We're investing more overseas than foreigners are investing here

 For pretty much all of Australia’s modern history, our strategy for getting more prosperous was to be a “net importer of [investment] capital” from the rest of the world. But four years ago, that was turned on its head, and we became a net exporter of investment capital.

If you think that doesn’t sound like a good thing, I agree with you – though probably not for the same reason as you. I think it does much to explain why the economy – and the productivity of our labour – have grown so weakly over the past decade. And are likely to continue growing slowly once the Reserve Bank has beaten inflation out of our system.

How come you haven’t heard about this historic turnaround? Because, though economists hate to admit it, economics is subject to fashions, and for many years they haven’t been much interested in talking about what’s happening in the economy’s “external sector”, which accounts for about a quarter of the whole economy.

All of Australia’s households’, businesses’ and governments’ economic dealings with the rest of the world during a period are summarised in a document called the “balance of payments” – payments to foreigners and payments from foreigners.

The balance of payments is divided into two accounts, the “current” account and the “capital and financial” account.

The current account shows the value of our exports of goods and services ($171 billion in the latest, March quarter) less the value of our imports of goods and services ($129 billion), to give us a trade surplus for the quarter of $42 billion.

But then it takes account of our interest and dividend payments to foreigners of $57 billion, less their payments of interest and dividends to us of $24 billion, to give us a “net income deficit” of $33 billion.

Subtracting this deficit from the trade surplus of $42 billion leaves us with a surplus on the current account for the quarter of $9 billion.

So, we ended up making a profit during the quarter, as we have in every quarter for the past four years, whereas for almost every year before that we ran deficits. We’ve made some progress.

Is that what you think? Sorry, as the father of economics, Adam Smith – born 300 years ago this year – spent his life explaining, this “mercantilist” notion that a country gets rich by trying to export more than it imports is wrong.

We benefit from importing the things that other countries do better than we do, and they benefit from us exporting to them the things we do better than they do. Economists call this the “mutual gains from trade”.

In any case, like the accounts of every business, the balance of payments is based on “double-entry bookkeeping”, where every transaction is seen as having two, equal sides, a debit and a credit. So, it’s wrong to think that debits are bad and credits are good.

Similarly, it’s wrong to think that the resulting deficits (debits exceed the credits) are bad, and surpluses (credits exceed the debits) are good.

And remember that the “current” account is only one half of the balance of payments so, since the debits and credits are always equal, if we’re running a surplus on the current account, we must be running a deficit of equal size on the other, capital and financial account.

Until four years ago, we always ran a surplus on the capital account, but now we’re running a deficit. But what does this switch actually mean?

It means that, until recently, our households, businesses and governments always spent more on investment – in new housing, new business equipment and structures, and new public infrastructure – than they could finance from their own savings.

(Households save when they don’t spend all their income on consumption. Businesses save when they don’t pay out all their after-tax profits in dividends. Governments save when they raise more in taxes than they spend on their day-to-day activities.)

How can we, as a nation, spend more on new physical investment than we’re able to finance with our own saving? By getting the extra savings we need from abroad. We can borrow it, or we can allow foreigners to own Australian businesses or real estate.

And that’s exactly what we did until four years ago. We borrowed overseas and let foreigners own “equity” in our economy. This is what it means to say Australia was a “net importer of capital”.

Why did we do that? Because we had more opportunities for economic development than we could finance from our own saving, and figured that allowing foreigners to join us in investing in our economy would leave us better off.

The consequence was that, for more than 200 years, our economy grew faster and our standard of living improved faster than if we’d kept everything to ourselves.

So, what’s changed? Why have we switched to being a net exporter of investment capital? Why have we begun investing more of our savings in other countries than they’ve been investing in Oz?

Partly because the build-up of our compulsory superannuation system means we, as a nation, are saving a lot more of our income than we used to.

Now here’s the killer: but also because, particularly since the end of the mining investment boom a decade ago, we’ve been investing a lot less in improving and expanding our businesses.

You wonder why, until the government and the Reserve Bank mistakenly caused the present brief inflationary surge, the economy’s growth was so weak? Now you know.

You wonder why the productivity of our labour’s been improving so slowly? Because we haven’t had enough business investment in new and better machines. Or in research and development, for that matter.

And the main thing we’ve got to show for this deterioration is a current account surplus. You beaut.

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How party politicking let mining companies wreck our economy

A speech by former Treasury secretary Dr Ken Henry last month was reported as a great call for comprehensive tax reform. But it was also something much more disturbing: an entirely different perspective on why our economy has been weak for most of this century and – once the present pandemic-related surge has passed – is likely to stay weak.

The nation’s economists have been arguing for years about why the economy has grown so slowly, why real wages have been stagnant for at least a decade, why the rate of productivity improvement is so low and why business investment spending has been so little for so long.

Most economists think we’ve just been caught up in the “secular stagnation” – or slow-growth trap – that all the advanced economies are enduring.

But Henry has a very different answer, one that’s peculiar to Australia. Unlike everyone else, he’s viewing our economy from a different perspective, the viewpoint of our “external sector” – our economic dealings with the rest of the world.

What conclusion does he come to? We’ve allowed ourselves to catch a bad case of what economists call “Dutch disease” – but Henry thinks should be renamed Old and New Holland disease.

When a country discovers huge reserves of oil or gas off its coast – or, in our case, the industrialisation of China causes the prices of coal and iron ore to skyrocket – all the locals think they’ve won the lottery and all the other countries are envious. Now we’ll be on easy street.

But when the Dutch had such an experience in the 1960s, they eventually discovered that, while it was great for their mining industry, it was hell for all their other trade-exposed industries.

Why? Because the inflow of foreign financial capital to build the new industry and the outflow of hugely valuable commodity exports send the exchange rate sky-high, which wrecks the international price competitiveness of all your other export and import-competing industries: manufacturing, farming and services.

Not only that. The rapidly expanding mining industry attracts labour and capital away from the other industries, bidding up their costs. Their sales are down, but their costs are up. You’re left with a “two-speed economy”. Remember that phrase? It’s what we’ve had for a decade or two.

Well, interesting theory, but where’s Henry’s evidence that Dutch disease is at the heart of our problems over recent decades?

He’s got heaps. Start with the way the composition of our exports has changed. Between 2005 and today, and in round figures, mining’s share of our total exports has doubled from 30 per cent to 60 per cent. Manufacturing’s share has fallen from 40 per cent to 20 per cent. Everything else – mainly agriculture and services – has fallen from 30 per cent to 20 per cent.

Over the same period, exports grew from 20 per cent of gross domestic product to 27 per cent. This means mining exports’ share of GDP has gone from about 6 per cent to more than 16 per cent. Manufacturing exports’ share has fallen from about 8 per cent to 5.5 per cent.

Next, who buys our exports? China’s share has gone from about 10 per cent to more than 45 per cent. Actually, that was the peak it reached before China’s imposition of restrictions after some smart pollie decided it would be a great idea for Australia to lead the charge of countries blaming China for COVID. Since then, China’s share has fallen to 30 per cent.

Since 2005, mining’s share of total company profits has gone from about 20 per cent to 50 per cent. Manufacturing’s share has fallen from about 20 per cent to less than 10 per cent. Financial services – banking and insurance – have seen their share fall from 20 per cent to less than 5 per cent.

Now, what’s happened to those industries’ share of total employment? Manufacturing’s share has fallen from more than 9 per cent to about 6 per cent. Financial services’ share has been steady at a bit over 3 per cent. Mining’s share has risen from less than 1 per cent to 1.5 per cent. You beauty.

“In summary,” Henry says, “mining employs a very small proportion of the Australian workforce – except in the boom times, when it induces a worker to leave other jobs for mine-site construction work – generates about 60 per cent of Australia’s exports, about half of pre-tax profits (mostly repatriated overseas to foreign shareholders) and exposes the Australian economy to highly volatile global commodity prices and a heavy strategic dependence upon a single buyer, China.”

Not to mention the way mining leaves us heavily exposed to “the risk of global decarbonisation”.

How have we profited from being a mining-dominated economy? Real GDP per person – a rough measure of our material standard of living – has been in trend decline for two decades. In the decade pre-pandemic, “we recorded the sort of growth rates only previously recorded in recessions,” Henry says.

This weakness is largely explained by our poor productivity performance. Though no one else seems to have noticed, our productivity growth is negatively correlated with our “terms of trade” – the prices we get for our exports, relative to the prices we pay for our imports.

That is, when our terms of trade improve, our rate of productivity improvement worsens. And our terms of trade are largely driven by world commodity prices, especially for coal, gas and iron ore.

Now the tricky bit. Why would a mining boom depress productivity improvement? Because of the way it raises our real exchange rate – our nominal exchange rate, adjusted for the change in our rate of production-cost inflation relative to those of our trading partners.

The resources boom increased our nominal exchange rate by about 25 per cent. Then, by 2011, high wages growth and weak productivity growth relative to our trading partners had added a further 35 per cent to the rise in the real exchange rate, Henry calculates.

