Surge in savings masks current account rise

One little-noticed consequence of the resources boom has been a big rise in the current account deficit on our balance of payments with the rest of the world. But when we get the latest figures on Tuesday we're unlikely to see any evidence of that. Why not? Because of the surge in household saving.

The current account deficit occurs because our imports and payments of interest and dividends to the rest of the world almost always exceed our exports and receipts of interest and dividends from the rest of the world.

Over the past 30 years the current account deficit has averaged about 4 per cent of gross domestic product. Since the start of the resources boom in 2003-04, however, the current account deficit has been nearer 5 or 6 per cent of GDP.

You might expect that, with the resources boom meaning the world is paying us much higher prices for our exports of coal and iron ore, the current account deficit would be smaller rather than larger. But it hasn't worked out that way.

Why not? Because the higher export prices represent an increase in the nation's real income, and when that extra income is spent by individuals and firms, much of the additional spending goes on imports.

But it's always easier to see the factors driving the current account deficit if we explain it in terms of saving and investment rather than exports and imports.

How is it possible for us to go on year after year having our recurrent payments to the rest of the world exceeding our recurrent receipts? It's possible only if we can cover the difference by having someone in the rest of the world lend us that difference (or by accepting foreign ''equity'' investment in Australian businesses).

These capital transactions are recorded in the capital account on the balance of payments. So it turns out that if we're running a deficit on the current account this has to be exactly matched by a surplus on the capital account.

And the capital account surplus represents the amount by which the nation's investment in new housing, business plant and structures, and public infrastructure during a period exceeds the nation's saving during that period.

Households save by spending less than all their income on consumption. Companies save by retaining some of their after-tax profits rather than paying them all out as dividends. And governments save when they raise more in taxes than is needed to cover their recurrent spending.

The amount we save pays for the amount we invest. So when a nation's physical investment spending during a period exceeds the amount it has saved during that period - as it always does in Australia - it has to cover the gap by calling on the savings of foreigners.

Looked at this way, the resources boom increases the current account deficit because it leads the mining companies - many of which are foreign-owned - to greatly increase their investment in the construction of new mines, natural gas facilities and so forth.

In the first stage of the resources boom - before the global financial crisis interrupted - there was an increase in national saving, but a greater increase in national investment, thus causing the current account deficit to be 1 or 2 percentage points of GDP higher.

Then there was the period of the crisis - particularly in 2009 - when national saving increased but national investment fell, thus causing the current account deficit to narrow to about 3 per cent.

But now we've got the economy recovering from the mild recession induced by the crisis. We have seen a bit of growth in investment in new housing, stronger growth in companies' investment in ''non-dwelling construction'' (mainly continuing construction of new mines), though no growth in companies' investment in new machinery and equipment, and very strong growth in governments' investment in infrastructure, particularly the state governments.

So national investment spending is up on the crisis period. But national saving is up by more. As we saw in this column last week, the household saving ratio has shot up to 10 per cent of household disposable income (equivalent to about 6 per cent of GDP).

Corporate saving is quite high, as companies use retained earnings to repay debt and improve their gearing. Yet governments have gone from saving to dissaving as their revenues have been hit by the delayed effect of the downturn while their recurrent spending has been swollen by stimulus measures.

Putting these three components together, national saving is well up on what it was before the crisis struck. Whereas gross national saving had coasted along each year at about 20 per cent of GDP (here, ''gross'' means before making a deduction for the annual depreciation in the value of the stock of the nation's physical capital), now it is up to about 25 per cent.

So, though national investment is up a bit on what it was during the crisis, national saving is up a lot - mainly thanks to the remarkable increase in household saving. This suggests the current account deficit, which got down to 3 per cent of GDP during the crisis, has taken a step lower to 2 per cent. It averaged 2 per cent in the June and September quarters of last year and, when we see the balance-of-payments figures on Tuesday and the national accounts on Wednesday, they're likely to show the current account deficit stayed at about 2 per cent in the December quarter.

Two conclusions. First, the fact that the increase in the current account deficit during the noughties occurred because of higher investment rather than reduced saving (which actually increased a bit), suggests that the foreign debt we are racking up is financially sustainable. In the main, we're borrowing from foreigners to expand our capacity to sell more coal, iron ore and natural gas to foreigners.

Second, the expectation that the resumption of the resources boom will lead to many more years of outsized current account deficits arises because we know there's a huge amount of investment in mining construction to come, with much of the funding for that investment coming from foreigners.

But this expectation assumes no change in the nation's saving habits. So to the extent that our households continue saving a lot more of their incomes than they used to, we can have the mining construction boom with lower-than-expected current account deficits and less increase in our foreign debt.

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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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