EA Balance of Payments: the Current Account
I’ve been doing quite a bit of research on the balance of payments flows within the Euro Area (EA). Given the complexity of the balance of payments, there are too many angles to tackle in one post. Therefore, spanning the next week I will dedicate my commentary to the EA balance of payments. In this post, we start with square one: the current account.
The Euro area (EA) current account
Often times I hear comparison of the EA sovereign debt crisis to past emerging market balance of payments crises. This is not correct, since the EA runs only mild current account deficits, -0.9% of total EA GDP as of Q2 2011 (Q3 data reported in December). There’s no need for a sharp revaluation of the euro to drive the balance of payments to its identity – remember, the current account (CA) + capital account (KA) + official reserves + errors/ommissions = 0.
The standard emerging market-style balance of payments crisis goes something like this: large current account deficits must be financed by foreign inflows of capital (financial account surpluses), so that the currency comes under pressure when foreigners lose confidence in said emerging market economy. As foreign capital flows start to reverse, the currency comes under pressure to balance the financial and current accounts. Under currency depreciation, relative costs rise (via imported goods), so the central bank ‘defends’ the level of the currency through FX intervention (they sell down FX reserves and buy the domestic currency). With the central bank’s stock of FX reserves depleting quickly, speculators can sell the domestic currency for much longer than the national central bank can buy up those assets. Eventually, the whole thing comes crashing down. The currency depreciates (quite materially in some cases) and brings the current account into balance.
The EA initial condition for a balance of payments crisis is just not there: the current account is, well, rather ‘balanced’. Within the EA, country-level current accounts are well out of balance. This is the central theme associated with the EA sovereign debt crisis: debtor countries are reliant on foreign inflows of capital from the credit countries to support current spending.
The chart above illustrates the 4-quarter moving average current account deficit (red)/surplus (green) as a % of national GDP ending in Q2 2011.
In the context of the standard balance of payments crisis, Greece and Portugal would/should have seen precipitous nominal FX depreciation by now. In contrast, the Netherlands or Germany would have seen significant appreciation. However, the single currency union prevents nominal depreciation, so the focus has been on real depreciation. The debtor countries are forced into a policy of internal devaluation (fiscal austerity, they call it) to shift relative prices and real exchange rates. This could work if global growth was going gangbusters, but it’s not.
These imbalances are no longer sustainable.
I’ll leave you with a link as to the direction we’ll be headed here on The Wilder View. Last month Thomas Mayer released a report titled Euroland’s hidden balance-of-payments crisis, which describes imbalances building in the EA financial flows. Next post we’ll look into the balance of payments flows within the EA.
originally published at The Wilder View…Economonitors