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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Why surpluses aren't necessarily good, or deficits bad

According to the Essential opinion poll, only 6 per cent of people regard the size of the national surplus as the most important indicator of the state of the economy. I think that’s good news, but I’m not certain because I’m not sure what “the national surplus” is – or what the respondents to the poll took it to mean.

They probably thought it referred to the balance on the federal government’s budget. But the federal budget is not yet back to surplus and, in any case, it can’t be the national surplus because it takes no account of the budgets of the state governments that, with the feds, make up the nation.

Assuming respondents took it to be the federal budget balance, its low score is good news about the public’s economic literacy, but bad news for Scott Morrison and Josh Frydenberg, who are hoping to make a huge political killing when, in September next year, they expect to announce the budget finally is back in surplus.

The pollies are assuming that voters know nothing more about the economy than that anything called a surplus must be a good thing, whereas anything called a deficit must be very bad.

Actually, no economist thinks all surpluses are good and all deficits bad. Sometimes surpluses are good and sometimes they’re bad. Vice-versa with deficits. It depends on the economy’s circumstances at the time.

But the confusion doesn’t end there. There are lots of measures in the economy that can be in deficit or surplus, not just governments’ budgets. When I wrote a column some weeks back foreshadowing that the current account on the nation’s balance of payments would probably swing into surplus for the first time in 44 years, some people assumed I must be referring to the federal budget.

Wrong. The federal budget records the money flowing in and out of the federal government’s coffers – it’s bank account. The “balance of payments” summarises all the money flowing into and out of Australia from overseas – covering exports, imports and payments of interest and dividends in and out (making up the “current account”), and all the corresponding outflows and inflows of the financial payments required (making up the “capital and financial account”).

The trick is that, thanks to double-entry bookkeeping, the balances on the two accounts making up the balance of payments must be equal and opposite. So the longstanding deficit on the current account was always exactly offset by a surplus on the capital account.

And that means the (probably temporary) current account surplus was matched by the capital account swinging from surplus to deficit. Oh no.

Although Australia has been a net importer of (financial) capital almost continuously since the arrival of the First Fleet, for the June quarter we became a net exporter, lending or investing more money in the rest of the world than the rest of the world lent or invested in us.

If you tell the story of this change in plus and minus signs from the current account perspective, it’s mainly that the resources boom has greatly increased our exports, while the slowing in the economy’s growth means our imports of goods and services are also weak.

But there’s also a story to be told about why the capital account has gone from surplus to deficit. As Reserve Bank deputy governor Dr Guy Debelle explained in a speech at the time, the composition of the inflows and outflows of financial capital have changed a lot since 2000.

Since Australia has always been a recipient of foreign investments in our businesses, by June this year, the value of the total stock of that equity investment amounted to a liability to the rest of the world of $1.4 trillion.

But the value of our equity investments in the rest of the world amounted to assets worth $1.5 trillion. So, when it comes to equity investment, the latest figures show we had net assets of $142 billion.

The fact is, the value of our shares in them overtook the value of their shares in us in 2013. That’s a remarkable turnaround from the previous two centuries of being a destination for foreign investment.

Why did it come about? Mainly because of our introduction of compulsory superannuation. Our super funds have invested mainly in local companies, but they’ve also invested a lot in the shares of foreign companies.

For the most part, however, our seemingly endless string of current account deficits has been financed by borrowing from the rest of the world. By June, our debt to foreigners totalled $2.4 trillion. Their debt to us totalled $1.3 trillion, leaving us with net foreign debt of a mere $1.1 trillion.

There was a time when Coalition politicians carried on about that debt – owed more by our banks and businesses, than our governments - rather than the (much smaller) debt of the federal government, only about 55 per cent of which is owed to foreigners.

Why does our huge net foreign debt rarely rate a mention these days? Because it’s always made economic sense for a young country with huge development potential to be an importer of financial capital – it’s part of what’s made us so prosperous.

Because all the debt we owe is denominated in Australian dollars or has been “hedged” back into Aussie dollars – meaning a sudden big fall in our dollar would be a problem for our creditors, not us.

But also because, though our net foreign debt keeps growing in dollar terms, our economy is also growing – and hence, our ability to pay the interest on the debt. That’s a sign that, overall, the money we’ve borrowed has been put to good use.

