Max Pacella
Investment Analyst
Macro & Markets
2 Dec, 2021

Some months ago, a client and I were discussing the level of debt being issued by governments globally, and he replied with “mate this current account deficit is out of control, we’re borrowing from the future”.

Any economics majors out there – and you have my condolences if you are – may have tilted their heads at that one, given the subject at hand was more appropriately a “debt as a % of GDP” conversation.

But it’s a fine nuance and importantly it does shine light on the focus we have on our balance of payments, given their presence in our public discourse particularly by our politicians.

As a brief definition, the balance of payments of a country’s registered transactions between “residents” and “non-residents”, i.e., the transactions made between the country and the rest of the world.

There are two sides to the balance of payments coin: the current account, and the capital account. We run a double-entry system where a positive (credit) in one account is a negative (debit) in the other.

This note I would like to focus on the current account and its implications.

Given that our latest balance of payments data was released this week, now presents an opportune time to assess our current account surplus, as well as consider what a historical current account deficit implied for our domestic economy.

Our Current, Current Account Balance

Contrary to the usual trend, Australia has been in a current account surplus since Q2 CY19, with our latest surplus balance being $21.382 billion AUD.

This was the first time we were in surplus since 1975.

There are a few practical ways to interpret a positive current account balance:

  1. Our nation’s foreign income is greater than expenditure paid to foreign nations
  2. The country is a net lender to the rest of the world
  3. The level of savings is higher than the level of investment (easier to think of as “borrowing”) in the economy 

The levels of surplus we experience today have been largely driven by income from the export of “goods” – given that resources and agriculture make up a significant portion of our global exports, we have rising commodity prices to thank largely for our return to current account surplus.

Chart 1 – Domestic Current Account Balance

Source: Mason Stevens, FactSet

Our current account registers transactions to do with trade, be it of goods or services, as well as income from foreign investments.

Income from exports, or dividends/interests from investments abroad, are registered as credits (positive) on our current account.

In the two charts below, note the rise in resources as a % of our total exports, and then the similar shape of the iron ore price chart versus our current account balance.

Chart 2 – Composition of Australian Exports

Source: ABS, RBA

Chart 3 – Iron Ore ($USD/tonne)

To see surplus is generally a good thing – ask any Federal treasurer who has managed to pull our budget into the green and they’ll tell you that.

Having a current account surplus puts Australia in the position of being a net-lender, which benefits our currency as become a pseudo-safe haven asset.

This quality extends from the fact that there are relatively few economies running a current account surplus (notably Japan, Singapore, South Korea, China and Germany).

On the topic of Japan, having a surplus and savings lends us an amount of independence, not being reliant on other nations for financing our national activity and consumption.

This is relevant in times of potential conflict or war – consider the economic issues which may arise from relying on a nation to finance your country’s liabilities, which you then go to war with. This concern is one of the drivers behind why Japan has maintained one of the highest national savings balances in the world the World War II.

However, this surplus scenario has been a relatively short-term luxury for Australia, so it may be valuable to consider if we were in a disadvantageous position running a current account surplus previously.

Was the Historical Deficit Bad?

By its nature, running a current account deficit for four decades implied that Australia was a larger borrower than it was a saver.

To get to a current account surplus, we either had to reduce borrowing or increase savings (or both). Suffice to say we have not decreased our level of investment (see below), so that surplus was driven by an increase in savings = more income from exports.

Chart 4 – Australia’s International Investment Position (2001-2020)

Source: ABS

So why would anybody, country or individual, run a deficit on their national balance sheet to invest more than they save?

A quick example to illustrate the macroeconomics:

  • On Day 1, I borrow $100 from Mr X, at a 5% daily interest rate
  • On Day 2, I must pay Mr X back $105
  • On Day 1, I can buy a bond which will pay me a 7% daily interest rate
  • On Day 2, I can sell the bond for $107

As an individual, I enter debt on Day 1, to finance a net gain on Day 2.

A country can engage in the exact same behaviour, just on a much larger scale and in perpetuity if they can continue to find attractive investment returns.

If Australia can find investment opportunities which will pay out above our cost to borrow, and we cannot fund them simply with domestic savings, then we will enter a current account deficit in order to fund that investment. Such is the benefit of our access to international financial markets, both as investors and as a country.

This is sometimes known in economics as “consumption smoothing” – the consumer (here, Australia) goes into debt in the present, in order to invest and increase its income in the future, which can pay off its debt without reducing the overall level of consumption in the country.

Big disclaimer here that this is in no way saying that running a current account deficit is always good, or more importantly always sustainable.

Where Does that Leave Us?

In the midst of a new COVID-19 variant, the lagged effect of lockdowns on our GDP and capital market fragility, it sometimes helps to step back and view the bigger picture.

As an economy, we sit in the relatively robust position of being able to maintain high levels of international investment, whilst also being net savers and lenders to the rest of the world.

Many countries can only pick one or the other, and one day we will likely return to deficit – but it does provide an encouraging perspective on the strength of our position in the global economy, not only as a country but as the component individuals and companies within.

This note is not intended to be a bullish thesis for domestic equities, but it certainly does provide a listed company an advantage to be in a stable and healthy economic environment.

The views expressed in this article are the views of the stated author as at the date published and are subject to change based on markets and other conditions. Past performance is not a reliable indicator of future performance. Mason Stevens is only providing general advice in providing this information. You should consider this information, along with all your other investments and strategies when assessing the appropriateness of the information to your individual circumstances. Mason Stevens and its associates and their respective directors and other staff each declare that they may hold interests in securities and/or earn fees or other benefits from transactions arising as a result of information contained in this article.