Including Derek Sicklen's reply, and Keith's rejoinder.
New Zealand has had a deficit on the balance of payments current
account since 1974. 1973 was the last year in which export and
foreign investment earnings exceeded import and foreign investment
payments. Yesterday, a record deficit of $NZ 6 billion was announced.
The balance of payments, defined strictly, is always zero. Everything
that New Zealanders buy from nonNew Zealanders is paid for
in some way, whether from current earnings (ie exports), from
asset sales, or from other forms of foreign investment.
The important feature of the balance of payments is its two subcomponents:
the current account and its flipside, the capital account. The
current account balance, through the laws of arithmetic, is always
the opposite of the capital account balance. The former (current
account) is the balance on earnings. The latter (capital account)
is the balance on foreign investment.
Since 1974 the current account balance has always been less than
zero (ie negative, in deficit). Therefore the capital account
balance has always been greater than zero (ie positive, in surplus).
A surplus on capital account is generally considered to be bad
news; it represents an increase in a nation's liabilities to foreign
interests. The exception - when it is not bad news - is when foreign
investments generate domestic incomes in excess of the costs of
servicing the investments.
Orthodox economic theory suggests that a capital account surplus
is the result of the current account deficit, and not the converse.
Under such a scenario, the current account deficit has some cause,
such as excessive domestic demand, a lack of domestic savings,
or an overvalued exchange rate. In the days of fixed exchange
rates, the problem would often arise from the exchange rate being
fixed too high by the government of the day. New Zealanders might
buy imports even though some New Zealand workers were unemployed,
because imports were artificially cheap.
Under a system of floating exchange rates, it is not so simple.
The problem lies in the reason why the exchange rate is too high.
The Government does not set the exchange rate. Typically the exchange
rate is too high because of a capital account surplus. Rather
than the capital account surplus being the result of the current
account deficit, the current account deficit becomes the result
of the capital account surplus.
The Economics 101 theory of international economics claims that
it is impossible for a nation with a floating currency to have
a balance of payments deficit on current account. The market always
sets the price of the currency. This was the theory used to justify
New Zealand's shift to float the dollar.
On closer examination, the reason for the lack of a deficit (or
a surplus) is that the floating currency model assumes that
there is no capital account. If there is no capital account
then the current account balance must always be zero; if there
is no capital account then the current account of the balance
of payments is the balance of payments, which cannot be anything
other than zero.
In the era of high oil prices, from 1974 to 1985, it was sound
policy for New Zealand to run a current account deficit. The alternative
would have been a massive devaluation of the New Zealand dollar.
In those days, it was appropriate for oilpoor countries
to borrow from oilrich countries, at least until the international
economy settled at a new equilibrium, which it did in the late
After 1985, however, international conditions were ideal for New
Zealand to have its current account in balance if not in surplus.
What happened instead was that the capital account went into a
massive surplus after the exchange rate was floated, thereby causing
a new growth in the current account deficit. This case did not
conform with undergraduate teaching. From 1985, big capital account
surpluses have caused equally big current account deficits.
Why has New Zealand had a capital account surplus since
1985? Not because of an overheated domestic economy; nor
because of an inability of New Zealanders to save. Rather,
it is because a central feature of public policy in New Zealand
has been to generate a net inflow of foreign capital.
This policy was pursued despite the fact that the rationale for
floating the exchange rate depends crucially on there being no
net inflow of foreign capital.
New Zealand governments have conducted this policy in two ways.
First, they have used high interest rates as a tool ostensibly
to reduce inflation. This monetarist "one tool fixes all"
approach is simply incompatible with any commitment to balancing
the current account. The antiinflation policy works only
to the extent that a net inflow of foreign capital causes the
exchange rate to be overvalued. And an overvalued exchange rate
is always known to cause a current account deficit. This policy
is now entrenched as the 1989 Reserve Bank Act.
From mid-1994 to early 1997, the Reserve Bank has quite explicitly
pursued a high interest rate policy, with the full intention of
a capital account surplus pushing up the exchange rate and thereby
reducing import prices. Not surprisingly, the current account
deficit has steadily increased; a faithful mirror image of the
policydriven capital account surplus.
The second way in which New Zealand has conducted the policy of
having a net inflow of foreign investment is through the process
of sending Finance Ministers overseas, not to beg for export access
to Europe as they once did, but to sell New Zealand as an attractive
destination for foreign investment, as a destination not lacking
in public and private assets for sale.
Why does the government deliberately choose to have a surplus
on the capital account of the balance of payments? That amounts
to a deliberate policy for New Zealanders (or at least some New
Zealanders) to consume at a level that cannot be sustained by
New Zealand's earnings.
I cannot know for sure why any government would choose such a
selfcontradictory policy, but I suspect that it may be because
the whole reform process was only ever intended to benefit one
section of the New Zealand population. That section today is able
to live a lifestyle of conspicuous consumption; a lifestyle for
a few being funded by cumulative increases in New Zealand's foreign
liabilities. Each year, more New Zealand workers are having to
work less for themselves and their families, and more for their
creditors; for New Zealand's creditors.
Reply to The Balance of Payments Deficit, by Derek
Sicklen from Sydney, 9/10/97.
1. Capital v. current account. I'm a little sceptical about a
priori causality running between the current and capital accounts.
