If you’ve heard of the current account, then you’ve probably heard of National Accounts.
Stuff such as GDP (Gross Domestic Product), and Gross National Product (GNP) are usually mentioned.
We have to define the account which interests us, but first let’s get a picture of where it fits.
To put it short (not selling here), the current account is a big account in National Accounting.
Ok, but what is National Accounting?
It’s a collection of statistics every country compiles on its economic activity.
Why do countries do this? I answered this in our GDP page, so check it out if you want a full explanation.
Basically, countries strive to increase the well-being of its citizens. And to do this, they have to track how the economy is doing.
There are many different measures (or economic indicators), but some of these measures fall under the umbrella of National Accounting.
For example, you have Consumption, Investment, Net Exports, and Government Expenditure.
All of these are accounts which are added to get to our GDP number.
And each of these accounts are composed of many other smaller accounts, each containing smaller accounts, until you have the smallest dis-aggregation.
Net Exports is Exports minus Imports.
But Exports is subdivided into Exports of Goods, Exports of Services, and Foreign Investment.
Then an account such as Exports of Goods is further subdivided into agricultural goods, industrial goods, etc…
Now, each country has its own idiosyncrasies (if you don’t export gold, you won’t separate that account from the rest).
But there are general big-picture guidelines for compiling and preparing these accounts.
By the way, Net Exports = Current Account,
since I’m considering monetary flows, not just goods and services.
A country needs to know its net borrower or lender position against the rest of the world (in a given period).
This is what the current account does.
If its balance is positive, then we call it a surplus, and the economy is a net lender.
Conversely, a negative sign is called a deficit, and the country is then said to be a net borrower.
You can think of the current account as a balance on how much money came into the economy VS how much money went out of the economy.
If you export, money comes from abroad (since someone is paying you for those goods or services).
When you import, money from your economy leaves (since you’re paying someone abroad for their goods or services).
But money doesn’t flow only on transactions of goods or services.
Money also flows through investments.
When a manufacturer decides to move to China due to lower labor costs, it invests directly into China, and this money is now injected into China’s economy (this is therefore positive in the account).
If you buy foreign securities, say a stock, or a bond, or when you open a bank account abroad, you are essentially transferring money from your economy to the other country’s.
Thus, your money is accounted for as a flow, but it is negative for the account, since in this case, your money is a liability for the foreign economy.
After all, the banks owe you those deposits. As do the bond, or stock issuers (in the case of stock, account treatment may differ).
On reverse, the interest payments you receive for your foreign bond holdings represent a positive flow of money for your economy, and is accounted for as such.
So you add up all the credits (positive flows, money coming in).
And you add up all the debits (negative flows, money going out).
Finally, you get the difference between them to get the current account balance.
This is the same as asking why is this important?
Well, there are a few reasons.
The size of the current account balance in relation to GDP will (sometimes) tell you how important currency exchange rates are for that country’s economy.
For example, for the United States, which has had a relatively low balance as percentage of GDP (2-3% in past few years) according to trading economics.
Compare that to China a few years ago (around 10% of GDP).
This of course, could be misleading, since even a small % doesn’t mean the country doesn’t depend heavily on its exports, and thus, exchange rates.
For example, a country like Japan has a balance around 3-4% of GDP.
Does this mean they don’t care about exchange rates?
Since both their exports and imports are huge (close to 18% of GDP by themselves), a strong appreciation of JPY could hamper their exports enough for GDP figures to worsen (thus, decreasing the well-being of the economy), since imports not only stay the same, but might actually increase.
Knowing this, a Central Bank concerned about growth might have a greater incentive to keep rates low.
Occasionally (I wouldn’t say it’s that frequent), a Central Bank might start paying attention to the current account balance.
It is under these circumstances that trading such data release becomes an interesting opportunity to make some pips.
Otherwise, don’t go trading robotically just because the surplus got bigger, or the deficit decreased.
Hence, I would only pay attention to the current account balance in the oft-times the Central Bank is paying attention to it.
Especially if the markets are buying into the Bank’s rhetoric.
That’s it for now.
This was a somewhat more “technical” piece for an economic indicator, but I worked as a statistics compiler for the Current Account Goods section at the Central Bank of my country, so I got some insight into this particular indicator.
See you soon,
The Forex Economist
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