Abstract
Do the imbalances in current accounts still matter in today’s deep global financial markets that exhibit two-way gross economic flows that dwarf the new outcomes provided by current accounts? Contrasting the adult perception of the world and complete markets, extreme current account imbalances indicate severe financial and macroeconomic stresses, particularly as was the case in the mid-2000s. The increasingly massive valuation differences in nations’ net global investment standards and positions, as well as risk allocations, cannot be relied upon to offset the variations in regional wealth systematically as implied in the current accounts. The same conditions that warrant caution in international imbalances imply that the information concerning global cash positions and flows are central to the evaluation of economic stability risks. The mismatches in financial statements of leverage corporations outline direct indicators of instability just as global imbalances portray deep-sited financial threats. Consequentially, the evaluation reinforces the essence of current accounts in international trade.
Introduction
Are the variations between regional imports and exports a legitimate cause for national concern and remedy? The question outlines the aspects of an old economic approach regarding deficits in international trade and the balance of payments. Global commerce has had more than two centuries of imbalances in the national units even though there are countries that share a common currency. Even in the ideal globe that is free from supply conditions, foreign demand, and economic frictions there are several constraints that limit the maximal welfare of the national unit. The government thus faces incentives to remedy the constraints. However, the deepening of the international markets leaves economists to wonder whether current account imbalances really matter in the real-world. This paper strives to develop a comprehensive analysis of current account imbalances by reviewing the work of Maurice Obstfeld.
In a standard neoclassical concept, all nations stand to gain from free trade as well as balanced commerce. But in the real planet filled with political and economic distortions, a government’s intended short-run benefits can be improved by policies that focus on trade surplus. Such regulations will affect the country’s trading partners since a larger share for the nation means a smaller portion for the neighbors. Policies that are mostly motivated by securing a national advantage can be counterproductive if pursued widely. Hence, nations should seek to coordinate their commerce and financial markets to increase the returns of policy cooperation. The move will also reduce the country’s vulnerability to external and internal shocks as well as spillover impacts (Obstfeld, 2012).
Body
The recent international crisis experienced in 2008 brought out possibilities that were unimaginable to many states. According to Obstfeld (2012), observers linked the financial catastrophe to the rapid rise in economic globalization. Were it not for the strong trade and financial linkages many nations would not have propelled the crisis across their borders. The contentious debates lurked around the era of Hume focusing on current account balances as the primary cause of financial vulnerability and global shock transmission. A region’s current account arises from the difference between domestic investment as savings or between imports and exports.
The global economic catastrophe was preceded by international imbalances in various countries’ current accounts and large deficits in the world industries. Michael utilizes figures to portray the dispersion of international current account disparities from the late 1900s to 2007, the year before the occurrence of the financial crisis. The author’s article is keen to outline whether current account imbalances are fundamental in the 21st century. Lawmakers seem to reaffirm the opinion since in 2006 a multi-dimensional consultative process was launched by the International Monetary Fund to support the unwinding of large foreign disparities. Similar issues have stuck as the primary agenda of twenty nations after the economic catastrophe (Obstfeld, 2012).
In 2010, the European Union came up with an enhanced surveillance network to monitor its members using a series of indicators of current accounts and macroeconomic imbalances. The international financial disparities emerge from complicated multilateral gross economic flows that are larger than the gaps in the current accounts. The financing patterns raise the query as to whether smaller current account loopholes matter. They also draw attention to the effects of financial stability and asset prices of larger cash flows. Some economists argue that the current account is losing its importance in today’s business sector (Obstfeld, 2012).
The two basic lines of attack concerning current accounts rely on the depth of international financial markets and increasing fluidity. However, they both strive to take different takes when it comes to the matter. Michael highlights the contrasts between the two views of current accounts in their extreme modes. The first argument regarding the importance of current accounts from the policy makers assumes that regions have diversified idiosyncratic risks in complicated, well-functioning and contingent security markets. In the real globe, the Arrow-Debreu asset approach allows nations to pull their financial risks to maximum feasible extents. Except in situations where the current account disparities supersede the government deficits (Obstfeld, 2012).
The second argument raised by several economists concerning the non-importance of the current accounts portrays an ideology that is less optimistic. It is founded on the view of imperfect risk sharing and that the extensive volumes of global financial activities are skewed expectations and incentives for implicit leadership guarantees, tax evasion and avoidance, regulatory arbitrage, etc. Based on the second argument, the imperfections in the economic markets can reinforce one another to magnify the systematic risks that are endogenous in the financial system (Obstfeld, 2012).
