Intro: Rather than being merely a reflection of import or export strength, a country’s current account picture tells a story about the balance of savings relative to investment. All else equal, the higher the level of savings in an economy, the more positive the current account picture.
If a country runs a current account surplus this means that it is effectively producing more than it is spending on consumption and investment, and shipping the surplus goods and services overseas in return for financial assets. Because saving is equal to total production minus total consumption, we can conclude that a current account surplus reflects the excess of saving relative to investment, and vice versa:
GDP = Consumption + Investment + Exports – Imports
GDP = Consumption + Saving
Saving – Investment = Exports – Imports
The implication is that a current account surplus reflects either a low level of investment relative to GDP, or a high level of savings, or a combination of the two. Likewise, a country with a large current account deficit either has a low savings rate or a high level of investment relative to GDP. A country’s saving rate will tend to change very slowly over time which means that its current account picture will be largely determined in the near term by investment spending relative to GDP.
Terms of Trade Impact
Terms of trade play a major role in current account swings. The relative price of imports versus exports can vastly outweigh the impact of real changes in import and export volumes. This is most visible in economies which are heavily reliant on commodity exports.
chart of Aussie tot vs cas
Take the case of Australia. When iron ore prices rise, export sales rise even in the absence of rising export volumes, and the country’s current account tends to benefit all else equal. In terms of the saving-investment balance, Australia finds itself experiencing a sharp rise in its overall savings rate as dollars flow into its economy. Interestingly, during times of resource price increases, Australia also tends to see a rise in investment as a share of GDP as businesses seek to ramp up production further, which often leads to their being no real correlation between the current account balance and terms of trade.
The Link Between the Current and Fiscal Accounts
A country with a large current account deficit is likely to also have large fiscal deficits. The reason is based on the fact that fiscal deficits usually act as a drag on a country’s savings rate. All else equal, a rise in government consumption spending will lead to a reduction total saving and therefore a deterioration in a country’s current account. Of course, if the private sector runs a large surplus which offsets the government deficit, then the current account will be in surplus.