Adding our net foreign assets to our net foreign debt gives our net foreign liabilities. Measured against the size of the economy (nominal gross domestic product), our net foreign liabilities reached a peak of about 60 per cent in 2009, but have since fallen to about 50 per cent.

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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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You'd be surprised what's propping up our living standard

It’s the last lazy long weekend before the year really gets started, making it a good time to ponder a question that’s trickier than it seems: where has our wealth come from?

The question comes from a reader.

“Australia has been without a recession for 25 or more years, the economy seems booming to me, just by looking around: employment, housing prices, explosive building in major capitals, etc. Where is the wealth coming from? Mining? Other exports? Because the resources have to come from somewhere,” he writes.

That’s the first thing he’s got right: it’s not money that matters (the central bank can create as much of that stuff as it sees fit) it’s what money is used to buy: access to “real resources” – which economists summarise as land (including minerals and other raw materials), labour and (physical) capital.

But here’s the first surprise: of those three, when you trace it right back, probably the most important resource is labour – all the work we do.

The first complication, however, is the word “wealth”, which can mean different things. It’s best used to refer to the value of the community’s assets: its housing, other land and works of art, the equipment, structures and intellectual property owned by businesses (part of which is represented by capitalised value of shares on the stock exchange), plus publicly owned infrastructure (railways, roads, bridges and so forth) and structures.

To get net wealth you subtract any debts or other liabilities acquired in the process of amassing the wealth. In the case of a national economy, the debts we owe each other cancel out, leaving what we owe to foreigners. (According to our national balance sheet, as calculated by the Australian Bureau of Statistics, at June last year our assets totalled $15.4 trillion, less net liabilities to the rest of the world of $3.5 trillion.)

But often the word wealth is used to refer to our annual income, the total value of goods and services produced in the market during a year, as measured by gross domestic product (which in the year to June was $1.8 trillion).

The people in an economy generate income by applying their labour to land and physical capital, to produce myriad goods and services. Most of these they sell to each other, but some of which they sell to foreigners. Why? So they can buy other countries’ exports of goods and services.

Only about 20 per cent of our income comes from selling stuff to foreigners and only 20 per cent or so of the stuff we buy comes from foreigners. This exchange leaves us better off when we sell the stuff we’re better at producing than they are, and buy the stuff they’re better at than we are.

Much of what we sell to foreigners is minerals and energy we pull from the ground and food and fibres we grow in the ground. So it’s true that a fair bit of our wealth is explained by what economists call our “natural endowment”, though it’s also true that we’re much more skilled at doing the mining and farming than most other countries are.

Speaking of skills, the more skilled our workers are – the better educated and trained – the greater our income and wealth. Economists call this “human capital” – and it’s worth big bucks to us.

How do the people in an economy add a bit more to their wealth each year? Mainly by saving some of their income rather than consuming it all. We save not just through bank accounts, but by slowly paying off our mortgages and putting 9.5 per cent of our wages into superannuation.

It’s the role of the financial sector to lend our savings to people wanting to invest in the assets we count as wealth: homes, business structures and equipment and public infrastructure. So if most of our annual income comes from wages, most of our savings come from wage income and our savings finance much of the investment in additional assets.

But because our natural endowment and human capital give us more investment opportunities that can be financed from our savings, we long have called on the savings of foreigners to allow us to invest more in new productive assets each year than we could without their participation.

Some of the foreigners’ savings come as “equity investment” – their ownership of Australian businesses and a bit of our real estate – but much of it is just borrowed. These days, however, our companies’ (and super funds’) ownership of businesses or shares in businesses in other countries is worth roughly as much as foreigners’ equity investments in Oz, meaning all our net liability to the rest of the world is debt.

Naturally, the foreigners have to be rewarded for the savings they’ve sunk into our economy. We pay them about $60 billion a year in interest and dividends, on top of the interest and dividends they pay us.

The main thing we get in return for this foreign investment in our economy is more jobs (and thus wage income) than we’d otherwise have, plus the taxes the foreigners pay.

People worry we can’t go on forever getting wealthy by digging up our minerals and flogging them off to foreigners. It’s true we may one day run out of stuff to sell, but our reserves – proved and yet to be proved – are so huge that day is maybe a century away (and the world will have stopped buying our coal long before we run out).

A bigger worry is the damage we’re doing to our natural environment in the meantime, which should be counted as reducing our wealth, but isn’t.

