Current Account Deficit: Magic or Disaster?

For those who believe China’s huge current account is the root cause the financial crisis, this is good news- their surplus is finally shrinking. In the first half of this year, the surplus narrowed to $130 billion, one-third lower than a year earlier, and barely half its level in the second half of 2008. The narrowing surplus can help China’s government to ease the pressure on the Yuan to appreciate, and also reduce imbalances in the world economy. China’s statistics, however, are notoriously tricky, and this is why some analysts still hold a skeptical attitude toward these figures.

Being one of the primary components of the balance of payments, the current account is the sum of the balance of trade, net factor income and net transfer payments, illustrating how capital flows across borders. When a country has a current account deficit, it means that people in this country spend more than they have earned, resulting in the decrease of the country's net foreign assets. Based on IMF data, the following map is the accumulated current account from 1980 to 2008, telling us a vivid story about how the capital has “traveled” around the world over the past two decades: The hard working Asian spend much less than they’ve earned, and saved the rest of it in the way of buying all kinds of financial products issued by the private or public sector, like American Treasury bonds, hedge funds, etc. With all this hot money flowing back to the U.S., Americans have been buying or investing in things they cannot really afford, leading to the ballooning asset prices.



If you have read the book “The Age of Turbulence: Adventures in a New World” by Greenspan published in 2007, you would be interested in his point of view on America’s current account deficit. In the book, he emphasized that mainly driven by the private sector, America’s deficit merely reflects the attraction of America’s investment environment, and therefore, it is not a problem. Securities and assets with high and stable yields are like magnets, attracting money from all over the world back to America’s investment market, pushing up the need for US dollars, and offsetting the pressure on the dollar to depreciate. This theory even has an academic name: "Pitchford Thesis." With the help of this financial magic, Americans experienced a prosperous decade in the 1990s: a high economics growth rate, low inflation rate and low unemployment rate. Some economists even called this the economic miracle of America. Now, we all know this magical story ended in tragedy, but if the world economic imbalance still lasts, then the financial crisis this time will not be the only thing we should worry about.

The narrowing current account surplus of China seems to imply the decrease of the world economic imbalance, if the statistics are reliable. But from past record, however, China’s government is not so trustworthy. Their national GDP, for example, is always very different to the sum of provincial GDPs, making the numbers lackcredibility. And the current account they reported this time is much smaller than those suggested by its trading partners’ data. Actually, if you add up all country’s trade with China, China’s surplus should be $295 billion, more than twice as much as the $130 billion surplus logged by China itself. It is no wonder that some conspiracy theorists conclude that Beijing is deliberately understating its embarrassingly large surplus.

It is almost certain that Beijing’s number is understated. But despite its inaccuracy, the crucial thing for the rest of the global economy is not the precise size of China’s surplus, but the fact that it is finally shrinking.