This caused our non-mining producers to suffer a “profound loss of international competitiveness”. Is it any wonder that, between the turn of the century and 2019, the annual rate of investment by non-mining businesses fell from 7 per cent of GDP to 5 per cent?

The result is that two centuries of “capital-deepening” – increased equipment per worker – have stalled. This move to “capital-shallowing” explains our poor productivity.

And also, our move from current account deficit to current account surplus. “We are exporting [financial] capital because Australia has become an increasingly unattractive destination for doing business in the eyes of foreign investors and Australian [superannuation] savers alike,” Henry says.

“The mining boom has left us with a very big competitiveness overhang that will probably take decades to work off,” he says, including by decades of weak growth in real wages.

What should we have done differently? Had we applied a rational tax to the windfall profits of the mining companies, we would not only have retained for ourselves more of the proceeds from the export of our own natural resources, but also caused the rise in our real exchange rate to be lower.

Remember Kevin Rudd’s proposed “resource super profits tax”? The mining lobby set out to stop it happening, telling a pack of lies about how it would wreck the economy. The Abbott-led opposition threw its weight behind the mainly foreign miners.

Julia Gillard consulted the industry and cut the tax back to nothing much. The incoming Abbott government abolished it.

Petty, short-sighted politicking caused us to sabotage our economy for decades to come.

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A quick economic rebound seems assured - but then what?

The good news in this week’s “national accounts” for the three months to end-September is that the Delta-induced contraction in the economy was a lot less than feared – not just by the financial market economists (whose guesses are usually wrong) but by the far more high-powered econocrats in Treasury and the Reserve Bank. So now it’s onward and upward.

According to figures from the Australian Bureau of Statistics, real gross domestic product – the economy’s total production of goods and services – fell by 1.9 per cent in September quarter, thanks to the lockdowns in Sydney, Melbourne and Canberra.

This contraction of 1.9 per cent compares with the fall of 6.8 per cent in the June quarter of last year, caused by the initial, nationwide lockdown. We know that, as soon as that lockdown ended, the economy rebounded strongly in the second half of last year, and kept growing in the first half of this year – until the Delta variant came along and upset our plans.

So we have every reason to be confident the economy will rebound just as strongly in the present December quarter now the latest lockdowns have ended. We’ve yet to assess and respond to the latest, Omicron variant but, now so many of us are vaccinated, it shouldn’t require anything as drastic as further lockdowns.

We can be confident of another rebound not just because we now understand that the contractions caused by temporary, government-ordered, health-related lockdowns bear little relationship to ordinary recessions, but also because the early indicators we’ve seen for October and November – including those for what matters most, jobs – tell us the rebound’s already started.

In ordinary recessions, it can take the government months to realise there is a recession and start trying to pump the economy back up. With a government-ordered lockdown, the government knows what this will do to reduce economic activity so, from the outset, it acts to make up for the loss of income to workers and businesses.

As with all contractions, most people keep their jobs and their incomes and so keep spending. In a lockdown, however, they’re prevented from doing much spending by being told to stay at home.

This means everyone has plenty they could spend – even people whose employment has been disrupted. So their savings and bank balances build up, waiting until they’re allowed to start consuming again. When the lockdown ends, the floodgates open and they spend big.

After last year’s lockdown, the proportion of their income being saved by the nation’s households leapt to more than 23 per cent, up from less than 10 per cent. Over the following four quarters, it fell to less than 12 per cent.

What we learnt this week is that, following the latest lockdown, the household saving ratio jumped back to almost 20 per cent. So there’s no doubt households are cashed up and ready to spend.

The main drop during the September quarter was in consumer spending (down 4.8 per cent), with business investment spending down 1.1 per cent, and housing investment treading water. Even so, earlier government support measures mean the outlook for business and housing investment spending remains good.

Why was the blow from the latest lockdown so much smaller than that from last year’s? Mainly because it only applied to about half the economy. The other states grew by a very healthy 1.6 per cent during the quarter.

But the main reason this year’s contraction proved smaller than economists were expecting seems to be that businesses and households have “learnt to live with” lockdowns. We now know they’re temporary and we’ve found ways to get on with things as much as possible.

Businesses have thought twice about parting with staff, only to have trouble getting them back. Businesses have become better at using the internet to keep selling stuff and consumers better at using the net to keep buying.

The volume (quantity) of our exports rose during the quarter and the volume of our imports fell sharply, meaning that “net exports” (exports minus imports) made a positive contribution to growth during the quarter of 1 percentage point.

However, this was more than countered by a fall in the level of business inventories, which subtracted 1.3 percentage points from growth. The two seem connected.

The fall in imports seems mainly explained by temporary pandemic-related constraints in supply. And inventory levels are down mainly for the same reason. Seems cars are the chief offender.

Our “terms of trade” – the prices we receive for our exports relative to the prices we pay for our imports – improved a little during the quarter to give a 23 per cent improvement since September last year.

Both the improvement in our terms of trade and the improvement in net exports help explain some news we got earlier in the week: the current account on our balance of payments (a summary record of all the financial transactions between Australia and the rest of the world) rose by $1 billion to a record $23.9 billion surplus during the quarter.

The surplus on our trade in goods and services rose to almost $39 billion and, while our “net income deficit” (the interest and dividends we paid to foreigners minus the interest and dividends they paid us) rose to more than $14 billion, that was a lot less than it used to be.

If you think that sounds like good news, you have more economics to learn. We’ve run current account deficits for almost all the years since white settlement because, until recent years, we’ve been a “capital-importing country”.

The sad truth is, in recent years we’ve been saving more than we’ve needed to fund investment in the expansion of our economy, so we’ve been investing more in other people’s economies than they’ve been investing in ours.

But that’s because we haven’t had much investment of our own. The rebound to a growing economy seems assured, but returning to the old normal isn’t looking like being all that flash.

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Our dealings with the world have reversed, for good or ill

One of the most remarkable developments in our economy in recent times is also the most unremarked: after endless decades of running a deficit on the current account of our balance of payments, for the past two years we’ve been running a surplus. Which looks likely to continue.

Because a “deficit” sounds like it’s a bad thing, and the media know their audience finds bad news much more interesting than good news, I guess it’s not so surprising this seemingly good news hasn’t attracted much attention.

But one thing economics teaches is that, contrary to popular impression, not all deficits are bad and not all surpluses are good. It depends on the circumstances. But regardless of whether they regard a current account surplus as a good sign or a bad one, I suspect most economists think there are more important issues to worry about.

This week the Australian Bureau of Statistics revealed a record trade surplus of $10.5 billion in just the month of June.

We recorded a current account surplus of $17.6 billion during the March quarter this year. That compares with a peak deficit of $23.5 billion in September quarter, 2015.

Since the bureau started publishing the figures in 1959, we’ve run 221 quarterly deficits, but just 26 surpluses. Eight of those have come over the past two years.

But let’s start at the beginning. A country’s “balance of payments” is a summary record of all the transactions during a period of time between, in our case, an Australian on one side and a foreigner on the other. Those on either side could be businesses, governments or individuals. Mainly they’re businesses.

Conceptually, the balance of payments is recorded using double-entry bookkeeping, where one side of the transaction is recorded as a debit and the other as a credit. So, when you add up all the debits and add up all the credits, the two amounts should be equal. Thus the balance of payments is in balance at all times.

This matters because the balance of payments is divided into two main accounts, the “current account” and the “capital and financial account”. The value of transactions involving exports or imports of goods and services goes in the current account, as do payments – in or out - of income such as interest and dividends.

But the other side of each of those transactions involving exports, imports or income payments, the amount someone has to pay – the financial side of the transaction – goes in the capital account, as do purely financial transactions, such as when one of our banks borrows from or lends to some overseas bank, or when one of our superannuation funds buys or sells shares in a foreign company.

Bear with me. The income we earn from foreigners who buy our exports or pay us dividends or interest is recorded as a credit, whereas the money we pay to foreigners for our imports or as dividends on the Australian shares they own or interest on the money they’ve lent us is recorded as a debit.

When we sell them shares in an Aussie business, borrow from them or sell them some real estate, that’s a credit in the capital account. When they sell us shares or land or lend us money, that’s recorded as a debit.

An account where the debits exceed the credits is in deficit. When the credits exceed the debits it’s in surplus.

There had to be a reason for explaining all this, and we’ve reached it. Historically, we almost always imported more than we exported, running a deficit on trade in goods and services. Likewise, we always had to pay more in dividends and interest to foreign owners and lenders than they had to pay us on our foreign shareholdings and loans to them, thus causing us to run a “net income deficit”.

Put the trade deficit and the net income deficit together and you get the balance on the current account, which was always in deficit. Oh no!

But here’s the trick. Since the double-entry system means the debits always equal the credits, if we always ran a deficit on the current account of the balance of payments, that means we always ran an equal and opposite surplus on the capital account. Yippee!

