Sunday, September 24, 2006

Monster deficits and economic nationalism

BUSINESS HERALD: Monster deficit worst in 31 years

New Zealand came up a whopping $15.16 billion short in its dealings with the rest of the world in the year ended June - the biggest shortfall, relative to the size of the economy, since the oil shock days of 1975.

Wow! That's a really bad thing, isn't it? Certainly, this guy seems to think so: ANZ National Bank chief economist Cameron Bagrie said the current account deficit was "monstrous."
"We have been saying it is close to a turning point for 18 months, but it keeps on getting worse. Will a lower dollar really turn it around materially? I suspect not. I think the only way to get it back down below 5 per cent [of gross domestic product] is to have an outright domestic recession."
Well, he might be an economist, but unless he's simply pointing out the dangers inherent in trying to 'fix' such a thing -- which is possible, I admit -- I would have thought "moron" would be a better description for him.*

According to conventional wisdom, the country's current account deficit gets "worse" as it gets higher. But does it really? After all, this isn't the balance sheet of some trading entity called New Zealand Inc (which entity exists only in the imagination of economic nationalists), this figure represents private transactions, ie., the sum of all private transactions freely entered into that cross the New Zealand borders over the last year, with the level of the figure representing nothing more than the money that's heading offshore in return for the goods and services bought with it. These are transactions that have been voluntarily entered into by individuals in the full expectation of either making a profit from them, or being able to afford them.

In short, it's a measure of the degree to which foreigners want to trade with us and invest in us, and to which we can afford to trade with the rest of the world. The money going offshore didn't come from nowhere -- as supply creates its own demand (think about that for a minute) the money going offshore to buy imported goods and services was first produced here, often by virtue of previous imported goods and services used in the service of producing more wealth.

It's a "problem" only to extent that a protectionist sees all interaction with foreigners as a problem when it involves us handing over money to those nasty people, a "problem first invented by sixteenth-century mercantilists who sought to make their countries great by restricting imports and subsidising exports. But it's a problem only if one ignores what we get with that money, as this aggregated figure does.

As Ludwig von Mises notes of the "balance of payments problem":
While an individual's balance of payments conveys exhaustive information about his social position, a group's balance discloses much less... No provident action on the part of a paternal authority is required lest a country lose it whole money stock by an unfavaourable balance of payments. Things in this regard are no different between the personal balances of payments of individuals and those of a soverign nation. No government interference is needed to prevent the residents of New York from spending all their money in dealings with the other forty-nine states of the Union [or of Aucklanders in dealings with the residents of the rest of New Zealand]. As long as any American [or NZer] attaches any weight to the keeping of cash, he will spontaneously take charge of the matter.
Perhaps this is why, despite the monstrous headline and the talk of needing a depression to "cure" the problem (another example of a "cure" being worse than the disease) the Herald itself reports,
the ratings agencies [upon whose say so many of these private decisions are made] always more relaxed about current account deficits that were not the government's doing but reflected private sector transactions.
So why do people and headline-writers get so upset about these figures? After all, we don't get excited about the balance of payments problem that Auckland has with Wellington, do we? And as Walter Williams points out in this classic debunking of the 'Trade Deficit Fallacy,' we don't get excited about our 'trade deficit' with the grocer either:
I buy more from my grocer than he buys from me, and I bet it's the same with you and your grocer. That means we have a trade deficit with our grocers. Does our perpetual grocer trade deficit portend doom? If we heeded some pundits and politicians who are talking about our national trade deficit, we might think so. But do we have a trade deficit in the first place? Let's look at it.

Insofar as the grocer example, there are two accounts I hold. One is my "goods" account, consisting of groceries. The other is my "capital" account, or money. Let's look at what happens when I purchase groceries.

Say I purchase $100 worth of groceries. The value of my goods account rises by $100. That rise is matched by an equal $100 decline in my capital account. Adding a plus $100 to a minus $100 yields a perfect trade balance. That transaction, from my grocer's point of view, results in his goods account falling by $100, but when he accepts my cash, his capital account rises by $100, again a trade balance.

The principle here differs not one iota if my grocer was located in another country as opposed to down the street. There would still be a trade balance when both the goods account and the capital account are considered.

Imbalances in goods accounts are all over the place: My grocer buys more from his wholesaler than his wholesaler buys from him. The wholesaler buys more from the manufacturer than the manufacturer buys from him, but when capital accounts is put into the mix, in each case trade is balanced.

International trade operates under the identical principle.
Exactly. Perhaps it's because too many economists view this place as New Zealand Inc., as one big aggregate rather than as many individuals cutting their own deals, making their own payment plans, and mapping out their own entrepreneurial path. The sum total of all these things (when the plans work out well) is an overall increase in wealth, and as Cato's Alan Reynolds explains the common factor in markets with "monstrous" current account deficits
is that they are all growing; talking in June for example about the US's "improved " current account surplus he pointed out:
The Economist's survey of world forecasters estimates the current account deficit will reach 7.3 percent of gross domestic product in Spain this year and 5.6 percent of GDP in Australia. I think the U.S. current account deficit will be about 6? percent. The flip side is that 61/2 percent of GDP measures the difference between foreign investment rushing into America minus U.S. investment flowing abroad. We have a large capital surplus, otherwise known as a current account deficit.

