic demand, by exchange rate changes (China and Germany dictate these - but Germany exiting Euro for example), by default (perhaps inflation or negative real rates) by the debtor countries (US, UK, PIGS etc) or via capital controls, trade tariffs and so on against China and Germany. The latter looks more and more likely and is being more widely discussed.

Many of the problems we are seeing come back to the poitn you have raised, although I think it is fair to say there is a vocal contingent who disagree and blame it all on the debtor countries and their govts. More fool them.

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I'm reading this book at the moment:

Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics

http://www.amazon.co.uk/gp/product/B003XT60KO

Seems a great book, really learning a lot of stuff that I didn't realise before.

One very good point made is that imports and exports are two sides of the same thing. If we import something, they then have £s which they use to buy something of us. They have to balance out. I get that each year there's some fluctuation, but how do we run a deficit for so many years?

I'm thinking one of the following

- Countries are lending us the money back? (possible, but they say we owe most of our money to ourselves)

- Countries holding many £s

- We're just printing more (unlikely, other than recent)

- The BoP calculations are not correct

- The BoP calculations don't include foreign people buying property here

But really not sure and hoping someone clever on here can shine some light?

Hi, I am only an amateur armchair economist but for what it's worth I think the UK has funded its trade deficit for the last 30 years in 3 main ways:

Firstly we indeed were/are steadily getting more and more in debt to foreigners. German companies sell goods to us, say, and meanwhile the pension funds of the workers of those German companies are using the savings of those workers to buy British Government bonds. In other words the pounds that the German exporter earns are (indirectly) given back to the UK economy via government. There are other mechanisms for foreigners to buy our debt too, by simply placing the pounds as bank deposits or buying corporate or mortgage backed bonds (that was a big tool in fuelling the house price bubble, which was closely linked to our trade deficit) Anyway, the net result in my example is someone in the UK has a new BMW and someone in Germany has a promise from the UK government (i.e. the UK taxpayer) that they will be paid £30,000 in ten years time, plus interest, or something like that.

Secondly the UK earnt a lot of money on investments abroad. Until the 1980s (that is, until the UK stopped running a trade surplus) the UK was a major net investor in foreign concerns (that's what much of our surplus was spent on). This is partly thanks to the UKs historic position as a trading and manufacturing nation, exporting to the Empire and investing in the colonies. Even after the Empire was all over we continued to be particularly active in investing abroad compared to other European countries. Did you know, for example, that the largest ice cream maker in Brazil is British owned? The build up of all that capital that the UK achieved while it was a major exporting economy meant that we were earning significant amounts of interest in foreign currency on all that foreign capital. In later years those earnings were used to fund our trade deficit.

Thirdly we've been selling off assets, be it those foreign interests mentioned above or domestic concerns like UK property and businesses. When you hear of Cadbury's being sold for 9 billion quid to Kraft - well, those dollars (about 15 billion of them) will fund our entire trade deficit for 3 months. Not bad, except that after 20 years of Kraft taking Cadbury's profits out of the country we're left with much less than what we had. On a smaller scale, selling Frank Lampard to Roman Abramovich or the whole of Park Lane to some oil Sheik brings in a lot of foreign moolah that we can use to buy those goods that we can't be arsed to make for ourselves no more, innit guvnor.

I hope that helps.

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I suspect this is what is known as a 'Eureka' moment.

China and Germany have decided they wish to run export surpluses to support their manufacturing model.

China does it by fixing it's currency against the dollar. This generates a trade surplus with the US. The trade surplus generates a capital account deficit which means they recycle capital back to the US. They do this by buying (in the main) US treasury debt. This forces the US to (effectively) run govt deficits by creating US Treasury debt to satisfy this demand for capital inflows. In essence China is financing the US to continue to purchase their crap to support their manufacturing export model.

Germany does similar by also fixing their currency. In this case by the fixed currency mechanism of the Euro.

Both China and Germany ought to have free floating currencies, which would then (largely) appreciate until the balance of payments corrects itself.