So if you think it’s good news that our current account is now in surplus, what do you think of the news that our capital account is now in deficit? Time to stop assuming all deficits are bad and all surpluses good.

In all the decades that our current account was in deficit, economists never thought that a bad thing. They knew Australia was – and should be – a “capital-importing country”. We always had a lot more investment opportunities than we could finance with our own saving, so we invited foreigners to bring their savings to Oz to participate in our economic development.

This continuous inflow of foreign capital gave us a continuous surplus on the capital account and thus allowed us to import more than we exported. Naturally, we had to pay big dividends and interest to those foreign investors.

So, why has all that reversed? Well, the reversal began in about 2015, long before the pandemic. Its first main cause is the rapid industrialisation of China, which has greatly increased our exports of minerals and energy and, until the pandemic, education and tourism.

But a second, less-favourable development has been our part in the rich economies’ slowdown in economic growth since the global financial crisis in 2008. This has involved increased saving and reduced investment spending – both of which have helped move our current account towards surplus and our capital account towards deficit.

Economists at the ANZ Bank predict the current account will fall back towards balance over the next few years. But we won’t return to our accustomed capital-importing status until we and the rest of the rich world escape the present low-growth trap.

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It'll be a long haul to get the economy going properly

If you’ve been away on Mars for the past five months, it will have been a huge surprise to learn this week that the economy is now "officially" in recession. For the rest of us, the news is the size of the recession, how it compares, what contributed most to the contraction, and the cloudy outlook for recovery.

The Australian Bureau of Statistics’ "national accounts" show real gross domestic product fell by 7 per cent in the June quarter, on top of the 0.3 per cent fall in the previous quarter. This is by far the largest fall in any quarter since we began measuring quarterly GDP in 1959.

The next biggest was a fall of 2 per cent in the June quarter of 1974. As Callam Pickering, of the Indeed global job website, reminds us, our total fall since December compares with peak-to-trough falls of 1.4 per cent in our previous recession in the early 1990s, and 3.7 per cent in the recession of the early 1980s.

So, no doubt this is indeed the worst recession since the Great Depression of the 1930s. Why so bad? Because, as David Bassanese of BetaShares tells us, "this is a recession like no other," being caused by the almost instantaneous spread around the world of a deadly virus and the consequences of our efforts to suppress the virus by ceasing much economic activity.

This coronacession is distinguished by its very front-loaded and cruelly uneven nature. “Unlike past recessions, which usually evolve over a year or so, most of the contraction in the economy took place within two short months,” Bassanese says.

The sudden need to lock down much of the economy and get people to leave their homes as little as possible raises the hope that, as the economy is re-opened, much of that activity will be resumed. And if we switch the focus from what’s happening to GDP – the economy’s production of goods and services – to the more important issue of what’s happening to jobs, we see this is already happening.

Treasurer Josh Frydenberg reminds us that, of the 1.3 million people who either lost their job or were stood down on zero hours following the outbreak, more than half were back at work by July.

This suggests we should be able to expect a significant bounce-back in production in the present September quarter, which has less than a month to run. Sorry, Victoria’s second wave and return to lockdown have put paid to that fond hope.

With the rest of the nation re-opening, but Victoria accounting for about a quarter of GDP, the optimists in Treasury are hoping for a line-ball result, but most business economists seem to be expecting a further (though much smaller) fall.

With any luck, however, Victoria should have started re-re-opening by the end of this month. So, a big recovery in production in the run up to Christmas? Sorry. Unless the government changes its tune by then, the economy will be struggling to cope with the withdrawal of much of Scott Morrison’s budgetary support.

Time for some good news. Remember that, no matter how tough things are looking in Oz, they’re looking better than in the rest of the developed world, with the United States losing 9 per cent during the June quarter, the Europeans down 12 per cent, and Britain down 20 per cent.

Why have we been hit less hard? Because we closed our borders earlier and had more success at containing the virus. We didn’t have to lock down as hard and were able to re-open earlier.

Now back to the details of how our 7 per cent contraction came about. The great bulk of it came from consumer spending - accounting for well over half of GDP – which fell by a remarkable 12.1 per cent during the quarter.

Consumption of goods fell a bit, while consumption of services fell hugely. Why? Because staying at home and social distancing slashed our spending on services such as hospitality, recreation and transport (public, car and air).

To the fall in consumer spending we must add falls of 6.8 per cent in new home building and 6.2 per cent in business investment in new equipment and structures. Note that this continued the declines in these two areas that began well before the virus arrived, showing the economy was weak even before the crisis.

This collapse in private sector spending was partly offset by growth in two parts of the economy. First, public sector spending grew by 2.5 per cent, mainly reflecting greater health care costs. (Note that, being "transfer payments", the huge spending on the JobKeeper wage subsidy scheme shows up as an addition to wage income, while the greater spending on JobSeeker unemployment benefits also shows up as an addition to household disposable income.)

This increased government assistance, at a time when job losses meant wage income was falling, actually caused household disposable income to rise by 2.2 per cent. Combined with the remarkable fall in consumer spending, however, this helps explain why the rate of household saving leapt from 6 per cent of household income to almost 20 per cent.

Second, our international trade made a 1 percentage point positive contribution to growth because, although the volume of our exports of goods and services fell, the volume of our imports of goods and services (which subtract from growth) fell by more.

(Just so you know, partly because of this we recorded our largest quarterly current account surplus on record of $18 billion, or 3.8 per cent of GDP. This is our fifth consecutive surplus, the longest run of surpluses since the 1970s. For a financial capital-importing economy like ours, this is actually a sign of economic weakness.)

Remembering that the outlook for coming quarters isn’t bright, I leave the last, sobering word to the ANZ Bank’s economics team: “Significant further stimulus over the next few years is likely to be required to generate growth and jobs and drive the unemployment rate down.”

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The tables have turned in our economic dealings with the world

If you know your economic onions, you know that our economy has long run a deficit in trade with the rest of the world which, when you add our net payments of interest and dividends to foreigners, means we’ve long run a deficit on the current account of our balance of payments and, as a consequence, have a huge and growing foreign debt.

Except that this familiar story has been falling apart for the past five years, and is no longer true. In that time, our economic dealings with the rest of the world have been turned on their head.

Last week the Australian Bureau of Statistics announced that we’d actually run a surplus on the current account of $8.4 billion in March quarter. Does that surprise you? It shouldn’t because it was the fourth quarterly surplus in a row.

But that should surprise you because the first of those surpluses, for the June quarter last year, was the first surplus in 44 years. And now we’ve clocked up four in a row, that’s the first 12-month surplus we’ve run since 1973.

Of course, when the balance on a country’s current account turns from deficit to surplus, its net foreign liabilities to the rest of the world stop going up and start going down.

What’s brought about this remarkable transformation? Various factors, the greatest of which is our decade-long resources boom, which occurred because the rapid development of China’s economy led to hugely increased demand for our coal, natural gas and iron ore.

A massive rise in the world prices of those commodities, which began in 2004 and continued until 2011, prompted a boom in the construction of new mines and gas facilities which peaked in 2013. From then on, the volume of our exports of minerals and energy grew strongly as new mines came online.

But while our mining exports expanded greatly, the completion of the new mines and gas facilities meant a fall in our extensive imports of expensive mining equipment. As a consequence, our balance of trade in goods and services – which between 1980 and 2015 averaged a deficit equivalent to 1.25 per cent of gross domestic product – has been in surplus ever since.

The rise of China’s middle class gets much of the credit for another development that’s helped our trade balance: strong growth in our exports of services, particularly inbound tourism and the sale of education to overseas students.

When our country has gone since white settlement as a net importer of foreign financial capital – which has been necessary because our own savings haven’t been sufficient to fund all the physical investment needed to take full advantage of our country’s huge potential for economy development – it’s not surprising we have a lot of foreign investment in Australian businesses and have borrowed a lot of money from foreigners.

In which case, it’s not surprising that every quarter we have to pay foreigners a lot more in interest and dividends on their investments in our economy than they have to pay us on our investments in their economies.

This “net income deficit” – which is the other main component of the current account - has grown enormously since the breakdown of the post-World War II “Bretton Woods” system of fixed exchange rates prompted us to float our dollar in 1983 and started a revolution in banks and businesses in one country lending and investing in other countries, including the rise of multinational corporations.

That was when Australia’s net foreign debt started rising rapidly and the net income deficit began to dominate our current account. The net income deficit has averaged a massive 3.4 per cent of GDP since the late 1980s.

It hasn’t changed much since the tables started turning five years ago. Except for one thing. The rapid growth in our superannuation funds since the introduction of compulsory employee super in the early 1990s has seen so much Australian investment in the shares of foreign companies that, since 2013, the value of our “equity” investment in other countries’ companies has exceeded the value of more than two centuries of other countries’ investment in our companies.

At March 31, Australia had net foreign equity assets worth $338 billion. You’d expect this to have significantly reduced our quarterly net income deficit, but it hasn’t. Why not? Because the dividends we earn on our investments in foreign companies aren’t as great as the dividends foreigners earn on their ownership of our companies. Why not? Because our hugely profitable mining industry is three-quarters foreign-owned.