But mining activity accounts for a smaller part of our high standard of living than most people imagine – only about 8 per cent of our annual income.

Most of our prosperity – our wealth, if you like – derives from the skill, enterprise and technology-enhanced hard work of our people.

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Not even the IMF is worried by our huge foreign debt

In its latest report on Australia, the International Monetary Fund says it isn't worried by our net foreign debt, now just a squeak short of $1 trillion. Just as well, since none of us ever worries about it either.

Still, it's nice to have the fund's judgment that "the external position of Australia in 2017 was assessed to be broadly consistent with medium-term fundamentals and desirable policies".

Australia's negative "net international investment position" – consisting of our net foreign debt plus net foreign equity investment – has varied between 40 and 60 per cent of gross domestic product since 1988, it says. At the end of 2016, it was equivalent to 58 per cent.

That's high. So why's the fund so relaxed? Because, it says, both the level and the trajectory of our net international investment position are "sustainable".

It has calculated that a current account deficit between 2.5 and 3 per cent of GDP, which is larger than the deficit of 1.9 per cent it expects for 2017, would allow our total net foreign liabilities to be stabilised at about 55 per cent of GDP.

Note that, for some years now, our net foreign debt actually exceeds our total foreign liabilities (debt plus equity). That's because the value of our equity investments abroad (mainly foreign businesses owned by Australian multinationals and our super funds' holdings of foreign shares) now exceeds the value of foreigners' equity investments in Australia, to the tune of about $30 billion.

The fund derives much comfort from the knowledge that our foreign liabilities (both debt and equity) are largely denominated in Australia dollars, whereas our foreign assets (debt and equity) are denominated in foreign currencies.

Get it? In a globalised world of floating currencies and free capital flows between countries, the big risk for an economy heavily indebted to the rest of the world is a sudden loss of confidence by its foreign creditors, which would be manifest in a sudden drop in its exchange rate (as we experienced at the turn of the century, when the Aussie briefly fell below US50¢).

But when our foreign liabilities are expressed in Australian dollars, the depreciation doesn't increase their Australian-dollar value, whereas it does increase the Australian-dollar value of our foreign assets, leaving our net foreign liabilities reduced.

The broader conclusion is that an indebted country able to borrow abroad in its own currency has a lot less to worry about. And the fact that foreigners are willing to lend to us in our own currency is a sign of their confidence in our good economic management.

And, of course, a big drop in our dollar does improve the international price competitiveness of our export and import-competing industries.

Speaking of which, the fund estimates that, after the heights it reached in 2011 when prices for our coal and iron ore exports were at their peak, our "real effective exchange rate" (that is, the Aussie's average value against all our major trading partners' currencies, adjusted for the difference between our inflation rate and their's) depreciated by 17 per cent between 2012 and 2015.

Since then it's appreciated by about 5 per cent, up to September last year. The fund calculates that, by then, it was about 17 per cent above its 30-year average, leaving it between zero and 10 per cent higher than it probably should be, making it "somewhat overvalued".

The fund says our gross foreign liabilities (debt plus equity) break down into about a quarter as "foreign direct investment" (foreign control of Australian businesses, starting with our mining companies), about half as "portfolio investment" (mainly our banks' borrowings abroad, plus foreigners' holdings of Australian government bonds) and a quarter of odds and sods.

So the mining investment boom was mainly funded directly by the foreign mining companies themselves, including by ploughing back much of the huge profits they made while export prices were sky high.

But this was happening when, after the global financial crisis, our banks were increasing the stability of their funding by borrowing more from local depositors and less from overseas financial markets.

What most people don't know is that most of our net foreign debt is owed by our banks, though that's less true than it was, particularly because recent years have seen more central banks buying Australian government bonds from their original Aussie holders.

Though the central bankers like our higher interest rates, it's another indication that the rest of the world isn't too worried about our financial stability.

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Why we needn't worry about our massive foreign debt

When you consider how many people worry about the federal government's debt, it's surprising how rarely we hear about the nation's much bigger foreign debt. When it reached $1 trillion more than a year ago, no one noticed.

That's equivalent to 60 per cent of the nation's annual income (gross domestic product), whereas the federal net public debt is headed for less than a third of that – about $320 billion – by June.

Similarly, when you consider how much people worry about the future of the Chinese economy, American interest rates and all the rest, it's surprising how little interest we take in our "balance of payments" – a quarterly summary of all our economic transactions with the rest of the world.