According to Obstfeld (2012), the second view maintains the stability of the effects of current account balances in comparison to gross cash flows that finance most global transactions. The bulk of the cash flows present risks that can develop to be acute and result in an economic crisis. Hence, the impacts of net current account balances on a nation’s external resources are dwarfed by the capital losses and gains in gross liability positions and foreign assets. Michael’s lecture presents a controversial case in the economics of deep and internationalized markets. The regional current account flows remain an essential variable in policy making in both macroeconomic and financial grounds.
Nonetheless, Obstfeld (2012) argues that while lawmakers proceed to monitor the world current accounts the attention is not sufficient enough to facilitate international financial stability. Adequate surveillance will require enhanced data on the direction, size, and nature of the gross world financial trades as well as a better comprehension of how the cash flows fit in global economies and financial developments. A fundamental fact about the economic globalization that has been taking place since the late 1900s reveals that gross financial flows and stocks of foreign liabilities and assets have grown in some nations. The second figure in the article illustrates America’s experience in a closed economy.
The two sides of the second figure provide the gross payments of cash flows in the United States’ recent current accounts. The first panel shows the new and foreign purchases of American citizens and that of foreign residents. The sum of the results of the illustration indicates a net increase in the United States’ international assets compared to liabilities. The second panel shows the nation’s exports and imports as well as the net transfers and income flows. The sum of the series in the second side provides the current account balances of America. Gross economic flows were smaller than trade returns in the mid-1970s. However, with time gross financial flows have risen to exceed the trade returns (Obstfeld, 2012).
The third figure in Michael’s article indicates the explosive development of the stocks of several countries. The information outlines a rapid increase in external positions in the later 1990s in most of the wealthy regions. For instance, Japan’s economic openness has doubled since the 90s while that of America has tripled to almost 1.5 times the previous GDP. The Eurozone is also at its all-time high together with various countries in the New Industrialized Asia such as Taiwan, China, and Korea. The author creates a relationship between the global flows of asset purchases and sales and the reported balance of payments of foreign liabilities and asset stocks (Obstfeld, 2012).
The reality of world globalization needs utmost care in interpreting regional implications of gross positions. However, some economies that host foreign national institutions have accurate balance sheets with Ireland being a leading example. The balance of payments concept depends on residence and not the nationality principle; hence, large fractions of external liabilities and assets belong to the world nationals and can only be relevant to the welfare of domestic nationals. Also, the regional government may find it unnecessary or undesirable to support resident companies of foreign origin that experience financial challenges (Obstfeld, 2012).
The current account serves as an indicator of changes in national trade; hence, its absolute size and direction imply variations in the overall consumption of the economy and the investment opportunities. An opposite balance in the international economy should match a nation’s balance. There are several arguments that contend the imbalances in the current accounts can be self-correcting. In financial models with global asset markets, the amount of current account imbalances will be reduced while the potential adverse interactions between economic market imperfections and asset flows will be absent. International lending and borrowing assists countries to smoothen their consumption using deficits in the current accounts (Obstfeld, 2012).
Obstfeld (2012) utilizes the prominent two-nation endowment theory instituted by Lucas. In the model, two regions swap half their claims on stochastic endowments to ensure that the residents in the countries hold identical pooled portfolios. In the situation, the individuals share the endowment shock to create a wealth asymmetry. The complete market theories in investment can introduce current account surpluses or deficits. There are also likely to be smaller than the models in incomplete markets. For instance, Michael evaluates the real consols and equity claims model to show that a resource structure sufficient to formulate complete markets has two shocks in investment efficiency and productivity.
In the real consols and equity claims paradigm, maximum portfolio actions result in a zero balance in current accounts since bond flows always offset the equity returns. However, other complete market approaches will show nonzero accounts. For example, when organizations are established in a nation, their equity shares are distributed to international investors in the current account deficit and financial inflows. Clearly, the scenarios give no basis for efficient policy interventions. An alternative interpretation of neglect holds that are forward-looking and optimizing will provide current account flows consistent with the resource allocation as long as the deficits in the public sector are not excessive (Obstfeld, 2012).
The current account imbalances can adjust to moderate levels with time conforming to the natural adjustment procedure of Hume’s self-limiting commerce disparities. The perception that utility-maximizing households and profit-maximizing firms do not over-borrow funds has been adopted in numerous situations of current account cash flows. According to Obstfeld (2012), the best-known illustration of neglect of current account balances was provided by Lawson. He asserted that an external discrepancy in the private sector should not raise concerns. Lawson’s Doctrine places the burden of national stability of the government’s financial activities.