If you add our net foreign equity assets and our net foreign debt to get our net foreign liabilities, they’ve been falling as a percentage of GDP for the past decade. If you look at the absolute dollar amount, just since December 2018 it’s fallen by more than 20 per cent.

If all this sounds too good to be true, it’s certainly not as good as it looks. The final major factor helping to explain the improvement in our external position is the weakness in the economy over the 18 months before the arrival of the virus shock.

The alternative way to see what’s happening in our dealings with the rest of the world is to focus on what’s happening to national saving relative to national (physical) investment. That’s because the difference between how much the nation saves and how much it invests equals the balance on the current account.

Turns out that national investment has fallen in recent times (business investment is weak, home building has collapsed and government investment in infrastructure is falling back) while national saving has increased (households have been saving more, mining companies have been retaining much of their high profits, and governments have been increasing their operating surpluses).

So much so that the nation is now saving more than it’s investing, giving us a current account surplus. But this is a recipe for weaker not faster “jobs and growth”.

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Your antidote to Frydenberg’s budget-update talking points

At a time when the Prime Minister is refusing to accept that our weak economy needs a boost rather than a drag from the budget, stand by for loads of look-over-there spin from his unfortunate Treasurer Josh Frydenberg when he unveils the mid-year budget update today.

That was Frydenberg’s way of bluffing his way round the news earlier this month that the economy had grown by a disappointing 1.7 per cent over the year to September. So it wouldn’t be surprising to see some of those talking points get another run today.

He started with the line that, despite a result that laughed at his forecasts made only eight months earlier, the economy remains “remarkably resilient in the face of significant global and domestic economic headwinds”.

That’s a spin doctor’s way of saying “it could have been even worse”. Arithmetically true, but cold comfort. Since Frydenberg is boasting about our strong growth in exports, it’s hard to see much evidence of the global headwinds he claims are holding us back. And the domestic headwinds we’re suffering are home-grown and all too evidently a sign of poor economic management.

But Josh has more: “While other major developed economies like Germany, the United Kingdom, South Korea and Singapore have experienced negative economic growth, the Australian economy is in its 29th consecutive year of economic growth.”

Yes, but at present almost all our growth is coming from high immigration-fed population growth, not rising prosperity. As AMP Capital’s Dr Shane Oliver has noted, our annual growth in gross domestic product per person is just 0.2 per cent, compared with America’s 1.4 per cent, Japan’s 1.6 per cent and even the Eurozone’s 1 per cent.

In the first of his look-over-there arguments, Frydenberg boasts that we’ve maintained our AAA credit rating from three leading US rating agencies. Since these agencies’ lapse in ethical standards contributed significantly to the global financial crisis, this isn’t a recommendation I’d be skiting about. Any government that lets those disreputable characters dictate its budget policy lacks the courage of its convictions.

Next, we’ve seen our current account on the balance of payments “return to surplus for the first time in more than 40 years”. Not sure whether this boast is a sign of our Treasurer’s economic illiteracy, or his assessment of ours. Only the same people who think now’s a good time for the budget to take more out of the economy than it puts back – that is, return to surplus – would be foolish enough to think a current account surplus was a sign of economic strength.

It’s actually a sign that business investment is so unusually weak that our households, companies and governments are saving more than is needed to fund our national investment in new productive assets. Our usual current account deficit would be a much better sign of strong investment in future expansion.

Then we’re told that “welfare dependency is at its lowest level in 30 years”. With the unemployment rate at 5.3 per cent and the under-employment rate at 8.5 per cent, that’s not because they’ve all got jobs, it’s because of the government’s greater use of excuses to cut people off the dole and make them reliant on charity for their survival. Talk about reversion to the mean.

In a breathtaking case of Orwell’s Newspeak, Frydenberg claimed “growth has been broad-based with household consumption, public final demand and net exports all contributing to GDP growth”.

This is the very opposite of the truth. Since growth in consumer spending was a negligible 0.1 per cent during the quarter, the vast private sector of the economy actually went backwards, with what little growth we got coming from the much smaller (and despised) public sector and from net exports.

Growth in the September quarter was weaker than expected because Frydenberg’s repeated assurances that his middle-income tax offset would boost consumer spending failed to happen. Talk about chutzpah. He changed his line to “whether spent or saved, the tax cuts are putting households in a stronger economic position, making them more financially secure with more money in their pockets” without a blush.

Finally, it’s the drought’s fault – and you surely can’t blame the government for that. “Farm GDP is 5.9 per cent lower through the year to the September quarter and falling in four of the past five quarters. Rural exports fell by 2.8 per cent in the quarter,” Frydenberg said.

Arithmetically correct, but calculated to mislead. What he hopes you won’t remember is that, these days, agriculture accounts for only about 2 per cent of GDP, meaning the drought shaved only 0.1 percentage points off growth in the quarter, and 0.2 points over the year.

All this is the balderdash we get when pollies give politics priority over policy.

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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.

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Current account deficit improves without us noticing

They say a watched pot never boils, so maybe it's a good thing we now spend so little time worrying about the current account deficit. While our attention's been elsewhere, it's got a lot smaller.

This news comes courtesy of the International Monetary Fund's latest country report on Australia, issued this week.

Settle back. The nation's "balance of payments" is a statement summarising all the transactions between Australians (whether businesses, governments, or individuals) and the rest of the world.

It's divided into two main accounts. First is the "current account", which summarises exports and imports of goods and services, plus inflows and outflows of income, particularly payments of dividends and interest on loans.

Then there's the "capital and financial account" which, as its name implies, summarises the inflows and outflows arising from the financial-capital dimension of the transactions included in the current account.

Because the balance of payments is calculated using the accountants' double-entry bookkeeping system of debits and credits, the balance of payments is always in balance. So if the current account sums to a deficit, the capital account must sum to a surplus of the same size.

The fund's report acknowledges that Australia almost always runs a deficit on the current account, with an offsetting surplus (net capital inflow) on the capital account.

This is because we've always invested a lot more each year (in new business equipment and structures, homes and public infrastructure) than we (businesses, households and governments) have saved each year, so we've always needed to call on the savings of foreigners to make up the gap.

Foreigners' savings come as either loans (known as "debt capital") or the purchase of shares in our businesses or real estate ("equity capital").

Worries about the size of the deficit on the current account go back to the days before 1983, when the Australian dollar's rate of exchange with other currencies was fixed at a certain level by the government.

It was the government's job to defend that fixed rate by making sure the current account deficit and the capital account surplus were never too far apart.

This "balance of payments constraint" meant that if the current deficit got too big relative to the capital surplus, the government would have to crunch the economy so as to get imports down and thus help it keep the dollar's value unchanged.

If this didn't happen, the government would suffer the ignominy of devaluing our dollar and hoping this would get the current deficit and capital surplus back together.

When, in 1983, we decided to allow the value of the dollar to "float", however, this allowed it to move up or down automatically and continuously by however much was needed to keep the current deficit and the capital surplus exactly equal at all times.

It took until some years after the float for economists to realise that, in the new, more globalised world of floating currencies and unrestricted flows of financial capital between countries, there was much less reason to worry about the excessive size of the current deficit.

The necessary "devaluation" of the exchange rate would be brought about by the foreign exchange market, not the government.

The fund's report notes that, in the 1960s and '70s, the current account deficit fluctuated around 1 and 2 per cent of gross domestic product.

During the 35 years since the float, however, the current deficit blew out, averaging about 4 per cent of GDP. In consequence, there was a huge increase in our foreign liabilities, particularly our net foreign debt – to a mere $990 billion at last count.

This is what worried many people – until the economists and politicians decided to stop talking about it and focus on something different, the federal government's budget deficit and net government debt.

But here, at last, is the news: the fund reports that, since the global financial crisis in late 2008, the current account deficit has been a lot smaller. It's expected to have been only 2 per cent in 2017.

Why the improvement? Since the current deficit and the capital surplus are two sides of the same coin, you can explain changes by looking at either side – or both. The report offers two reasons for the smaller current deficit and three for the smaller capital surplus.

On the current account, it says we suffered a larger slowdown in growth in domestic demand (spending on consumption and investment goods) following the crisis than did our major trading partners (which, remember, are mainly fast-growing Asian economies).

So our imports from them weakened by more than our exports to them.

As well, the current deficit has been reduced by a lower "net income deficit" – gone from 3 per cent of GDP before the crisis to 1.5 per cent since – because world interest rates are so much lower, and our interest payments to foreigners far exceed their interest payments to us.

On the capital account surplus – representing the amount by which national investment exceeds national saving - the report notes that households have been saving a higher proportion of their incomes since the crisis than before it (even though they're saving less now than they were a few years back).

Second, since the crisis, our companies have saved more by retaining more of their profits rather than paying them out in dividends and, despite the surge in investment spending by mining companies that's only now ending, other companies haven't been investing much until recently.

