Just like we have banking accounts, our country has 3 main accounts: CURRENT, CAPITAL, and FINANCIAL accounts, which together make the Balance of Payments. My role is to convey vital economic knowledge in an easy to read article, so let’s focus on the current account, since we often hear that word coming up in the news around the world.
Here is the basic formula:
CA= (Exports-Imports of goods and services) + (net factor income from foreigners (interest on dividends)) + (net transfer payments (aid)). The first part of the equations is the balance of trade and it is the most important component of the current account.
What is a Current Account Deficit?
It is basically first a Trade Deficit, which means that we are importing more than we are exporting. However, other factors influence the outflow of our money which are: foreign aid, money sent by immigrants to families abroad, spendings on the military bases abroad, etc. Since the 1980s, the USA have persistently had a negative current account. At the end of 2002, the value of US assets owned by foreigners exceeded the value of foreign assets owned by the US. In Canada, it is only since 2009 that we have had a trade deficit. The main part of the deficits are the goods and the service component. Our last year’s deficit was -50.86 billion dollars, which is nothing compared to the -561 billion dollar deficit of the US. China, on the other hand, has a trade surplus of 272.5 billion dollars!
Is a current account deficit always a bad thing?
A current account deficit does not necessarily mean that the economy is going down. In fact, a country could be importing more goods than exporting to increase their own productivity and eventually export more. One must study the causes of the current account deficit. For simplicity, let’s look at the trade deficit at an individual level as a personal trade balance. We can always relate an individual economy to the country-level economy with a little imagination. First, we need exports (our labour skills) in order to exchange the income received for goods and services that we find useful (imports).
Is it possible for us to have a trade deficit, to spend more on goods and services than what we earn?- Yes, we can use our savings or just borrow money and repay it along with the interest payment in the future. What we have to keep in mind is that the more it is consumed today, the less there is consumption in the future. If we borrow money to spend it on education, a house, a car, it is reasonable since this spending will also have payoffs tomorrow. If we spend the borrowed money on parties and clothes, and have to repay that money along with interest, then we could be in trouble. One cannot have spendings higher than earnings forever, and this is true at the country level as well.
What about the large US debt that the Americans owe to the Chinese?
Since 1976, the US has accumulated lots of receipts from abroad (annual deficits) which have led to a large public debt, especially towards China. But let’s face it : it is virtually impossible for the American politicians to pay back the Chinese government. The president can’t just tell the Americans ‘Listen guys, we have to increase the taxes by 50 %, or cut the spending on education and social security’. Two things can happen: they will print the money to pay the nations they owe money to, which will lead to a decrease in the value of the US dollar, then leading to a decrease in the imports and an increase in the exports. Another solution could be to change the international policy by telling the Chinese government to friendly forget what they owe to them.