Many would argue that this demand for US debt that China led to artificially low interest rates which was recycled into the US economy in the form of a credit boom. In other words it is fundamental to the personal credit and housing booms. Similarly those money flows into the UK via US banks pumped up the UK credit and housing booms.

These imbalances need to be rebalanced either by China and Germany stimulating domestic demand, by exchange rate changes (China and Germany dictate these - but Germany exiting Euro for example), by default (perhaps inflation or negative real rates) by the debtor countries (US, UK, PIGS etc) or via capital controls, trade tariffs and so on against China and Germany. The latter looks more and more likely and is being more widely discussed.

Many of the problems we are seeing come back to the poitn you have raised, although I think it is fair to say there is a vocal contingent who disagree and blame it all on the debtor countries and their govts. More fool them.

ha nice one you trumped my reply! very lucid. I quite agree, China and Germany need to admit that they're part of the problem too.

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I'm not sure that any answer I give you will be much better than simply looking at a few basic references on balance of payments.

http://en.wikipedia.org/wiki/Balance_of_payments

http://www.khanacademy.org/video/floating-exchange-resolving-trade-imbalance?playlist=Current%20Economics

etc.

And it's a little hard to know what your question is as it's hard to know what the book has told you and what it has left out.

However, simply speaking when you talk about us running 'large deficits' in the west you are, I think, talking about the trade balance or exports minus imports.

And that is part of the current account, which is one of the key factors of the balance of payments. It's usually the most important, depending on the structure of economy that you have, so we can ignore the others for now.

The fact that the balance of payments should in fact balance is almost definitional (ignoring errors and omissions, and certain types of central bank action, which can be significant for some economies but are not typically a defining factor), so you are right that there has to be something offsetting it.

That tends to be the financial account. So you kind of hit on the answer yourself:

"- Countries holding many £s"

Yes, they can do. That's why a country like China has huge foreign exchange reserves at its central bank, for example (this is a by-product of the trade balance being in surplus AND the central bank buying up those dollars being collected in China and selling renminbi in return in order to prevent RMB appreciation).

"- Countries are lending us the money back? (possible, but they say we owe most of our money to ourselves)"

If other countries are sitting on a huge stash of currency then they will want to use it rather than see it just lose value, so they can either buy USD-denominated assets or lend in USD. The latter in particular means that they are essentially financing consumption of their exports by the deficit country.

- We're just printing more (unlikely, other than recent)

You can't just print more to run a deficit, because that would devalue your currency through inflation, which would mean that you have less international purchasing power in that currency, meaning you could afford to import less, not more. This isn't directly relevant for the balance of payments, but it is relevant for the situation where we are now, when the imbalances have resulted in large reserves on the surplus side and large debt on the deficit side.

The balance sheets of national economies cannot be directly compared to those of individuals. Although it might sound great to be a creditor nation the reality is that you are in trouble if the debtor nation cannot pay, just in different ways. A nation can print loads more currency to pay its debts to you, but your reserves will quickly be worthless paper unless you jack up interest rates you lend at to compensate. This can kill the economy in the debtor nation and trash their currency. Suddenly they can't afford to buy anything from the 'virtuous' creditor and are a cheaper place to manufacture and so compete with you like never before. So your economy, which is based on exporting to these debtor nations, also gets a good trashing in return. Not good for anyone. A lot of the 'China is going to buy your mother and the kitchen sink' chat is based on pretty poor economic understanding, it's doesn't work so simply as debtor pays and creditor enjoys the rewards.

- The BoP calculations are not correct

There are errors and omissions and these get published because they are the 'plug' number needed to reconcile the balance of payments to zero. For some countries they can be large, but they aren't a key factor for most.

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One very good point made is that imports and exports are two sides of the same thing. If we import something, they then have £s which they use to buy something of us. They have to balance out. I get that each year there's some fluctuation, but how do we run a deficit for so many years?

I think the crux of this is the difference between the current and the capital account. In each accounting period, a nation can run a current account deficit - and this is offset against the capital account in the next accounting period.