Finally, the tightening up of international capital adequacy requirements in reaction to the crisis has obliged our banks to increase their saving by retaining more of their profits.

The report foresees the current account deficit stabilising at about 2.5 per cent of GDP in the next few years – which would be almost back to its modest levels when our exchange rate was still fixed.

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We've handled the resources boom surprisingly well

Are we in for big trouble in the aftermath of a misspent resources boom, or has the boom been over-hyped, leaving us in good shape to face the future?

This is a matter of debate among some of Australia's most prominent economists. Professor Ross Garnaut, of the University of Melbourne, advanced the former argument last year in his book Dog Days: Australia After the Boom, and Dr John Edwards, a fellow of the Lowy Institute and member of the Reserve Bank board, makes the counter-argument in his new book, Beyond the Boom.

This week Dr David Gruen, of Treasury, weighed into the argument in a speech written with help from Rhett Wilcox. Gruen took a middle position, agreeing with each man on some points and disagreeing on others. Appropriately, he was speaking at the annual conference of economists in Hobart. They enjoy that kind of thing.

Gruen strongly disagrees with Edwards' claim that the resources boom "hasn't been as important for Australian prosperity as widely believed", saying the boom was "one of the largest changes in the structure of our economy in modern times" which "generated the largest sustained rise of Australia's terms of trade ever seen".

"The result was that resources investment increased from less than 2 per cent of gross domestic product pre-boom to around 7.5 per cent in 2012-13, an increase, in dollar terms, from around $14 billion to more than $100 billion a year," he says. "This has seen an additional 180,000 workers employed in the resources sector since the boom began and will see the capital stock in the resources sector almost quadruple by 2015-16."

But Gruen disagrees with Garnaut's implication that the economy was not well managed during the boom. He notes that all previous commodity booms - including the rural commodity boom of the early 1970s - led to blowouts in wages and inflation, followed by recessions after the boom busted.

This time, however, wages have been well controlled and the rise in prices has rarely strayed far from the Reserve Bank's 2 per cent to 3 per cent target range. The boom in the resources sector has not led to excessive growth in the economy overall. Real GDP growth averaged 3 per cent a year over the decade to 2012.

Edwards supported his claim that the resources boom has not been as important for our prosperity as commonly believed by comparing this 3 per cent growth rate unfavourably with the 3.8 per cent annual rate achieved over the decade to 2002.

But Gruen counters by noting the earlier decade "saw above-trend growth as the economy recovered from the deep early-1990s recession, with unemployment falling from above 10.5 per cent to below 6 per cent over the course of that decade".

So why has the upside of the resources boom been handled so much better than in earlier commodity booms? Gruen gives much of the credit to three micro-economic reforms: the floating of the dollar in 1983, the move to letting the Reserve Bank set monetary policy (interest rates) independent of the elected government, formalised by Peter Costello in 1996, and the decentralisation of wage-fixing, largely completed by the Keating government before 1996.

(This to me is a point worth noting: the greatest continuing benefit from the era of micro reform - but also from the move to set formal "frameworks" for conducting the two arms of macro-economic policy - is a much more flexible economy, one that is less inflation-prone and less unemployment-prone. By the way, Garnaut and Edwards can take their share of credit for these reforms.)

Next Gruen rebuts Garnaut's argument that the income the nation earned from the boom was misspent.

Garnaut might have in mind the Howard government's decision to respond to the temporary increase in collections from company tax and capital gains by cutting income tax for eight years in a row, a move that does much to explain the trouble we are having getting the budget back into surplus.

But there is more to the economy than what the feds do with their budget. And Gruen points out that, over the decade to March 2014, national consumption spending (by households and governments) actually declined from about 76 per cent of GDP to 73 per cent. If so, the nation's saving must have increased by 3 percentage points of its income (remember: income equals consumption plus saving).

Against that, over the same period bar the last few quarters, national investment has been high and rising, relative to income. "Rather than the income gains from the boom having been consumed, it would be more accurate to conclude that they were invested," Gruen says - a point Edwards also made.

(Had the nation been "living beyond its means", that would show up as a widening in the current account deficit. Instead, the deficit has been narrower in recent years.)

But what about the downside of the boom? Will the bust result in a period of contraction for the economy as a whole? Gruen's answer is "so far, so good", but he concedes that, over the next three or four years, investment spending by the miners is expected to fall from about 7 per cent of GDP to about 2 per cent or 3 per cent, a subtraction from growth of about 2 per cent to 2.5 percentage points (remembering that about half of mining investment is in imported equipment).

Remember, too, that mining production and export volumes will be growing strongly. Even so, avoiding recession will require a further significant fall in the dollar.

Gruen agrees with Garnaut that for the economy to benefit from such a "nominal" depreciation in the currency, it will need to be translated into a "real" depreciation by only moderate wage growth. But this could be achieved provided real wages grow by less than the growth in labour productivity.

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We own as much of their farm as they own of ours

Did you know that, at the end of last year, the value of Australians' equity investments abroad exceeded the value of foreigners' equity investments in Australia by more than $23 billion?

It's the first time we've owned more of their businesses, shares and real estate ($891 billion worth) than they've owned of ours ($868 billion).

These days in economics there's an easy way to an exclusive: write about something no one else thinks is worth mentioning, the balance of payments. We'll start at the beginning and get to equity investment at the end.

Before our economists decided the current account deficit, the foreign debt and our overall foreign liability weren't worth worrying about, we established that, when measured as a percentage of national income (gross domestic product), the current account deficit moved through a cycle with a peak of about 6 per cent, a trough of about 3 per cent and a long-term average of about 4.5 per cent.

Those dimensions were a lot higher in the global era of floating exchange rates than they'd been in the era of fixed exchange rates (which ended by the early '80s). This worried a lot of people, until eventually economists decided the new currency regime meant there was less reason to worry.

This explains why economists haven't bothered to note that for four of the past five financial years, the figure for the current account deficit as a percentage of GDP has started with a 3. And, as we learnt earlier this month, the figure for the year to December was 2.9 per cent.

So it seems clear that recent years have seen a significant change in Australia's financial dealings with the rest of the world. And the consequence has been to lower the average level of the current account deficit.

The conventional way to account for this shift is to look for changes in exports, imports and the "net income deficit" - the amount by which our payments of interest and dividends to foreigners exceed their payments of interest and dividends to us.

The first part of the explanation is obvious: over the past decade, the world's been paying much higher prices for our exports of minerals and energy. This remains true even though those prices reached a peak in 2011 and have fallen since then.

On the other hand, the prices we've been paying for our imports have changed little over the period. So, taken in isolation, this improvement in our "terms of trade" is working to lower our trade deficit and, hence, the deficit on the current account.

Next, however, come changes in the quantity (volume) of our exports and imports. Here, over the full decade, the volume of imports has grown roughly twice as fast as growth in the volume of exports. Until the global financial crisis, we were living it up and buying lots of imported stuff. And maybe as much as half of all the money spent on expanding our mines and gas facilities went on imported equipment.

The more recent development, however, is that the completion of mines and gas facilities means enormous growth in the volume of our mineral exports - with a lot more to come. At the same time, as projects reach completion there's a big fall in imports of mining equipment. That's a double benefit to the trade balance and the current account deficit.

Turning to the net income deficit, it's been increased by the huge rise in mining companies' after-tax profits, about 80 per cent of which are owned by foreigners. Going the other way, world interest rates are now very low and likely to stay low.

Put all that together and it's not hard to see why current account deficits have been lower in the years since the financial crisis, nor hard to see they're likely to stay low and maybe go lower in the years ahead.

The current account deficit has to be funded either by net borrowing from foreigners or by net foreign "equity" investment in Australian businesses, shares or real estate. This means the current account deficit is the main contributor to growth in the levels of the national economy's net foreign debt, net foreign equity investment and their sum, our net foreign liabilities.

Historically, our high annual current account deficits worried people because they were leading to rapid growth in the levels of our net foreign debt and net total liabilities.

But looking back over the past decade, and measuring these two levels relative to the growing size of our economy (nominal GDP), there's no longer a clear upward trajectory. Indeed, it's possible to say our net foreign debt seems to have stabilised at about 50 per cent of GDP, with net total liabilities stabilising a little higher.

Over the decades, the level of net foreign equity investment in Australia has tended to fall as big Aussie firms become multinational by buying businesses abroad and Aussie super funds buy shares in foreign companies, thus helping to offset two centuries of mainly British, American, Japanese and now Chinese investment in Aussie businesses.

But the net total of such equity investment is surprisingly volatile from one quarter to the next, being affected not just by new equity investments in each direction, but also by "valuation effects" - the ups and downs of various sharemarkets around the world as well as the ups and downs in the Aussie dollar.

Between the end of September and the end of December, net foreign equity investment swung from a net liability of $27 billion to a net asset of $23 billion. This was mainly because of valuation effects rather than transactions, so I wouldn't get too excited.