By definition they must be equal (excluding items such as unrequited
transfers). Using the same logic the CAD must equal the deficit
of domestic saving versus domestic investment but there is, in
my view, absolutely no causal relationship between these two at
the level of the national accounts. Thus, just as I have a problem
with the notion that the CAD 'causes' a capital account surplus,
so I have difficulty with the reverse. If 2+4=6, what does this
tell us about causation? Does the left hand side 'cause' the right
hand side? If I change the 2 to something else I have no idea
how the other numbers will simultaneously change, except that
whatever happens the remaining expression will be an identity.
An identity is an identity is an identity - there is and can be
no causation running between the two sides purely because of the
identity. Any causation needs to be explained in greater detail
2. The exchange rate is 'too high'. What does this mean? If it
means that the exchange rate is such that it doesn't bring about
current account balance (or trade balance) then this is a circular
argument - i.e. you can't argue that the exchange rate is overvalued
and therefore causes a trade deficit if the definition of an overvalued
exchange rate is its failure to balance imports and exports. Personally,
and even allowing for things such as PPP, I think there is no
meaning in the notion of an 'overvalued' or 'undervalued' exchange
rate, especially in a floating currency regime. An increase or
decrease in the exchange rate may induce trade or other flows
but this does not imply over/undervaluation. In Australia's case,
for example, the exchange rate follows commodity prices, but not
the commodity prices representative of Australia's export mix.
This is a conundrum but nonetheless casts doubt on almost all
known theories of exchange rate determination including interest
3. Appropriateness of CAD in 1970s. Why was it appropriate for
NZ to run a CAD in the 1970s rather than have a substantial currency
depreciation? It could be argued that a much lower exchange rate
may have stimulated more exports and import substitution which
could have helped avert some of the economic malaise that struck
NZ after, say, 1984. I'm not that familiar with the NZ data, but
the logic of this argument would need to be rebutted.
4. My own thoughts regarding the link between current and capital
accounts are that there are separate factors driving each, and
their equality is a creature of the national accounting identities.
Thus, for Australia, I see the following as principal causes of
the growth of the CAD over recent decades:
Thus, although I do see a causal relationship between the CAD
and capital inflow, it is not one derived from the arithmetic
of the accounting identities. Nor is it based on capital inflow
(or policy) resulting in an overvalued exchange rate. Indeed,
the Australian exchange rate fell (in line with commodity prices)
quite sharply in the early-mid 1980s, suggesting that exchange
rate factors were unlikely to have encouraged either excessive
importation or excessive capital inflow. Further, other non-capital
account factors are involved.
As is my understanding of different economies' growth performances,
so too I have the view that there are different roots to the CAD
paths displayed by each country. The fact that each country with
a CAD has a surplus on capital account does not, to me at least,
provide the reasons for the CAD.
I agree that there is no systemic causal relationship, at the
level of the national accounts, between the current account and
the capital account. There must be a causal relationship either
way, however, if policy or some other exogenous factor forces
either the current account balance or the capital account balance
to diverge from zero. The balance not directly affected by the
exogenous factor must adjust.
If 2+4=6 and you change the 2, then either of or both of the 4
or the 6 must change. But if you change the 6, then the left side
of the identity must change. My point has always been that government
or central bank policy has been, for most of the time since 1985,
to run a net current account deficit in order to
ensure that the exchange rate is higher than it would otherwise
have been, and not simply to attract foreign capital.
My definition of a policy-driven "overvalued exchange rate"
is simply an exchange rate set higher than would have been set
by the market in the absence of the policy. My argument is simply
a matter of comparative statics; contrasting two situations where
one exogenous variable (in this case policy) takes effect.
Taking both the whole context of the international economy as
it was in the late 1970s and the nationalist view that borrowing
may make adjustment less disruptive, I believe that New Zealand
policymakers in the late 1970s did the right thing. They borrowed
and devalued the currency, with the devaluation
being less than it would have been had the currency been floated
and unsupported. Furthermore borrowing, if done wisely (as some
of it was), has the potential to boost fixed capital investment
in new industries, reflecting changes in a nation's comparative
It is not clear to what extent the Government saw the problems
of the late 1970s as cyclical or structural. A huge devaluation
would have led to massive and painful restructuring. If the problem
was cyclical - as indeed it proved to be given the realignment
of oil prices in the mid1980s - then the devaluation would
have given disastrously incorrect price signals. As it was, the
devaluations were enough to generate a large increase in manufactured
exports. The New Zealand economy proved to be among the three
best performers (ie in terms of GDP growth and growth in shares
of international trade) during the world recession of the early
We cannot say that the current account and the capital account
are determined by entirely independent causes. There must be some
equilibrating force leading to balance where the factors driving
the two sides of the identity would otherwise lead to a contradictory
My view of protection is that it does act as an alternative to
a devaluation. Thus a general import tariff is not unlike a tax
on foreign exchange. In New Zealand in the early 1980s, the maintenance
of import tariffs and the expansion of export subsidies certainly
enabled the exchange rate to be higher that it would otherwise
have been. Roger Douglas argued before 1984 that it would be better
to simultaneously devalue, remove export subsidies, and get started
on reducing all forms of import protection. Hence the speculative
run on the New Zealand dollar during the 1984 election campaign.
With Roger Douglas expected to become Minister of Finance, the
direction of any movement in the currency became a oneway
bet. Many people took that bet, and, in the end, profited handsomely
by so doing.
I agree that there are many factors determining current payment
flows and capital inflows and outflows, and that each country
is different with respect to these factors. Nevertheless, I conclude
that the effective implementation of a policy to drive the exchange
rate up must lead to a higher current account deficit. In the
case of New Zealand after 1985, a capital account surplus was
the means by which the exchange rate was forced up.
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