Note, I'm not saying we should be worried about our foreign debt. We already do more worrying about the federal government's debt than we need to.

No, I'm just saying it's funny. Why do we worry about some things and not others?

Short answer: the politicians don't want to talk our "external sector" because it sounds bad. The economists don't want to talk about it because they know it isn't bad.

But since we're on the subject – and since Reserve Bank deputy governor Dr Guy Debelle gave a speech about it this week – let's see what's been happening while our attention's been elsewhere.

If you're unsure of the difference between the two debts, it's simple. The federal net public debt is all the money owed by the federal government to people, less all the money people owe it (hence that little word "net").

According to Debelle, about 60 per cent of all bonds issued by the feds is owed to foreigners and 40 per cent to Australian banks and investors. About a quarter of all bonds issued by the state governments is held by foreigners.

In contrast, the nation's net foreign debt is all the money Australian businesses and governments (and any other Aussies) owe to foreigners, less what they owe us. (For every $1 we owe them, they owe us 52¢.)

But how did we rack up so much debt?

Long story. Let's start with the balance of payments, which is divided into two accounts. The "current" account shows the money we earn from all our exports of goods and services, less the money we pay for all our imports, giving our "balance on trade".

Our imports usually exceed our exports, giving us a trade deficit. This deficit has to be funded (paid for) either by borrowing from foreigners or by having them make "equity" (ownership) investments in Australian businesses or properties.

Of course, when we borrow from foreigners, we have to pay interest on our debts. And when foreigners own Australian businesses, they're entitled to receive dividends.

The interest and dividends we pay to foreigners, less the interest and dividends they pay us (actually, our superannuation funds and Australian multinationals), is the "net income deficit".

We've been running trade deficits for so long, and racking up so much net debt to foreigners, that the net income deficit each quarter is much bigger than our trade deficit.

But add the trade deficit and the net income deficit (plus some odds and ends) and you get the deficit on the current account of the balance of payments.

The money that comes in from various foreign lenders and investors to cover the current account deficit is shown in its opposite number, the "capital and financial account".

Because the price of our dollar (our exchange rate) is allowed to float up and down until the number of Aussie dollars being bought and sold is equal, the deficit on the current account is at all times exactly matched by a surplus on the capital account, representing our "net [financial] capital inflow" for the quarter.

It turns out that, in the years since the global financial crisis of 2008-09, the current account deficit has narrowed.

In the 14 years to then, it averaged 4.8 per cent of GDP. In the years since then it's averaged 3.5 per cent. And in calendar 2016 it was just 2.6 per cent.

Why has it narrowed? Well, Debelle explains it's mainly a reduction in the net income deficit component of the overall deficit, which is at its lowest as a percentage of GDP since the dollar was floated in 1983.

The rates of interest we're paying on our foreign debt are lower because Australian – and world – interest rates are a lot lower since the crisis. And our dividend payments to foreign owners of Australian companies fell as the fall in coal and iron ore prices hit mining company profits.

That's nice. But while ever we have any deficit on the current account, our foreign debt will grow, and it already exceeds $1 trillion. Isn't that a worry?

Not really. It's not growing faster than our economy (GDP) is growing, and thus our ability to afford the interest payments.

More to the point, the current account deficit is just the counterpart to all the foreign capital flowing into Australia and helping us develop our economy faster than we could without foreign help.

The proof that such a massive debt doesn't mean we're "living beyond our means" is, first, that the nation – households, businesses and governments combined – saves a high proportion of its income rather than spending it on consumption.

Everything the nation saves each year is used to fund new investment in houses, business structures and equipment, and infrastructure. This investment is further proof we're not living beyond our means.

In fact, the nation invests more each year than we save. Huh? Well, the extra funding is borrowed from foreigners.

You can call it the surplus on the capital account of the balance of payments, or the "net foreign capital inflow" or – get this – the current account deficit.

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Foreign investment helped to make us rich

If foreign investment in Australian businesses is so unpopular with so many people and such a hot potato for Malcolm Turnbull and his government, why do we persist with it?

Short answer: because we prefer our material standard of living to go up, not down.

This week an Essential poll revealed the full extent of the public's reservations about foreign investment. Foreign investment in mining was regarded as "bad for the economy" by 28 per cent of respondents.

