The balance of payments is a tricky thing

Larry Elliott takes us through the balance of payments and why the UK is dependent upon oligarch money. Sadly, it’s not quite and wholly correct.

There was a time – many decades ago – when trade deficits were a big deal. Politicians used to fret about them. They were front-page news. Famously, a bad set of trade figures was supposed to have cost Labour the 1970 general election (although they probably didn’t). But since the early 1980s, Britain’s trade deficit has got bigger and we have worried about it less.

There’s a fairly obvious reason for us worrying less these days - we have a floating exchange rate. Back then we had a fixed exchange rate - well, until events proved too much and it had to be changed, as it was several times. The advantage of these markets things being that if the deficit does become impossible to finance then the exchange rate - without planning or government action - simply does change so that the balance of payments does balance.

In a fixed FX system you have to worry about the trade deficit because having the FX rate fixed means you’ve just lost your automatic stabiliser.

But there’s a deeper problem with the analysis:

The point about the balance of payments is that it has to balance. Countries such as the UK that run permanent trade deficits have to sell assets to foreign buyers to raise the cash to balance the books. Over time, Britain has run a cumulative trade deficit in goods and services of £1.3tn. But in the pink book that outflow has been matched by financial surpluses – cash – of the same amount. Money we got selling British assets to foreign buyers.

Entirely correct.

The structure of our economy is simple. For decades Britons have consumed more than they have produced.

Tht’s not, or that’s not necessarily so. Because those assets that are sold on that capital account, to finance the deficit on the current account, they’re also things that are produced. If we build a house and sell it to a foreigner then that’s on the capital account. But it’s still making something and selling it to a foreigner, it’s an export in its way. Building a company which is sold to a foreigner - capital account again but it’s the selling of something made in Britain to said foreigner again.

Warren Buffett described the extreme outcome in his Squanderville essay. If you keep selling all the capital assets then the foreigners own the country. But this depends upon the rate at which those assets are sold as against the rate at which they are created.

For the American economy, to switch instances, that sale of capital assets is around the $500 billion a year mark in order to finance the trade deficit. But in recent years the US has been creating wealth (we’re using household wealth as our measure here, perhaps not exactly right but a good proxy) at $2 trillion a quarter. The US is progressively selling off that capital base to the foreigners and the foreigners are ending up owning an ever smaller fraction of the American capital base.

So, the UK has run up that cumulative £1.3 trillion in trade deficits. Or, a £1.3 trillion surplus on the capital account. How much has the stock of wealth in Britain risen over that same period? With household wealth at £15 trillion and counting currently we’d insist that the stock of wealth has grown more than the portion we’ve sold to foreigners.

The British economy produces capital assets and sells some of them to foreigners. Yes, this finances the trade deficit but that’s something of a phantasm of national accounting. Flogging things we’ve made to foreigners is still flogging things to foreigners whether we record it as a current or capital transaction.

Houses, companies, football clubs, they are things that are made - they’re manufactures. Selling them to foreigners is an export and don;t let the accounting fool you into believing otherwise.