The current account is fairly straightforward, but the capital account is more interesting. It comprises:

  • Foreign direct investment

  • Portfolio investment

  • Other investment

  • Reserve account

Fort the UK, at least, the reserve account is not especially interesting - the BOE holds US-dollars; Euros; Yen and Gold (roughly in the ratio 2:2:1:1) - and doesn't appear to fluctuate wildly. Foreign direct investment involves the direct purchase of tangible assets that otherwise belonged to nationals... this is interesting, as these may employ leveraged finance... both in terms of British acquisition of foreign assets and foreign acquisition of national assets. Leverage can also affect portfolio investment - though if this is directly debt-financed, the level of leverage is likely lower. This leaves 'other investment' - which, essentially, covers bonds - or loans... and, curiously, these can be financed on balance sheets of banks and "special purpose vehicles". Where this 'other investment' consists regularly-rolled (as opposed to repaid) relatively short-term money-market loans, this gives a great deal of flexibility to the capital account... though this is not without risk... as, systemically, if such funding were withdrawn, it seems unlikely that the debts could be repaid - even if each individual loan could be repaid on demand.

It is relevant that imports and exports are symmetric - similarly so for investment, from the perspective of accounts. It is leveraged investment that permits abrupt changes to the capital account... and, I'd argue, this is also key to the mechanism by which some countries appear to be able to run substantial budget deficits year-in year-out. While capital assets appreciate - there's no real pressure to balance the budget... nothing obvious depends upon paying down debt. Today, however, capital assets have - essentially - stopped appreciating... because the inherent risk of financing their purchase became abruptly visible. If balance sheets aren't growing, and... on balance (pardon the pun) they don't appear to be... then it becomes more and more difficult to 'grow' the economy using the techniques which - in recent decades - appeared to work.

The big disadvantage with globalism is that just as the lack of knowledge about where real capital lies turbo-charged the boom on the way up, it also makes our current situation unstable. It has/will become more and more difficult to grow balance sheets as the 'smart capital' is de-leveraged... which means leveraged capital is even more thinly spread... making the risks - effectively - a self fulfilling prophecy.

Edited by A.steve

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-SNIP-

You can't just print more to run a deficit, because that would devalue your currency through inflation, which would mean that you have less international purchasing power in that currency, meaning you could afford to import less, not more. This isn't directly relevant for the balance of payments, but it is relevant for the situation where we are now, when the imbalances have resulted in large reserves on the surplus side and large debt on the deficit side.

The balance sheets of national economies cannot be directly compared to those of individuals. Although it might sound great to be a creditor nation the reality is that you are in trouble if the debtor nation cannot pay, just in different ways. A nation can print loads more currency to pay its debts to you, but your reserves will quickly be worthless paper unless you jack up interest rates you lend at to compensate. This can kill the economy in the debtor nation and trash their currency. Suddenly they can't afford to buy anything from the 'virtuous' creditor and are a cheaper place to manufacture and so compete with you like never before.

Great post :)

Two questions I ponder.

1) Would you necessarily get price inflation in the debtor nation if the creditor nation simply 'hoarded' the money rather than spent it back into the economy again? Indeed, if all creditor nations suddenly sold their foreign bonds and bought debtor countries products and assets, would you not then see the actual inflation you refer to? I guess what I am saying is, could you not inflate the money supply at a level above price inflation indefinitely as long as the creditor nation hoarded the cash?

2) Is it perhaps a death by a thousand cuts. Our trade deficit is around £50bn per year. Our GDP is around £1500bn and our annual government spend alone is £700bn. I think your second paragraph is correct.. we are getting poorer (and thus more competitive) relative to emerging economies. Just in a boiled frog kind of way.

For interest:

united-kingdom-balance-of-trade.png

Source here

Edited by libspero

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What would happen in your example (trade balance wise) if one country kept on expanding their money supply and the other country kept on taking it and giving them real goods in return?

You end up with China holding a mountain of cash folding, crinkly, devalued rubbish, and Britain holding a rubbish dump full of stuff.

Minor Correction. :huh:

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Yup, it's about the imbalances, which a few of us having been banging on about on this forum.