What it proves is that, these days, the value our equity investments in the rest of the world isn't very different from the value of their equity investments in Oz.

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Clear signs the economy is picking up

At last some good news on the economy. This week's national accounts for the December quarter show the economy speeding up and, in the process, starting its fabled "transition" away from being driven largely by mining investment.

The economy's medium-term "trend" rate of growth in real gross domestic product - the rate that holds unemployment constant - is thought to be 3 per cent a year. For much of last year the economy was seen to be travelling at only about 2.5 per cent, thus leading to a slow but steady rise in unemployment.

But this week's accounts from the Bureau of Statistics show real GDP growing by 0.8 per cent in the December quarter and by 2.8 per cent over last year. Applying a bit of judgment, we can say the economy is probably now growing at an annualised rate of about 2.8 per cent.

This isn't enough to stop unemployment rising - and we really need a period of growth well above 3 per cent to get the jobless rate heading back down to its own trend level of about 5 per cent - but it beats 2.5 per cent.

And, as I say, the accounts show reasonably convincing evidence the "rebalancing" of the economy - away from mining investment and towards the other sectors of the economy and sources of growth - is finally under way.

After quite a few quarters of weakness, consumer spending grew by 0.8 per cent in the quarter and by 2.6 per cent over the year. This strengthening is a bit of a surprise when you remember household disposable income is only crawling ahead, with no growth in employment and very low rises in wages.

Arithmetically, the explanation is a fall in the household saving rate from 10.6 per cent of disposable income to 9.7 per cent. But this ratio is volatile, so I wouldn't take it too literally. It's possible households have shaved their rate of saving - say, from the high 10s to the low 10s - but I doubt it signals a return to the low saving rates we saw in the couple of decades before the global financial crisis.

The second sign of rebalancing was long-awaited real growth of 1 per cent in spending on home building, including renovations. This is not unexpected considering the rises in established house prices and in the issue of local government building permits.

More recent "partial indicators" for the month of January confirm that consumption and home building have picked up. Nominal retail sales grew by a strong 1.2 in the month to be up 6.2 per cent on a year earlier. And residential building approvals rose strongly in the month to be up 34 per cent on a year earlier.

Public sector spending rose by 1.1 per cent in the quarter, contributing 0.3 percentage points to the overall growth of 0.8 per cent in real GDP. Most of this came from public infrastructure spending.

But now we get to the bad news. Most of the growth I've outlined so far was offset by a sharp fall in business investment spending, which dropped by 3.6 per cent.

Most of this decline is explained by a drop in mining investment as the investment phase of the resources boom comes to an end. It's now clear mining investment peaked about a year ago.

It was our knowledge that mining investment was about to fall back from the dizzying heights it reached that caused us to see the need for "transition" or "rebalancing" in the economy (plus a few other buzzwords I've forgotten).

But this brings us to the weak part in the transition so far. Although most of the fall in total business investment is explained by mining, it's clear investment spending in the non-mining sector also fell - which is not what the doctor ordered. Rough estimates by Kieran Davies, of Barclays bank, suggest it fell by 1.2 per cent in the quarter and by 7 per cent over the year.

So if most of the growth in domestic demand in the quarter was cancelled out by the fall in business investment, where did the overall growth in aggregate demand of 0.8 per cent come from? From the one place left: net external demand, otherwise known as "net exports" - exports minus imports.

The volume (quantity) of exports grew by 2.4 per cent in the quarter and by 6.5 per cent in the year, whereas the volume of imports fell by 0.6 per cent in the quarter and by 4.6 per cent in the year.
Put the two together and net exports made a positive contribution to overall growth of 0.6 percentage points in the quarter and 2.4 points over the year.

Why are exports growing so strongly? Mainly because of rapid growth in our exports of minerals and energy as new mines come on stream. Why are imports so weak? Partly because domestic demand has been weak, but particularly because of the fall off in mining investment, which involves a lot of imported equipment.

So the investment phase of the resources boom is coming to an end and leaving a hole in the economy, but the production and export phase of the boom is helping to fill the hole - helping to tide us over while the non-mining economy is getting back on its feet (to mix a few metaphors).

The resources boom's now favourable effect on net exports translates into a much lower current account deficit on our balance of payments. Whereas it used to get as high as 6 per cent of GDP in the old days, and averaged about 4.5 per cent, for the December quarter it was just 2.6 per cent.

Maybe the economy has a future after all.

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Budget will test Abbott's mettle

Will the Abbott government ultimately be judged a great reforming government or the worst money manager since Whitlam? In a delicious irony considering all the phoney outrage Abbott & Co expressed on the subject in opposition, this judgment will turn on how they respond to the budget's deep structural problems.

That conclusion leaps out from John Daley's latest budget report for the Grattan Institute. Normally, governments muddle through, taking some tough measures but not enough. In this case, however, Tony Abbott will need to take a lot of tough decisions or be judged a failure who ran a permanent budget deficit and incurred ever-mounting public debt because he lacked the guts to make us pay our way.

Daley finds that, on existing policies, federal and state governments face a decade of structural (operating) budget deficits, which by 2023 could reach 4 per cent of gross domestic product, or $60 billion a year in today's dollars.

About a quarter of this $60 billion arises from the Coalition's election promises. Some of these - the disability scheme and increased education spending - were common with Labor, but not the replacement of the carbon tax with "direct action" (which adds $5 billion a year), nor the more generous paid parental leave scheme.

Three-eighths of the $60 billion arises from the projected increase in spending on healthcare. This comes not so much from ageing as from the unceasing increase in both the supply of and the demand for ever-more-effective, but ever-more-expensive health technology.

One-eighth of the $60 billion arises from "welfare" - mainly, the sad fact that we won't be able to keep widening the income gap between sole parents and people on the dole, and the rest of us, including even people on the pension.

That leaves about a quarter of the $60 billion explained by the likelihood that our return to normal cyclical conditions will involve significantly lower prices for mineral exports and thus lower tax collections.

We can't grow our way out of this deficit. Being "structural", it already assumes the economy is back to growing normally. And above-average growth has much the same effect on both sides of the budget.

With one exception, the only way a structural deficit can be reduced is to make explicit decisions to cut spending or increase taxes. Worse, you have to resist the temptation to make any further unfunded spending or tax-cut decisions just to stop the structural deficit getting bigger.

The exception is bracket creep, which Daley estimates could contribute about $16 billion a year to closing the $60 billion gap. No doubt we'll get a lot of creep, though you can't avoid income-tax cuts for a decade.

Daley's report explodes some budget myths. One dear to the Coalition's heart is that the problem can largely be fixed by eliminating "waste and extravagance", including a bloated public service and (narrowly defined) middle-class welfare.

Sorry, there just aren't enough savings in anything you could do that is remotely feasible. You're talking chickenfeed.

Then there's business' dream that the solution is simple, if a little difficult politically: just cut government spending to fit (and cut company tax while you're at it). When last week's report card from the International Monetary Fund appeared to advocate "sizeable cuts in projected spending", the usual suspects raised a rousing cheer.

Sorry, leaving aside changes to the age pension, the best Daley can come up with on the spending side would produce savings of just $25 billion a year.

These would require reducing spending on infrastructure by a third, halving federal and state industry support, increasing university HECS fees, greatly increasing school class sizes and getting rid of the industry subsidies hidden in the pharmaceutical benefits scheme and defence spending (think subs).

The truth no one wants to know is that we won't get the budget back to structural balance without explicit tax increases. Daley shows, however, we could go a long way by getting rid of some inefficient and unfair tax expenditures, such as the capital gains tax exemption for the family home, the 50 per cent gains-tax discount and negative gearing (worth $22 billion a year in total).

But Daley's big one is retirement income support. Phase up eligibility for the pension or access to super to 70 and save $12 billion a year. Include the family home in the age pension assets test and save $7 billion. Make the super contributions tax fairer and save $6 billion a year.

What's that? You don't see Abbott and Joe Hockey doing anything much on that list? Well, stand by for endless budget deficits and ever-mounting government debt. No guts, no avoiding disgrace.

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Latest on the debt no one mentions

It's funny that people who like to worry about the supposedly humongous size of our "debt and deficits" have focused on one debt when they could have picked another one four times bigger.

They carry on about the federal "net public debt", which is expected to have reached $162 billion - equivalent to 10.6 per cent of gross domestic product - by the end of this month. It's now expected to peak at $192 billion - 11.4 per cent of GDP - in June 2015, before it starts falling.

But that's chicken feed compared with our "net foreign debt", which reached $760 billion - 51 per cent of GDP - in December.

Whereas the net public debt is the net amount owed by the federal government to people who hold its bonds (whether they're Australians or foreigners), the net foreign debt is the net amount Australian governments, companies and households owe to foreigners.

One reason for the lack of trumpeted concern about the foreign debt is you can't score any party-political points with it. In dollar terms, at least, it's just kept growing under Liberal and Labor governments.

