Friday, 14 October 2016

Balance of Trade

What are the consequences of Britain running a prolonged trade deficit? 

     I recently asked myself "Why tax?". Why not run a prolonged fiscal deficit, in which the government makes up the shortfall by printing new money[1]. Now I ask the question above: "What are the consequences of Britain running a prolonged trade deficit?"
     It is today a simple matter to find data on the web for Britain’s trade balance from 1956 to 2016 [2]. These show an approximate balance until the mid eighties, but a period of 6 years from 1986 - 1992 where the balance of trade and services went extremely negative. Balance was restored quite rapidly and remained in balance until Labour came into power in 1997, whereupon there began a progressive slump into negative balance of trade and services. From 2004 to the present we have been running more-or-less steady at a deficit averaging 3.2 B£ per month (B£40 per year). That is around 2.2% of GDP, but it fluctuates month by month. 
     A somewhat grimmer picture is seen in what the Office of National Statistics (ONS) calls the 'current account deficit' a figure which, in addition to the balance of trade and services, includes profits on our British investments overseas minus the profits in this country repatriated to other countries. In the second quarter of 2016 the 'current account deficit' reached 6.9% of GDP[3]).
     I posed myself two questions: (a) by what mechanisms does the market correct itself? and (b) why is there a lag before correction? If I (like many UK citizens) want to buy a German car, I can offer £ or buy € and offer that. If the seller wants €, my purchase will depress the exchange rate. But if the seller prefers he can accept the £, and use them to buy gilts, bonds, or real estate in the UK. 
     I suppose there was a period of years during which foreigners were prepared to trade in £ and leave their winnings in the sterling area. The £ (for some obscure, and maybe irrational, reason) traded at a higher value than it should. That foreign money now seems to be leaving. The pound is relaxing and the skewed balance of trade should soon rectify, with us all 6.9% worse off. 

Do please comment if you think I have got this wrong.

References
[2]  http://www.tradingeconomics.com/united-kingdom/balance-of-trade
[3]  http://www.ons.gov.uk/economy/nationalaccounts/balanceofpayments/timeseries/hbop/pnbp

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