For investment in ports it was 37 per cent and for investment in agriculture it was 44 per cent. For investment in infrastructure such as electricity it was 45 per cent and for investment in real estate it was 54 per cent.

The most opposed to foreign investment were voters for minor parties such as One Nation and the Xenophones​, but Greens voters weren't far behind. Then came Labor voters and, finally, voters for the Coalition.

But even among Coalition supporters there were almost always more saying it was bad than saying it was good.

When you remember that our level of material prosperity has been dependent on foreign investment since the arrival of the First Fleet, it's a wonder so few punters can join the dots.

Viewed through economic eyes, the First Fleet was just the arrival in this country of its first foreign investor, in boats laden with labour, materials and supplies, intent on getting a new subsidiary going.

There were a lot of imports with, on the other side of the transaction, an inflow of foreign capital owned by the British government.

The term's gone out of fashion, but since white settlement Australia has always been a "capital-importing country".

To develop a country economically you need lots of money - known here as financial capital - to pay for all the construction and equipment, known as physical capital. Where does this money come from? Someone has to save it by not consuming all their income.

Ideally, all the savings necessary to finance the economic development of our country would come from Australians. Then we'd own everything ourselves and all the profits would belong to us.

But we've always had a small population relative to the huge opportunities to farm our land, exploit our untold mineral wealth and develop our economy in many other respects, such as making ourselves an attractive destination for tourists and university students.

So, from the beginning, we've always invited foreigners to bring their savings to Australia and help us develop our economy much faster than we could if we relied solely on our own savings. That's what makes us a capital-importing country.

The attraction to the foreigners is that they own the businesses they build and keep the profits they make.

The attraction to us is we get a bigger economy than we otherwise would. The foreign firms provide a lot of employment for Aussies, buy a lot of their supplies from local businesses and, of course, pay tax to our government on their profits.

That's always been the deal. Had we kept the foreigners out, our economy and population would now be much smaller than they are and, in consequence, our standard of living would be much lower than it is.

At first the foreigners most willing to invest in Oz were the Brits. Then it was the Americans, then for a few decades the Japanese, and now the Chinese.

I'm old enough to remember when it was American investment that people objected to when we first started worrying about "selling off the farm".

But when the Japanese economy was riding high in the 1970s and '80s, and Japan began looking for profitable investments here, I remember how much the farmers carried on. They thought Japanese feed lots were the beginning of the end of Oz.

The Japanese came and stayed and eventually the farmers realised they were no threat. But now it's the Chinese, and farmers are back to manning the barricades. They're going to dig up our farms and take them back to China.

You know they will because their skin's a different colour. Or maybe they'll sabotage the communications and power networks they now own, just before they invade us.

The globalisation of financial markets has made it much easier for money to move between countries and thus complicated the picture I've just described.

These days, we can borrow foreigners' savings, not just let them set up new businesses here. And it's easier to sell them existing businesses.

It's easier for foreigners to buy some shares in listed Australian companies (known as "portfolio investment") rather than acquiring a controlling interest in a new or existing business ("foreign direct investment").

Before globalisation, countries tended to be either owners of many foreign businesses ("equity capital") or to have a lot of their businesses owned by foreigners. They either owed a lot of money ("debt capital") to foreigners or foreigners owed them a lot of money.

These days, every country does a lot of both. At March this year, we owed $2126 billion to foreigners, while foreigners owed us $1098 billion, leaving us with net foreign debt of $1028 billion.

Foreigners had equity investments in Oz worth $996 billion, while we had equity investments in other countries worth $1012 billion, leaving us with net foreign equity assets of $16 billion. You read that right.

But if this makes you think we'd be better off borrowing all the savings we need rather than selling off the farm, remember this final complication: foreign direct investors in Australian businesses don't just bring their savings, they also bring their managerial skills and often their more advanced technology, which Australian workers learn to use and then take on to local businesses.

And in this ever more integrated world, foreign investment and international trade tend to go together. Going for trade without investment is another way to be poorer than necessary.

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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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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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Debt is good when it means investment

One of the most remarkable, but unremarked, features of the election campaign was the extraordinary fuss made about a net federal government debt expected to peak at a mere $90 billion, while not a word was said about Australia's net foreign debt of $670 billion - and rising.

Similarly, despite all the feigned concern about the size of federal budget deficit, nothing was said about the current account deficit, which is almost always much bigger.