A better reason is there isn't a lot to worry about. Throughout the history of white settlement, Australia has always been a net importer of foreign capital because our scope for economic development has always been greater than we could finance with just our own saving.

And, as Treasury points out in this year's budget papers, there's now even less reason to worry than there used to be.

The net foreign debt is the partial consequence of a deficit that rarely rates a mention these days, the deficit on the current account of our balance of payments. (The balance of payments records all the transactions between Australians and the rest of the world.)

The current account deficit is usually thought of as the sum of our trade deficit (exports minus imports) and our "net income deficit" (our payments of interest and dividends to foreigners minus their payments of interest and dividends to us).

But it can also be thought of as the extent to which we have called on the savings of foreigners to fund that part of the nation's investment spending (on new homes, business equipment and structures, and public infrastructure) the nation has been unable to fund with our own saving (by households, companies and governments).

Actually, borrowing foreigners' savings is only one way to make up the saving deficiency. The other way is to attract foreign "equity" investment (ownership) in Australian businesses.

In December, when our net borrowing from foreigners totalled $760 billion, the net value of foreigners' equity investment in Australia was $110 billion, taking our total net foreign liabilities to $870 billion.

Our net foreign liabilities represent the accumulation of all our past current account deficits (and we've run such a deficit almost every year for at least the past 200).

Treasury makes the point that just because we don't save enough to finance all our annual new investment doesn't mean we don't save much. We save a higher proportion of national income (GDP) than many developed countries, and we've been saving a lot more since the early noughties.

Though governments are saving less, it's well known that households are saving a lot more. And companies are saving more by retaining a higher proportion of their after-tax profits. So national saving has risen to about 25 per cent of GDP.

Some of this rise has been offset by an increase in national investment spending, driven by the mining construction boom, which has taken national investment spending up to about 28 per cent of GDP.

Even so we've still reduced the gap between national investment and national saving to about 3 percentage points of GDP, which compares with an average of 6 percentage points in the years leading up to the global financial crisis. Treasury says this smaller gap (that is, smaller current account deficit) is likely to continue for at least the next two years.

Before the financial crisis, the dominant form of net capital inflow was "portfolio debt", Treasury says. This debt was held largely by our banks, but their foreign borrowing was really to meet the borrowing needs of their household and business customers.

Since the crisis, however, the household sector has ceased to be a net borrower and reverted to its more accustomed position as a net lender to other sectors of the economy.

The corporate sector (excluding the banks) is still a net borrower, but the mining companies in particular have funded a lot of their investment in new mining construction from retained earnings rather than borrowings.

Since the miners are largely foreign-owned, however, this use of retained earnings shows up in the balance of payments as an inflow of foreign equity.

This implies we've become less dependent on foreign borrowing to finance the current account deficit.

As part of this, our banks have been net repayers of their total foreign liabilities since mid-2010.

(The counterpart of this is that they've been getting a lot higher proportion of their funding from Australian household depositors, particularly through term deposits.)

One lesson from the financial crisis is that severe dislocations in foreign funding markets can impede the ability of even the most creditworthy borrowers (our banks, for instance) to obtain funds, even if only for a short time.

This helps explain our banks' subsequent move back to reliance on household deposits (made more possible by our households' changed saving behaviour, of course) and also their move to reduce their exposure to "rollover risk" (having trouble replacing a maturing debt with a new debt) by lengthening the average term of their foreign borrowers.

These days, 63 per cent of our foreign debt is more than a year from maturity, including almost a third with more than five years to run.

Finally, some people worry that, when we borrow in foreign currencies, a fall in our dollar would automatically increase the Australian-dollar amount of our debt. But Treasury points out, these days, almost two-thirds of our net foreign debt has been borrowed in Australian dollars.

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Why we've become good savers

Who would believe it? Australia is turning into a nation of savers. We've already lifted our rate of saving - we save more than people in other developed countries - and we're likely to increase our saving rate further.

Who would believe it? Australia is turning into a nation of savers. We've already lifted our rate of saving - we save more than people in other developed countries - and we're likely to increase our saving rate further.

This the surprising message in this year's budget statement 4 - otherwise known as Treasury's sermon. The facts and figures that follow come from there.

Expressed as a proportion of gross domestic product, gross national saving fell significantly from the mid-1970s until the early 1990s. Between 1992-93 and 2004-05, it was fairly steady at 21 per cent. It began to rise in 2005-06 - well before the global financial crisis - and since the crisis it's shot up to reach almost 25 per cent last year.

This is well above the average for the developed economies of less than 19 per cent. Now, their saving rates are down because they're still trying to put the Great Recession behind them and it's arguable that some part of our increased saving since the crisis is also a passing reaction to the uncertainty it continues to cause. But we were well above them before the crisis.

The nation's rate of saving is the sum of the saving done by the three sectors of our economy: the households, the companies and the governments.

Households save when they spend less than all their income on consumption. Companies save when they retain part of their after-tax profits rather than paying all of them out in dividends. Governments save when their revenue exceeds their recurrent spending.

Most of the reason for the increase in national saving - and most of the reason for expecting it to increase further - rests with households.

The household saving rate declined steadily from the mid-1970s to the mid-noughties but then it increased significantly and is now 11.5 per cent of GDP, up from a low of just under 6 per cent in 2002-03.

One reason for this turnaround is the maturing of the compulsory superannuation system. Award-based super was introduced in 1985 but the scheme really got going in 1992, when they began phasing up employer contributions to 9 per cent of ordinary-time wages by 2002.

The value of Australia's super savings is now as much as $1.3 trillion, equivalent to 95 per cent of annual GDP (compared with the average for the developed countries of 68 per cent). Treasury estimates the scheme now makes a gross contribution to national saving of 1.5 percentage points.

Treasury says the more recent increase in household saving is likely to reflect a combination of increased consumer caution following the crisis and a return to more sustainable rates of consumption growth.

To the extent it's a return to more normal rates of growth in consumer spending, it's likely to be lasting. To the extent it's just caution, retailers and others can hope it will go away as all the upheaval stemming from the global crisis is resolved, people become more confident and lower somewhat the rate at which they're saving.

Now, no one can say how much of our higher household saving rate comes from lasting ''structural change'' and how much comes from passing caution. Until more of history unfolds, we can only make guesses.

But my guess is most of it is structural and not much of it is passing. In any case, I can't see the global economy becoming a much more placid place any time soon. Europe's weakness could roll on for a decade.

I think the econocrats are holding out false hope to retailers and others with their talk of ''the cautious consumer'', implying the tough times will end as soon as shoppers cheer up. It would be better to encourage the retailers to get on with adjusting to the new world they live in.

Treasury says the fall in household saving up to the mid-noughties primarily reflected a prolonged, but essentially one-off, structural adjustment to financial deregulation from the early '80s and the transition to a low-inflation (and hence low nominal interest-rate) environment from the early '90s.

Easier access to credit and lower rates led to greater borrowing, rising house prices, high levels of confidence and - thanks to big capital gains - people reducing their saving rate and allowing their consumption spending to grow faster than their incomes.

This adjustment process is likely to have been a significant driver of change in household saving. From the second half of the noughties, however, households began to slow their accumulation of debt and, as a result, the household saving rate began to rise.

With this process now likely to have been completed, households as a whole can be expected to consolidate their financial position over coming years by returning to more normal levels of saving and borrowing.

That's a quick explanation of why we've gone back to being good savers. But why expect our saving rate to go on rising? Partly because our (largely foreign-owned) mining companies are retaining a high proportion of their huge after-tax profits (which they're using to help finance their investment in additional production capacity).

Partly because the federal politicians (and their state counterparts) are struggling to get their budgets back into operating surplus, meaning governments are shifting from dissaving to saving.

But mainly because the compulsory super scheme will soon begin phasing up the contribution rate from 9 per cent of wages, reaching 12 per cent in 2019-20. Treasury estimates this will make a further gross contribution to the national saving rate of 1.5 percentage points of GDP over the next 25 years, with most of that expected to occur over the next decade.

Just as every punter knows in their gut that deficit and debt are always and everywhere a bad thing (it ain't true), so everyone knows saving is always a good thing. But what's so good about it?

The main reason people save is to smooth their consumption over time. For instance, you consume less while you're working so you can have a higher standard of living when you're retired. You can even use saving to pass some of your income on to the next generation. And saving makes you more resilient by providing a buffer against unexpected adverse events.

At a national level, borrowing less and saving more makes us more resilient to possible external shocks. And it helps moderate inflation pressure and so allows interest rates to be lower.

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Is Australia living beyond its means?

It has become fashionable to say the US is ''living beyond its means''. But can the same accusation be levelled at Australia? It was a claim we used to hear often when people worried about the big deficits we were running on the current account of the balance of payments.

During the 1960s, the current account deficit averaged the equivalent of 2 per cent of gross domestic product. By the '80s, however, it was averaging 4 per cent, rising to 4.25 per cent during the '90s and noughties.

But though few people have noticed, in recent years the deficit has been falling. And for 2011 it was just 2.25 per cent.

