If you think surpluses are always good, prepare for great news

Don’t look now, but Australians’ economic dealings with the rest of the world have transformed while our attention has been elsewhere. Business economists are predicting that, on Tuesday, we’ll learn that the usual deficit on the current account of the balance of payments has become a surplus.

If so, it will be the first quarterly surplus in 44 years. If not, we’ll come damn close.

You have to be old to appreciate what a remarkable transformation that is. Back in the 1980s we were so worried about the rise in the current account deficit and the foreign debt that it was a regular subject for radio shock jocks’ outrage. They knew nothing about what it meant, but they did know that “deficit” and “debt” were very bad words.

By the 1990s, Professor John Pitchford, of the Australian National University, had convinced the nation’s economists that the rises were a product of the globalisation of financial markets and the move to floating exchange rates, and weren’t a big deal.

By now, economists have become so relaxed about the “balance of payments” that it’s rarely mentioned. So news of the disappearing deficit will be a surprise to many.

To begin at the beginning, the balance of payments is a summary record of all the monetary transactions during a period that have an Australian business, government or individual on one end and a foreign business, government or individual on the other.

The record is divided into two accounts, the current account and the capital and financial account.  The balance on the current account is always exactly offset by the balance on the capital account. If one has a deficit of $X billion, the other must have a surplus of $X billion, so that the balance of (international) payments is in balance at all times.

As a Reserve Bank explainer says, the current account captures the net flow of money resulting from our international trade. The capital account captures the net flows of financial capital needed to make all the exporting, importing and income payments possible. These flows during the period change the amounts of Australia’s stocks of assets and liabilities at the end of the period.

To work out the balance on the current account, first you take the value of all our exports of goods and services and subtract the value of all our imports of goods and services, to get the balance of trade.

Then you take all the interest income and dividends we earnt from our investments in foreign countries and subtract all the interest and dividend payments we make to foreigners who’ve lent us money or invested in our companies.

The result is the “net income deficit” which, after you’ve added it to the trade balance, gives you the balance on the current account. As Michael Blythe, chief economist at the Commonwealth Bank, noted this week, that balance has been a deficit for 133 of the past 159 years.

Why do we almost always run a deficit? Because our land abounds in nature’s gifts, and there’s great opportunity to exploit those gifts and earn wealth for toil. What we’ve always been short of, however, is the financial capital needed to take advantage of all the opportunities.

Moving from poetry to econospeak, for pretty much all of our modern history Australia has been a net importer of (financial) capital, as Reserve deputy Dr Guy Debelle said in a revealing speech this week.

Because we don’t save enough to allow us to fully exploit all our opportunities for economic development, we’ve always drawn on the savings of foreigners – either by borrowing from them or letting them buy into Australian businesses.

Blythe says “the shortfall reflects high investment rather than low saving. By running current account deficits, we have been able to sustain a higher [physical] investment rate than we could fund ourselves. Economic growth rates and living standards have been higher than otherwise as result.”

True. And Debelle agrees, noting that Australia’s rate of saving is on par with many other advanced economies. (So don’t let any silly pollies or shock jocks tell you a current account deficit means we’re “living beyond our means”.)

Be sure you understand this: a current account deficit is fully funded by the corresponding surplus on the capital account, which represents the amount by which we needed to call on the savings of foreigners because the nation’s physical investment in new housing, business plant and structures, and public infrastructure during the period exceeded the nation’s saving (by households, companies and governments) during the period.

But if all that’s true, how come we’re expecting a current account surplus in the June quarter? It’s a combination of long-term changes in the structure of our economy that have been working to reduce the deficit, and temporary factors that may push us over the line.

Debelle says that between the early 1980s and the end of the noughties, the deficit averaged the equivalent of about 4 per cent of gross domestic product. But it’s narrowed since 2015 and is now about 1 per cent of GDP.

Most of this change is explained by the trade balance. It averaged a deficit of about 1.25 per cent of GDP over the three decades to 2015, but since then has moved into surplus. It hit record highs during the three months to June, totalling a surplus of $19.7 billion for the quarter.

The resources boom has hugely increased the quantity of our minerals and energy exports, and there’s been a temporary surge in the price we’re getting for our iron ore. At the same time, the end of the investment phase of the resources boom has greatly reduce our imports of mining and gas equipment.

The rise of China and east Asia also means protracted strong growth in our exports of education and tourism.

At the same time, the net income deficit has widened a little in recent years but, at 3.4 per cent of GDP, is in the middle of its range since the late 1980s.

The marked reduction in the current account deficit overall means that Australia’s stock of net foreign liabilities (debt plus equity in businesses) peaked at 60 per cent of GDP in 2009 and has now declined to 50 per cent. But that’s a story for another day.