A leadership that manages its current accounts badly resulting in debt and undesired inflation is the primary threat to regional economic health. If the government’s resources are managed appropriately, then there is no need to worry about debts and deficits. The key challenge of Lawson’s principle is that it divides the actions of the public and private sector in crisis situations. The government’s irresponsibility will impact the private sector. Also, the activities of the private firms can adversely affect the budget of the leadership when the liabilities of collapsing financial institutions acquire public guarantees. In a national or international catastrophe, the activities of both the private and public sector become intertwined (Obstfeld, 2012).
According to Obstfeld (2012), economists claim that due to the emergence of a common currency in the eurozone, there is no need to continue using current accounts. However, the regulatory and fiscal responsibilities of governments in the Eurozone explain why it is essential for countries to have their own external and separate current accounts. The absence of a system to oversee the integrated bond market in the eurozone has proved to be a liability that has contributed to the overwhelming market segmentation with nations’ threatening to depart the similar currency. The author notices that the gross cash flows conceal the new returns of the current accounts indicating growth.
A region with a gross debt in the short-run is vulnerable to failure just as the financial institutions. The gross exposures pose a risk to financial stability and present balance sheet crises regardless of whether the country has a surplus or deficit in its current accounts. An implication of expanding liability and gross asset positions is the growing role of price-asset changes. For the rich and industrialized nations, the expansion of liabilities and assets is in the form of debt and deficit instruments as well as equity trade. The motivations for debt inflows in international banking are easily understood. There are several rationales stemming from microeconomics that can explain the usefulness of debt incentives and contracts (Obstfeld, 2012).
Debt can at times enhance the importance of bilateral agreements, smoothen the functioning of the market, and evaporate counterparty risks. Regulatory arbitrage and tax shifting are also motivations for debt transactions. Debt claims carry economic stability risks for the nations involved despite the current account positions. Short-term obligations have tremendous risks, liquidity problems, and threaten the solvency of financial institutions. When the resources of a firm become impaired, those who have lent the institution money or assets will lose credit. The contagion can easily be transmitted across company borders. Hence, the prevalence of the debt instruments is worrisome (Obstfeld, 2012).
Unlike equity, the debt claims feature predetermined obligations that are subject to waivers and defaults. The current account information appears too partial to provide reliable and valid information regarding financial cash flows. The netting in a current account can mislead since the assets are obtained from domestic residents; hence, they cannot meet liability claims from the rest of the globe. The aspect means that the risk traits of the national resources are different from foreign investments. The second reason that deemphasizes on current accounts cash flows is that the provisions are minor components of the entire variations in national trade. The changes offset the current accounts annually (Obstfeld, 2012).
The tables in Michael’s article illustrate the fading relationship between the disparities in regional trade and current account balances. The arguments concerning current accounts as highlighted earlier are self-correcting. They indicate that massive cross-border economic flows enhance efficient sharing of risks and that the self-interests of the private sector result in socially relevant allocations. The advancement of global economies seems to be making the use of current accounts insignificant due to double financial flows and large capital losses and gains in gross foreign liabilities and assets (Obstfeld, 2012).
Therefore, why should countries continue to worry about current accounts? Michael answers the question in three ways. They include the possibility that in the long-run current accounts may perform a reasonable role in tracking national commerce, the macro effects of imbalances in the accounts, and the related problems in the current accounts. Numerous financial catastrophes have preceded deficits in large current accounts such as the ones in Finland, the United States, Greece, Mexico, Thailand, etc. The predictive authority of the current accounts is not as exceptional as that of exchange rates and global reserves. There is a direct link between the current accounts and credit booms since the net returns of private capital need not coincide with the deficits in the accounts (Obstfeld, 2012).
Conclusion
The lessons gathered from the internationalized financial markets disclose stability risks that most nations and companies ignore. The persistent and large economic stresses and imbalances deserve the full attention of policy makers without any innocent presumptions. The changes in national trade and risk allocation cannot be relied upon to offset the discrepancies in regional wealth as implied by the current accounts. Michael’s analysis implies that gross international cash positions and flows are crucial in the assessment of economic stability risks. The current proposals for worldwide monetary and financial reforms seek to limit the foreign proliferation of dangerous economic positions that can result in long-lasting damages (Obstfeld, 2012).
The discussion concerning current accounts suggests that they are still essential in international commerce since their imbalances are detrimental to countries. However, focus is also given towards effective financial infrastructure to provide global coordination of liquidity facilities and economic regulation to facilitate the availability of the appropriate fiscal resources required in decision-making (Obstfeld, 2012). The changes will imply that the globe should have a large and diversified economic government. However, political barriers may limit the transformation. But based on the recent financial crisis, people should ask themselves how much further they are willing to push their international markets beyond the borders of global governance.
Reference
Obstfeld M. (2012). Does the Current Account Still Matter? National Bureau of Economic Research. Retrieved June 7, 2016 from http://www.nber.org/papers/w17877.pdf.
