UK Current Account Deficit That Cried “Wolf!” by Rupert Seggins & Marcus Wright, RBS Economics
A tale about the UK current account deficit What is the current account, what has happened to it, why, and what useful information does it give us about the economy?
- The balance of money & credit going into and out of the UK.
- The deficit has been large and recently got larger due mainly to the UK paying out more in profits than it takes in.
- Little by way of crisis warnings. But more by way of explaining low interest rates and sluggish Euro Area recoveries.
What is the current account balance?
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- It measures the difference between money and credit coming into the UK and money and credit going out.
- This comes from buying and selling goods and services (exports & imports) and from income paid on assets held by foreigners here or UK assets held abroad.
- It is affected both by economic policies and developments in the UK and outside it.
What has happened? The long term story
- During the pre-war Gold Standard & under the auspices of the British Empire, the UK ran persistently large current account surpluses, entirely due to net income from abroad. After leaving the dollar peg in 1972, that all changed.
- The UK international competitiveness issue is nothing new. We have run a trade deficit in 7 out of every 10 years since 1870.
What has happened more recently?
- The current account deterioration is not down to the trade deficit. That is smaller than before the crisis.
- On the financial side, we have been and continue to are reduce our assets abroad. But we are doing it slower than foreigners are reducing their assets in the UK.
- This has meant faster falls in profits, dividends and interest payments coming into the UK than going out.
Why has the current account deficit got worse?
- The major reason for the current account’s recent deterioration is that our income balance has changed from a surplus to a deficit. In particular, net income from foreign direct investment has seen the biggest plunge.
- There has also been some evidence of a loss of competitiveness with Europe and Africa, even as trade balances improved with other regions.
A consequence of a weak Euro Area recovery
- A recent ONS study has shown that the fall in net income from enterprises abroad has been driven by:
1) A fall in UK income from non-G7 OECD countries (mainly in Europe)
2) A fall in income going to very large UK companies
3) A fall in UK income from oil & gas and ICT with a rise in income paid to foreign wholesalers
The current account who cried “wolf!”
UK Current Account Deficit
- The problem with the current account as an indicator of economic trouble is that in the UK, it is always crying “wolf!”
- Historically a deficit has preceded some recessions, but not others. It has preceded more currency crashes. But persistent post- Bretton Woods deficits have weakened any value it may have had as an early warning signal.
Exchange rates. Rules of thumb as opposed to current accounts
- Sterling is volatile, undergoing both large appreciations and depreciations. A rough rule of thumb: a sterling slide of more than 10% against the dollar starts once every 4.5 to 5 years.
- A second rough rule of thumb: a monthly rise in sterling of more than 5% against the dollar has happened every 2 years since 1975. A 5% fall has happened once every 1.5 years.
The current account tells us little about sovereign solvency
- One popular line of argument is that the UK’s current account deficit indicates that it is vulnerable to a run on sovereign debt, potentially risking default as a result. This is unlikely.
- The UK government has little foreign currency debt; the average maturity of its debt is 16 years, providing a good cushion against spikes in yields; the UK has a good credit history; and more QE is always an option…
When the current account misleads…
- Current account deficits put the focus on who the UK is building up IOUs against. It’s equally important to monitor which countries have been running up debts to the UK.
- The biggest deterioration in the UK current account balance was with Germany and other European nations. Meanwhile the biggest increase in UK financial exposure has been with China and other Asian nations.
But global imbalances still matter for us
- Lower for longer interest rates are in part a symptom of global current account imbalances as emerging economies, in particular China, export capital to advanced economies.
- The problems in the Euro Area, our largest trading partner, are also being compounded by current account imbalances. In particular, Germany’s larger surpluses are hampering much needed economic adjustment.
The bottom line
- The UK current account is a poor early warning indicator for recessions and for big falls in exchange rates.
- It is more useful to note that exchange rates are volatile and that large swings happen more frequently than you think, regardless of the current account balance.
- Current accounts are important as part of the wider pattern of global external imbalances that are exacerbating the lower for longer interest rate environment & hampering the Euro Area’s (and the UK’s) recovery.
See full slides below.