Arguably, both individuals and the government could have refused the cheap credit, thus stopping the process in its tracks. Instead, individuals used the cheap credit to bid up house prices (which was largely due to the restrictions in government planning laws and government central banks manipulating the currency, along with the government regulated private banking cartel) and the government used it to 'invest' in various pointless pet projects.

Now, not only do we (including our children and future grand children) have a big bill to repay, but we have also hit a brick wall; you can't keep borrowing indefinitely, which should be plainly obvious to anyone with even half a brain.

What next? China, Germany et al (surplus countries) now have malinvested hugely in manufacturing, which are able to make far more goods than demand without ever expanding credit can afford. The UK, USA et al (debtor countries) now have a huge pile of credit to repay, along with insufficient manufacturing as much of it has moved to the surplus countries. Not only that, but we can't borrow any more... wallop, the wall has arrived.

This is why it's such a mess. There is no solution, other than a massive shift in investment on both sides of the equation. Neither side prepared for it and we have both slammed into a brick wall. Printing money has eased the credit card limit situation, attempts to re-structure the economy is moving us away from the brick wall too, but it seems like too little, too late. I suspect we will have mass defaults instead and a number of failed states too by the end of it.

As for talk of floating currencies being the solution, they are not. If they were, we wouldn't be where we are now (hint: governments can bend the rules to their short term advantage). Scrapping fiat currencies and central banks, and then allowing individuals and companies to trade in what (money) they like is part of the answer; this removes the manipulation by governments, along with any currency regions which can create imbalances - gold, silver, goods etc transcend borders (which are little more than fences to keep the tax livestock in) and are immune to manipulation.

Ofc, people may still accept promises in lieu of physical goods/money, but more fool them. One in the hand is most certainly worth two in the bush in many cases and it is high time that lesson was learned.

Individuals also need to reject government debt. They have no right to in-debt us and even less right to in-debt the unborn.

This is a problem caused by governments. Remove the governments and you remove the problem.

Edited by Traktion

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As said above, the current account is only one part of the balance of payments, but it gets all the attention so its easy to see why people get in this muddle.

Ron Paul gets it. :)

Bring the capital back home.

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1) Would you necessarily get price inflation in the debtor nation if the creditor nation simply 'hoarded' the money rather than spent it back into the economy again? Indeed, if all creditor nations suddenly sold their foreign bonds and bought debtor countries products and assets, would you not then see the actual inflation you refer to? I guess what I am saying is, could you not inflate the money supply at a level above price inflation indefinitely as long as the creditor nation hoarded the cash?

Interesting question. I'm tempted to say yes, although I'm not too confident in my answer.

Although you can't escape inflation (assuming constant goods amount and monetary velocity) through the identity MV=PQ, in this circumstance you are not looking at a closed economy. M might be increasing but it is being taken away by the country exporting to you (I think that would actually be recorded as a decline in velocity), and they are importing increased ampount of goods for the remaining money to chase.

But I don't think it would happen, because really all this situation means is that you are paying for your goods with paper - money isn't useful if it isn't actually used, especially if it's real purchasing power is being eroded by printing. And if you did find a country that illogical then they'd eventually go out of business so it would never be sustainable (but then no imbalances are in perpetuity)

It reminds me of Porsche, who used to finance themselves with bonds that their customers bought. The certificates were a work of art, like numbered prints. So of course the bondholders often never surrendered them to get their coupon interest or principal returned. Very clever way to sell art - it can literally be justified as an investment on purchase!

2) Is it perhaps a death by a thousand cuts. Our trade deficit is around £50bn per year. Our GDP is around £1500bn and our annual government spend alone is £700bn. I think your second paragraph is correct.. we are getting poorer (and thus more competitive) relative to emerging economies. Just in a boiled frog kind of way.

I like the boiled frog analogy, although the process is not always slow. If you look at the history of Turkey for instance (which always has a large trade imbalance and therefore currency account deficit because it has to import most of its energy) they have repeated severe currency devaluations and inflation, which is why the old lira became a joke with so many zeros until it was replaced. There's a bit more to it than that but it's just an example.

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  • 284 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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