This just proves politicians carry on about what it suits them to. It hasn't suited the opposition to bang on about the current account deficit because it was consistently high throughout the Howard government's 11 years - meaning the net foreign debt just kept getting bigger.

But the Liberals - and Labor, for that matter - aren't alone in not wanting to talk about the current account deficit (which is the amount by which our imports and income paid to foreigners exceed exports and income received from foreigners) and the resulting net foreign debt (which is the money Australians owe foreigners, less the money they owe us).

These days, the nation's "external accounts" hardly rate a mention in the media, either. So surprisingly little has been made of the news that, at $4.2 billion, the current account deficit for the June quarter was the lowest in almost a decade.

It turned out our export earnings were up 24 per cent on the previous quarter, whereas our imports were up 6 per cent, causing the trade balance to swing from a deficit of $2.8 billion to a surplus of $7.8 billion. Trade surpluses aren't all that common, and this one was our biggest since 1973.

For good measure, our net income payments to foreigners (covering interest payments on the foreign debt and dividend payments to foreign owners of Australian businesses) were down by a bit under $1 billion to about $12 billion, yielding the current account deficit of $4.2 billion. Wow. Why such an improvement? Because everything went right with our exports. For a start, there was a big increase in the prices we received for our exports of coal and iron ore. The volume of coal exports was up, as were exports of gold. Exports of oil were up as two new oil fields off the coast of Western Australia came on line.

But it's not such a bad thing the media didn't make a fuss about the improvement. Why? Because it can't last. It's the calm before the storm.

When our terms of trade improve - when export prices rise relative to import prices - as they have mightily this year, people always expect this to lead to an improvement in our trade balance and current account deficit, but it rarely does. They think this because they forget to ask one of the great economists' questions: but what happens then? You never get the right answer until you take account of what economists call "second-round effects".

What happens then is the rise in exports leads to a rise in imports. This happens several ways. First, the improved terms of trade represent an increase in the nation's real income. As this real income is spent, a fairly high proportion is spent on imports: imports of consumer goods, but also imports of components and capital equipment.

This process is accentuated because an improvement in our terms of trade usually leads to an appreciation in the exchange rate. The higher dollar makes imports cheaper, thus encouraging people to buy more of them relative to locally produced goods and services.

Second, a rise in world prices for minerals and energy encourages our mining industry to expand its production capacity, building new mines and natural gas facilities. A high proportion of the equipment needed for these expansions is imported. Take the coming Gorgon natural gas project on Barrow Island. It's expected to involve investment spending of about $50 billion over five years. Roughly half that money will go on imports.

The truth is the return of the resources boom is expected to involve a return to the big current account deficits (and thus faster-rising levels of foreign debt) we have seen since the start of the boom in the early noughties. So whereas the current account deficit got down to the equivalent of just 1.6 per cent of gross domestic product in the June quarter, the econocrats are expecting it to go back up to 5 or 6 per cent during the rest of the decade.

To see why this isn't as worrying as it sounds - and to debunk the Liberals' dishonest implication that anything labelled "deficit" or "debt" must always be bad - it's useful to pull another economists' trick and switch the discussion of our "external imbalance" from the language of exports and imports to the language of saving and investment.

Huh? Just as Australia almost always imports more than it exports, so the nation also spends more on investment (in new housing, business equipment and structures, and public infrastructure) than it saves (whether by households, companies or governments).

All physical investment spending has to be financed from savings, and when we don't save enough to finance all our investment we make up the difference by borrowing the savings of foreigners. This is why Australia runs a surplus on the (financial) "capital account" of our "balance of payments" to and from the rest of the world, which exactly matches and finances the deficit on the "current account" of the balance of payments.

The current account deficit is low at present because private sector investment spending fell somewhat in the economic downturn, while the mining companies are saving (as retained earnings) much of their extra income from higher world commodity prices.

Soon enough, however, national investment spending will boom as households build more houses, ordinary businesses invest in better equipment and, in particular, as the miners hugely increase their investment spending.

All this is likely to happen without much increase in the nation's rate of saving. If so, the capital account surplus is likely to be much bigger as we call more heavily on the savings of foreigners - and so is its mirror image, the current account deficit (as we import more capital equipment).

If the worsening in the current account comes from higher investment spending rather than lower national saving - as happened in the first part of the resources boom and is expected to happen now - we don't have a lot to worry about. Eventually, the investment will pay for itself.

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