Australia’s trade and current account with the rest of the world. Why is the external account so important?

The Aba and Gol communities resumed their mutual trading but at an exchange rate of 2 Golcoins to 1 Abacoin which seemed fair as the Gols had reduced the value of their Golcoins through adding the counterfeited Golcoins that they’d agreed to legitimise. Consequently, The Aba Community were paid twice as many Golcoins for their excess produce.

At the following Sunday’s meeting to discuss the universe, Mo seemed troubled.

When asked, Mo said “Something is just not right with the new arrangements with the Gols. I have this gut feeling. Whilst we have fixed the exchange system for the future what about the past?”

Young Ab piped up, “Mo’s right, I just can’t get the Abacus tech to balance. There’s a glitch in the software. The system says its balanced because it holds enough Golcoins for the Abacoins I have issued to our community in the past. But as the Golcoin valuation has changed I don’t think that’s correct.”

Another young wise head by the name Cus, spoke up with a confidence that belied their age. “I can see the glitch. Whilst we have rebalanced the system for for future trade with the Gols, we have not rebalanced the system for the time that the Gols were ripping us off by buying with counterfeit Golcoins. The Gols must make compensation so that the amount of Golcoins used to buy  our excess produce is topped up to today’s exchange valuation because the past valuation was incorrect.”

“Let’s go see those Gols and demand compensation” thundered Mo, now that the problem was explained to them. Mo was actually quite impressed with himself that his gut instinct was correct.

A delegation of young and old Abaite wise heads went to see the Golites. The situation was explained to the Golites and compensation duly demanded. The Golites had trouble understanding. They’d always had trouble understanding the Abacus tech as they were used to dealing in shiny metal coins that you hold in your hands and not some fan dangled machine with moveable beans that represented numbers and names.

Nevertheless, the Golites eventually understood. Ab calculated the amount of compensation in Golcoins that were needed at which the Golites answered that they could not pay that much Golcoins as to do so would leave them short in the future to buy the Abaites excess production that they had grown to rely on.

The Abaites and the Golites were collectively thinking, “Let’s hope Ab can solve this problem!”. Ab duly delivered.

Ab was thinking, “How can I explain the situation simply and without it appearing magical?”

“I’ve calculated that the Golites need to pay the Abaites half the amount of Golcoins that have been issued. Those Golcoins need to be converted into Abacoins and paid to the Abaites. This will be done in a few steps. First the Abaites will lend the equivalent amount of Abacoins to my Abacus Tech. The Abacus tech converts those Abacoins into Golcoins that are then lent to Golites”

“Have all you wise heads got this so far?” Ab questioned and received murmurs and nods in response.

At this point, the Abaites have an asset that is a loan to the Abacus Tech and the Golites have enough Golcoin to pay the compensation required but also the liability of a loan from the Abacus Tech.

“Now the Golites will pay the compensation amount in Golcoins to the Abacus Tech that will be converted into Abacoins and then paid to the Abaites as compensation” explained Ab. “The system balances with the Abaites having a loan asset in Abacoins and the Golites with a loan liability in Golcoins but with the Abacus Tech at the centre of that universe”.

One of the Golite wise heads, Gol, asked what would be the key question, “ so how does the Gol community repay the loan? It seems to me that if the Abacus Tech demanded repayment of the loan it would bankrupt the Gol community.”

 Ab’s answer was inspired. “The Golites must increase the amount and quality of goods they produce so they have excess products to sell to the Abaites, the income from which will repay the loan to the Golites by the Abacus Tech and reduce the Abaite’s loan to the Abacus Tech maintaining the book balance”

It came to pass that Ab’s solution worked. The Golites did improve their production of goods and repaid the loan over time. Ironically, from such a dire situation that needed an innovative solution, the Gol community being forced to improve its productivity, improved the wealth and lifestyles of both communities even though those communities were becoming more complex. Complexity brings issues that need solutions and that are well thought through.

Australia’s trade and current account with the rest of the world. Why is the external account so important?

The external account is Australia’s balance sheet with the rest of the world, simply how much Money the rest of the world has borrowed from Australia and how much Money Australia owes the rest of the world. The external account is critical to both the supply of Money and its value, and probably not understood by most citizens.

The external current account is not just the trading account that records what Money is exchanged for goods and services., it also takes account of capital transactions. Capital transactions are Money transfers that can be summarised as borrowing from, and investing in, the rest of the world including interest and dividends.

Transactions with the rest of the world influence all aspects of Money. If a country had zero transactions with the rest of the world, making its Money system totally enclosed, then the government would be able to always control where and how Money was used and who benefitted. Of course, and as history has shown, fully internalised economies do not lead to a good economic outcome for citizens. Citizens need to share in productivity and technology gains in the rest of the world through imports or investment. A country also needs to be able to export its goods and services to the rest of the world to earn Money to pay for imports and technology that lifts the standard of living for its citizens.

