Balance of Payments

The USD is dependant on the current account and capital account. Since the current account deficit is widening, the capital account needs to rise in order to stabilize the USD. If the equity markets fall with a rising current account deficit, the USD will fall.

Current account declining:

Capital account rising:

Stable USD:

This video explains it:

U.S. dollar will have a correction

The U.S. dollar is overdue for a correction to the downside as budget and current account deficits balloon. To bet on this, you should of course buy precious metals.

The Reason For China Current Account Deficit: Tourism

China's current account deficit is attributed to tourism. It's not like China isn't producing goods anymore, it's just that China is now consuming its money and they go all over the world to spend their money, creating a services deficit.

 

But this services trade deficit is narrowing and the current account surplus is rising again.

Buying Japan is Picking Flowers in Front of an Incoming Train

Japan is undergoing a lot of changes today and one of the most important changes to investors is their fiscal situation. In a previous post almost a year ago, I analyzed the dismal fiscal situation in Japan, pointing out how their budget deficits and debt burdens are growing. I want to make an update on that as investors are focusing more and more on Japan these days.

The Ministry of Finance Japan has issued a new report on the fiscal situation which can be found here. This report is dated from December 2013.

Let's first focus on the trade and current account deficit in Japan. Both have been deteriorating rapidly in 2013. In fact, we are hitting new lows as we speak. The primary reason is that the yen has devalued a lot since 2013. As I noted earlier in other posts, the currency valuation is correlated to the deficit. If the valuation of the currency of a country goes down, that means that they will need to import products at a higher price and they will export products at a lower price. This naturally leads to a higher deficit. Evidence can be found in the soaring costs for importing oil to Japan. Oil imports basically almost doubled in price as noted in this article.

Chart 1: Japan Current Account and Trade Balance

If we then move on to the budget deficits, there is a bit of light at the end of the tunnel. The deficit to outlay ratio (which gives the likelihood for hyperinflation) has come down from a peak of 62% to 48% which is an improvement, but we are still in hyperinflationary territory (ratio above 40% is hyperinflationary).

Chart 2: Deficit to Outlay Ratio Japan

Chart 3 illustrates that the government has cut back on spending (red chart) and the budget deficits have come down (green chart). It also shows how tax revenues in Japan (blue chart) have gone up due to a rising Japanese stock market. This rise in tax revenues has decreased the budget deficits in Japan.

Chart 3: Japan: Tax Revenue, Expenditures, Budget Deficit

Now we come to the most interesting part of this analysis: the interest payments on government debt. To find out about this, go here.

Budget - Trade - Current Account Deficit

It can be interesting to watch how the budget deficit, the trade deficit and the current account deficit evolves over time. As I said before, deficits are inversely correlated with the currency value. Ever since 1970, the U.S. dollar decreased in value as deficits went up. The following chart gives the annual budget - trade - current account deficit.

The budget deficit (yellow chart) is a measure of how much the federal government is spending more than it receives. The budget deficit = Federal government spending minus Federal government receipts. We currently have an annualized $1 trillion budget deficit.

The current account (BOPBCA) (green chart) is simply a measure of how much money is flowing out of the country compared with how much is flowing in from foreign sources.

The balance of trade (BOPGSTB) (red chart) is the biggest part of the current account. It measures the value of what we sell overseas minus what we buy from overseas. The U.S. trade deficits started since 1970, when the U.S. started to import a lot of oil and consumer goods.

The U.S. has a trade surplus in services and a trade deficit in goods.

The trade balance can be predicted by looking at air freights.

Import and export air freights.

Import and export of all commodities.

Imports and exports of goods and services.

 

High deficits lead to currency devaluation.

 

The current state of the budget deficit:

Euro Vs. USD: Take Two

5 months after I wrote the article about the Euro Vs. the USD, it looks like the USD has won the match against the euro. Since April 2012, the euro has lost 5% against the USD. Let's look at what has changed in those months.

Following list gives the most important indicators for the future of a currency:

• Current account balance of the country
• Total national debt of the country
• Inflation rate
• Interest rate

If the current account balance of the country is positive, a country will export more than it imports. As the population of the country exports more, they will receive more foreign money. This money will then be converted into their own currency, which is then spent or put in their banks. As the foreign money is converted into the money of the country's population their own currency will appreciate in value.

The larger the national debt of the country, the more expensive it will be to sell debt to foreigners. The government will then be obliged to monetize this debt to keep interest rates low and to be able to service this debt. Rising debt load will therefore devalue the currency.

The higher the inflation rate, the lower the currency will go. An example is Vietnam, where the dong lost much of its value due to high inflation.

When interest rates are lower than the inflation rate, there is no incentive for foreigners to buy the currency. There is no incentive to save money. The consequence is a lower currency value.

Let's look at the current statistics:

1) Current account
5 months ago, the current account deficit of the US was in the order of $US 110 billion per quarter, which amounted to $US 450 billion per year (2011).

For the Eurozone, the 12-month cumulated seasonally adjusted current account recorded a deficit of EUR 44.9 billion.

Today, the eurozone is posting a current account surplus of 14.9 billion euro in June, while the U.S. is increasing its quarterly deficits to $US 137 billion in the latest quarter.

So in this case, the eurozone is still the winner.

Europe VS USA: 1-0.

Euro Area Current Account (Million euro)

U.S. Current Account (Billion USD)

2) Total National Debt
Total US national debt is $US 16 trillion. Total eurozone national debt to GDP is 88.6%, the GDP is $US 17.578 trillion in 2011, which translates to $US 15.6 trillion in Eurozone debt. So again, Europe wins by a small margin.

Europe VS USA: 2-0

3) Inflation Rate
5 months ago, the inflation rate in the Eurozone was 2.6%, while the inflation rate in the U.S. was 2.9%. Today the inflation rate in the Eurozone is 2.4%, while the inflation rate in the U.S. is 1.4%. This is a significant and surprising decline in inflation rate in the U.S Vs. Europe.

Europe VS USA: 2-1.

Euro Area Inflation Rate

U.S. Inflation Rate

4) Interest Rate
5 months ago, the interest rate in the Eurozone was 1%, while the interest rate in the US was essentially zero. As we already know, Mario Draghi lowered interest rates to 0.75%, but this is still higher than the interest rate in the U.S. (0.25%). Europe VS USA: 3-1

Euro Area Interest Rate

U.S. Interest Rate

     

Conclusion: Europe still wins by 3-1 against the USA, but is losing ground through inflation. Though I think the current account surplus of Europe is the most important positive indicator of the strength of the euro in the future.