What do countries with large capital account surpluses have in common? Economic growth over the last year was 3.1 percent in Australia, 3? percent in Spain and 3.6 percent in the United States.
Perhaps the easiest explanation to understand all this is that given by Frederic Bastiat, "who once reasoned that a country's balance of trade can be better restored if ships carrying imports just sank rather than reach the country." Is that what New Zealand's economists would prefer?

But in the end, perhaps the best solution is that proposed by this Texan banker:
My solution is to stop keeping foreign trade statistics. We don't keep records on interstate trade between Texas and California, so we don't know which state has the deficit and which has the surplus. And we don't care. But if we kept the statistics, we would know and the deficit state would do something foolish to correct the "problem."
Let's hope the economic nationalists presiding over own "deficit state" aren't reading ANZ economist Cameron Bagrie's mail.

* UPDATE: Cameron Bagrie has confirmed to me a) he's not a moron; and b) he was pointing out the dangers inherent in trying to 'fix' such a thing, which was precisely the point, he says, that he was making to the Business Herald. Which goes to show, perhaps, just how reliable journalists are when they want a headline.

LINKS: Our trade deficit - Walter Williams, Washington Times
Our capital account surplus - Alan Reynolds, Washington Times
The Balance of Trade - Frederic Bastiat, from the book 'Economic Sophisms'
Why Bastiat is my hero - McTeer, Texas A&M
Balance of payments - Concise Encyclopaedia of Economics
Mercantilism - Concise Encyclopaedia of Economics

RELATED: Economics, Politics-NZ

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3 Comments:

Anonymous Polemic said...

The grocer analogy is flawed.

Your example is similar to having a trade deficit with a specific country - but we're talking about the total trade deficit.

As such, my total earnings less what I have paid for goods and services is my 'trade deficit'. While it being negative is not necessarily a bad thing, I do need to know about it to effectively govern my economic affairs (since, essentially, I am either dipping into savings or borrowing money).

Until we're living in a libertarian utopia you have to accept that governments have influence over the economics of the countries they govern. As such, the trade balance is one measure of the health of the economy over which they have responsibility.

9/24/2006 05:42:00 pm  
Anonymous Erik Hogan said...

Polemic,

I’m not exactly an economist, so this may end up as a long winded load of bollocks, but I would have thought that for most individuals, a collective measure of the entire trade deficit of a nation would not be a good guide to how one should invest their own wealth, and a much better measure would be for them to keep track of their own investments. If there is a large trade deficit, does that mean I should stop purchasing from overseas, even if I could increase my own wealth and the wealth of other New Zealanders by doing so? Shouldn’t my own intuition decide whether or not overseas investment is a good idea, or should the Government have the power to make that decision for me?

Ultimately, more cash is going out of New Zealand then coming in. But should an individual stop investing if he has spent more then he has received from others in a particular year, if he has been making investments in his business or the stockmarket for the future?

I thoroughly agree with Peters point regarding free trade and I feel that trade restrictions between cities in New Zealand would eventually make every city, and every New Zealander, worse off. Trade restrictions between States in America would eventually make every State, and every American, worse off. Trade restrictions between nations do make nations, and the whole of humanity, worse off.

9/24/2006 10:29:00 pm  
Anonymous Falafulu Fisi said...

I 've always wondered how economists do their forecast. Time-series forecasting is a proper branch of mathematical science, however I have come across an economic book that the forecasting method described in it is completely different from statistical "Time-series" forecasting techniques. I am no economist, and no disrespect here for professional economists in this forum, but I have emailed some well-known economists in this country and basically asked if they use ARIMA algorithm (auto regressive integrated moving average) for forecasting. Most answers came to a big "NO". All had never used ARIMA and most never heard of it. ARIMA is just one of the many popular forecasting algorithms commonly used for any time-series forecasting task.

I have also seen lots of peer review published papers in economics where those authors used advanced methods similar to ones adopted in statistics and engineering, but I doubt that the top economists here at our major banks are aware of those publications yet or perhaps they don't read them at all or may be they read different journals from the ones I have come across (there are tons of different economic journals out there).

The economists I have communicated with in the past were Dr. Gareth Morgan of Gareth Morgan Investments, Dr. Brent Layton of NZIER Ltd, Kevin Armstrong of National Bank (Head of Forex Division), Kel Sanderson of BERL Ltd, Warren Couillault of FisherFunds Ltd and others.

I have no doubt that all the economists I have listed above are top practitioners in their own field, but I question the way they interpret mathematical modelling in their economic analysis, such as FORECASTING.

9/29/2006 09:20:00 pm  

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