There is no avoiding a current account if a country trades in the global market. In theory, with a floating currency, if a country like Australia has a cumulative current account deficit (owes money to the rest of the world) the currency should reduce in value, making imports more expensive in local currency terms and exports more valuable. In theory this currency adjustment is meant as a stabiliser that encourages a country to spend less on imports and export more to achieve a zero balance with the rest of the world, ie neither a net borrower nor lender. Whilst there is some balancing effect of currency adjustments, this piece of neo-liberal theory has not worked in practice. The reasons that it does not work are complex but two fundamental reasons are that capital flows (and not just trade flows) effect Money values. Many countries play under different rules and don’t report balances correctly, or deliberately manipulate their Money’s relative value and interest rates to their advantage. Although neo-liberal theory says that trading countries must operate under the same set of trade and currency rules, that just does not happen in practice resulting in a distortion of global debt and investment balances, and thereby Money values.

While theoretically Australia should have a close to zero balance, Australia’s account with the rest of the world is, in round numbers, a net $900BN (foreign debt less overseas investment). In the last few years Australia has reduced its net position by having a strong positive trading account and current account. This positive position has been almost exclusively because of increased revenues from iron ore, gas and coal on the trading account. Australia exports very little added value goods and services compared to its imports and is on very shaky ground by relying on the commodities listed as its main source of income, especially when the biggest buyer is China.

If this positive current account continues and significantly pays down Australia’s negative Money balance, then the market’s historical value of Australian Money would be broadly correct. However, there must be significant doubt that a surplus on current account will continue for much longer. Lastly, currency speculation does play a role in setting and perhaps distorting the value of a country’s Money, but speculation is unlikely to be a significant cause in setting the value of Australia’s Money in international markets in the medium and long term.

What is the effect of Australia’s current account on the value and amount of Money? If Australia has a current account deficit, as had occurred for most of the last 40years, then to pay for that it either uses internal $As or, it borrows to meet the deficit. As Australia has a net deficit of $900BN it means that we borrowed to fill the deficit gap, thereby keeping the Money system stable and balanced without greatly effecting the currency value. If Australia was forced to fund the cumulative account deficit through using its own Money supply, then this would reduce the volume and value of that Money relative to other currencies. Remember the Money supply is all in Megabank.

When Money is needed to meet the cumulative current account deficit by paying the obligations into an offshore banking system from Megabank, there is a hole in the Money supply and Megabank also needs to reduce loan balances. Megabank could only fill that hole by borrowing offshore, reducing lending or government borrowing and spending. Reducing lending would reduce the amount of Money available and certainly reduce Australian citizen’s standard of living. The government could also fill Megabank’s Money hole by borrowing offshore and injecting that Money into Megabank through spending.

In fact, when Australia does again run current account deficits and borrows Money from the rest of the world to fund these deficits, the current account deficit would have no detrimental effect on the Money supply, and citizens are no better or worse off. If Australia has a current account surplus as it has in the last few years, the reverse has been occurring. The surplus has generated Money that has been used to decrease the size of the net external account deficit by about $160BN since 2019 with little effect on the actual Money supply. But it did and does demonstrate that Australia is able to generate Money to repay foreign debt.

So in an era of high commodity prices and volumes, Australia reduced its external net liabilities without increasing or decreasing the Money supply. This has been achieved by generating an external surplus and using that surplus to reduce external liabilities.

It all appears as a nothing burger for most citizens’ Money balances and value, but at that I’d disagree. There are no countries with Australia’s population and position in the world that could enjoy the benefit of global lenders that Australia does. That’s not about mining or gas companies, it’s about Australian democracy, and citizens who obey the rule of law, support Megabank and the mortgage market, and are mostly educated and hard workers. It’s because Australian citizens can be relied upon and if they have to repay debt they will ensure it happens. It’s not about the largely internationally owned companies that sell rocks and gas mainly to China. International lenders rely on Australian citizens to give them comfort of being repaid, but to maintain that largess Australia needs a plan B.

External account Rule 15:

Rule 15: For 40 years Australian’s lifestyles have been funded firstly by the rest of the world lending us Money ($1Trn+), and then, the rest of the world (mainly China) buying our rocks and gas at extraordinary prices and extraordinary volumes. The ability to borrow when required from the rest of the world rests on the giant shoulders of Australian citizens.

So what’s the problem for Australia?

The problem is that while the extraordinary exporting of rocks and gas continues, or lenders line up to fill any deficit or Money gap, there is no problem. But if that reverses and Australia again generates current account deficits, then the debt to the rest of the world starts to increase again. In circumstances where the rest of the world not only refuses to lend to fill the Money gap but wants the existing debt to be repaid, it becomes a problem.

Imagine for a moment the effect on Australia if say $500BN of the Money supply was removed. Imagine the effect on the value of the currency, by having to sell A$500BN in international markets. Debt access and repayment of the deficit could be said to be low risk, but the result would be extremely negative, and that needs to be addressed and recognised in government policy.

In the absence of a Plan B for Australia when the current deficit funding scheme ends, it does appear that Australia sits in a very precarious position relative to its Money balance. There is an absolute necessity for Australia to sell something to the rest of the world to fund what it buys from the rest of the world, or some resource or product that it can show will be sold so Australia can borrow against that asset.  Iron ore, coal and gas may be doing a great service to funding the deficit but for how much longer?

Rule 16: Australia needs a new “something” to sell to get Money to pay for things we buy offshore, a Plan B. Australia needs to create goods and services that produce productivity gains that it can sell as its “something”, otherwise the risks of future decreases in living standards are great.

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 [JW1]Owes Australia?

 [JW2]This is a bit hard to read. Rephrase?