Why the decline? And what does this tell us about whether we are or aren't living beyond our means?

It gets down to what's happening to the nation's levels of saving and investment. And James Bishop and Natasha Cassidy provide a detailed account of trends in national saving and investment in the latest Reserve Bank bulletin. Most of the facts and figures I'm using are from their article.

The nation's annual investment spending occurs in three categories: households investing in the construction of new homes, companies investing in new equipment, buildings and other structures, and governments investing in infrastructure.

The money to pay for all that investment spending has to come from somewhere and, for the most part, it's provided by the nation's savers.

Households save when they spend less than all their income on the consumption of goods and services. Companies save when they retain part of their after-tax profits rather than paying them all out to shareholders in dividends. Governments save when their raise more in revenue than they need to pay for their recurrent spending.

If Australians saved more than we wanted to invest in a period, we'd lend our excess saving to foreigners. If we want to invest more than we've saved in a period, we call on the savings of foreigners to make up the difference. We either borrow their money or we sell them Australian assets.

In fact, we almost always want to invest more than we save, and the amount we need to acquire from foreigners is called the current account deficit.

The level of our national investment spending has stayed reasonably steady over the years, somewhere below the equivalent of 30 per cent of GDP. Business investment accounts for more than half of this.

You might expect business investment to be particularly high at present because of the huge spending on new mines and natural gas facilities. But while mining investment has been exceptionally strong, other business investment spending has fallen sharply in recent years. This may be due to the effect of the high dollar on the profits of trade-exposed industries.

Public investment spending - covering such things as transport, hospitals, educational facilities and state-owned utilities - declined significantly as a share of GDP during the '90s. This partly reflected efforts to balance budgets and reduce government debt but also the trend to having the private sector, rather than the public sector, provide infrastructure such as expressways.

But this decline was reversed during the noughties, public investment reaching 6 per cent of GDP in 2010. Initially this recovery was underpinned by infrastructure spending by state governments, though in later years it was driven by the federal government's stimulus spending on school buildings and public housing. The latter has fallen off very recently, of course.

Households' investment spending on new housing usually fluctuates between 4 and 6 per cent of GDP. But it was particularly strong in the noughties and has fallen back in very recent years.

Putting these disparate trends together, national investment has actually fallen as a share of GDP in the past year or two, dropping to 27 per cent in 2011.

Australia's level of investment has almost always been significantly higher than the average for the developed economies, our 27 per cent at present comparing with their 19 per cent.

On the face of it, our desire to invest heavily in the further development of our economy hardly qualifies as a case of living beyond our means.

As the authors remind us, investment is a key driver of the productivity of labour. And when we spend on expanding the nation's capacity to produce goods and services, we're ensuring a higher material standard of living in future. The income we generate should easily cover the cost of servicing our foreign borrowings.

But it ain't quite that simple. Well-directed investment is a virtue, no doubt. But if we're having to borrow from foreigners because we're not doing enough saving of our own, that could be a problem.

Are we saving as much as we should be? Don't forget, saving equals income minus consumption. So if we're consuming too much, we won't be saving enough. But how much is enough?

As a nation we are saving - at present, a bit under 25 per cent of national income (GDP) - so we can't be accused of borrowing to finance consumption, which is surely the most obvious case of living beyond your means.

But, equally obviously, we could be saving more than we do, so are we saving enough?

Looking at the components of national saving, saving by companies has been slowly trending up over the decades and at present is at a record level of about 14 per cent of GDP.

Government saving was very weak in the '70s and '80s but, following the deep recession of the early '90s, strengthened to about 5 per cent of GDP during most of the noughties.

It's now back to zero, however, in consequence of the 2008-09 recession the pollies keep saying we didn't have.

The rate of household saving fell steadily through the '70s, '80s and '90s but began increasing sharply in the mid-noughties and is now back up to about 10 per cent of GDP, its highest since the '80s. Pulling the components together, national saving is now back up to almost 25 per cent of GDP, also its highest since the '80s. And this is about 6 percentage points higher than the average for the developed countries.

Why has our current account deficit almost halved to 2.25 per cent of GDP in the past year or two? Because national investment is down a bit on the one hand, while national saving is up a bit on the other.

The charge that we're living beyond our means has never been less applicable.

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Thrift paying big dividends on current accounts

The nation's econocrats have been pondering the resources boom for years, but one thing they've been expecting isn't coming to pass: we're not getting huge deficits on the current account of the balance of payments.

Last week's figures showed a deficit of just $5.3 billion for the June quarter, about half what it was in the March quarter. This included a surplus on the balance of (international) trade in goods and services of

$7.5 billion - the fifth quarterly surplus in a row - offset by a deficit on net income payments (our payments of interest and dividends to foreigners less their payments to us) of $12.8 billion.

Switching to the year to June, the current account deficit was $33.6 billion, down from $53.3 billion the year before. Expressed as a proportion of gross domestic product, this was an amazingly low 2.4 per cent, down from 4.1 per cent the year before.

So why were the econocrats expecting bigger deficits? Because most of the money to finance the surge of investment in new mines and natural gas facilities would have to come from foreigners, thereby adding to the surplus on the capital account of the balance of payments which, with a floating currency, is always exactly balanced by a deficit on the current account.

And why haven't the big deficits come to pass? Because household saving has been a lot greater than the econocrats were expecting. The more the nation saves, the less it has to call on the savings of foreigners to finance its investment spending.

Last financial year's current account deficit is down because saving is up while the mining investment boom is only just getting started.

As that boom gets under way, the current account deficit is likely to grow. This year's budget forecast a deficit of 4 per cent of GDP for this financial year, rising to 5.25 per cent in 2012-13. Even so, those figures are smaller than the econocrats had been expecting before they realised how much more households were saving.

Last week's national accounts showed households saving a net (that is, after allowing for the year's depreciation in the value of household assets) 10.5 per cent of household disposable income. This is unlikely to be an aberration; it's more likely to be a reversion to our earlier thrifty habits.

If you're more used to thinking about the current account deficit in terms of exports and imports, I should explain that these days economists tend to look on the other side of the coin, which shows saving and investment.

The current account deficit equals the capital account surplus, which represents the net inflow of foreign financial capital to the Australian economy. As we've seen, we call on the savings of foreigners to finance that part of our investment in new physical capital than can't be financed by our own saving.

This net inflow of foreign financial capital allows us to import more goods and services than we export, including imports of capital equipment.

The net capital inflow also helps us finance our net payments of interest on the nation's net foreign debt and our net payments of dividends on net foreign equity investment in Australia's businesses - though the ultimate justification for our foreign borrowing is the profits we make from our physical investments.

The nation's annual investment spending includes not just business investment in equipment and structures, but also public investment in infrastructure and households' investment in the construction of new homes.

Similarly, the nation's annual saving includes not just the amount saved by households, but also the saving companies do when they retain part of their after-tax profits rather than paying them all out in dividends and the saving governments do when they raise more in revenue than they need to cover their recurrent spending.

According to an article in the federal Treasury's latest Economic Roundup, in the decade or so before the first stage of the mining boom began in 2003, the current account averaged 3.7 per cent of GDP. During the first stage it averaged 5.7 per cent, but since the global financial crisis it's averaged 3.3 per cent.

Before the mining boom, gross national investment spending (that is, before allowing for the annual depreciation of assets) averaged 24.3 per cent of GDP. Since the start of the mining boom it's averaged 27.9 per cent.

Had the level of gross national saving stayed unchanged, that would have increased the average current account deficit by 3.6 percentage points. In fact, national saving has increased from 22.2 per cent to 24.5 per cent.

While households have been saving a lot more in the period since the global financial crisis, federal and state governments have fallen into operating deficit, meaning they've gone from saving to dissaving. As they get their budgets back to operating surplus in the next year or two they'll be adding to rather than subtracting from national saving.

Company profits have been high in recent years and many companies have been saving a fair bit. Mining companies, in particular, have been reinvesting a lot of their after-tax profits in expanding their activities. (To the extent that those retained earnings are owned by foreign shareholders, and were initially counted in the balance of payments as capital outflows, their reinvestment is counted as foreign capital inflow, even though the actual dollars never left the country.)

Australia's persistent current account deficit has always reflected a high rate of national investment rather than a low rate of national saving. Although our household saving rate was quite low during the decade or so to the mid-noughties, our overall, national rate of saving has been around the average for the developed economies.

Point is, should our current account get a lot bigger in the next few years, it will be because the mining construction boom involves a lot more investment spending, not because we're saving less.

We've done much hand-wringing lately about ''the cautious consumer'' (especially when we imagined consumer spending was weak, which we learnt last week it isn't), but the fact that increased household saving has stopped the strong growth in household income translating into booming consumer spending has some big advantages.

If we can avoid a consumption boom occurring at the same time as an investment boom, the Reserve Bank won't need to increase interest rates as much to control inflation and this, in turn, will avoid adding upward pressure to the Aussie dollar.

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