Woes About understanding CAD (1 Viewer)

[Sparcod]

I have problems understanding CAD. I'll break this up into four parts.

1. What is net foreign liablilities? (Is it part of the Current Account?)
2. How bad is our CAD?
3. What are the economic effects of the CAD? ( In the answer, please make reference to inflation, deppreciation in $Aus and borrowing, employment, exports/imports.) I do know that out net incomes is negative and so is our balance of goods/services giving us a CAD.


This topic of CAD is pretty big and very hard for me to understand.

Thanks to all those who help.

Sparcod

 

[Demandred]

1. Net foreign liabilities is how much we owe to foreigners as a means of paying off a high CAD. Everytime we run a CAD, we sell a little bit of Australia as sort of a security

2. How bad? By IMF standards, anything over 3% is something over a concern, anything over 6% is redlining. It's not a cyclical thing, its a structural thing. What I wrote on biki:

http://www.boredofstudies.org/wiki/...ance_of_Payments#Reasons_for_the_these_trends

n structural terms, much of it has been owed to the lack of export performance and domestic savings within the Australian economy. The composition of Australia's export structure are mostly based on primary goods - agriculture & minerals. These are often subjected to cyclical fluctuations within the global economy, agricultural products are especially suspectable to over-supply and cut-throat competition from the European Union's (EU) Common Agricultural Policy which has been known to dump huge surpluses onto the global market. The rise of globalisation and the move towards neo-liberal free market ideology since the 1980s will see Australia's economy being pushed further into the primary sector, further decreasing the stability of Australia's CAD. Secondly, the high amounts of investment inflows from overseas demonstrate Australia's lack of savings which can be used for investment. Australia's level of savings has been slowly decreasing over the last 30 years. This creates two factors to induce international investment inflows, firstly using a simple supply and demand diagram, a decreasing level of savings (left ward shift in supply) combined with steady demand will result in a high interest rate, the Mundell Flemming model suggets that investment will flow to areas of high interest, hence increasing the CAD through the net income section. Secondly, a more simpler answer, the relatively high levels of interest rates within Australia has become an increasing opportunity cost for not borrowing from overseas.

3. Increasing foreign liabilities = more and more of Australia is owned by foreigners. Last I checked 60% is owed to foreigners. What if all of a sudden these liabilities starts fail? Income would be instantly drained from the economy, if only a small fraction of these liabilities fail, Australia's GDP would be in reverse mode. Keep in mind that these act as some sort of security for the high levels of CAD, at the moment its about 6% of our GDP, if these investors starts to lose confidence in Australia's capabilities at repaying its CAD, they will withdraw and Australia instantly loses up to 60% of its GDP - holy fuck!.

Increasing CAD = less GDP growth as more and more of GDP is diverted to pay off CAD. Debt sustainability and vicious debt cycle results from an increasing accumulation of CAD. There's also a looming debt problem, there will be al likely contractionary monetary policy to counter imported imported inflation

This is from my own notes:

Over time, when trade deficit increase and net payments overseas increase, the Australian dollar would fall as more $A are flooded into the international market. Under law of supply, as more goods on the market, price drops. This is due to the loss of confidence amongst investors from investing into a heavily indebted economy, capital inflow will only stay the same if they are compensated for greater risks by holding financial assets in return for CAD, so unless domestic interest rate rise, they will not be willing to purchase Australian interest bearing assets as same quantities before.

As import prices increase from depreciation, inflation goes through the roof if import dependence is strong. Depreciation also means it is more expensive to buy more of foreign currency as a means to balance CAD, thus CAD will increase. This would result in contractionary policies. Interest rates are used to boost investor confidence and reduce inflation pressures, reduce domestic income and hence exports. Contractionary fiscal policy will lower imports by reducing income. Thus output falls and unemployment rises.

Okay, as for the debt problem, it's going to be way to hard to explain in proper economic terms, so I will say this: RBA increases interest rates, everybody goes into debt, if everbody goes into debt, no money to spend, no money to spend = no GDP growth, if no GDP growth = use your imagination.
----------------------------------------------------

Please don't blatantly copy and paste this, plagerism is evil.

And Sparcod, you're becoming way too regular at asking questions

 

[Sparcod]

Thanks.
So don't worry about Question 2. I'll check up for all the stats. I thought that having a debt worth 50 % of the GDP is considered as a limit by the IMF.

For the Economic downturn part. I'll put it this way.

CAD -> more borrowing ->more interest owed -> bigger CAD

CAD -> Govt tries to get a budget surplus (that extra money is not spent on public services but rather on paying of debt or saving it) GDP is spent on paying off rather than invested. -> lower productivity

That's the best way I can put it. I'm still lost.

We have a large CAD because of our:
-poor productivity, not enough exports
-low national savings and reliance of foreign savings (Also our interest rates are too high, thats why we prefer funds from overseas and also, foreigners are saving in our banks which means that our banks are paying them interest)


(What do you mean I ask too many questions?)

 

[MoonLiteDreamz]

Thanks.
So don't worry about Question 2. I'll check up for all the stats. I thought that having a debt worth 50 % of the GDP is considered as a limit by the IMF.

1. Net Foreign Liabilities - It is Net Foreign Debt + Net Foreign Equity
N. Foreign Debt - the difference between the money we lent overseas and the money overseas lent to us

N. Foreign Equity - difference between the assets overseas have in Australia and the overseas assets Australia has.

the two adds up to net foreign liabilities.

CAD -> Govt tries to get a budget surplus (that extra money is not spent on public services but rather on paying of debt or saving it) GDP is spent on paying off rather than invested. -> lower productivity

I dun think so. Cuz CAD has nothing to do with the govt spending. it is the individuals' debt. so it's like CAD include how much Qantas owe overseas, not Govt borrowings.

But Govt does introduce policies to decrease CAD. such as RBA increase interest rate. or Howard govt introduced Govt Budget Balance. so the govt can spend as much as it has to inject in the eco. but also to not have Budget deficit, because then that means Govt will have to borrow from the National Savings, which Australia is already lack of.

If u have anymore questions. msg me! hehe ^_^
(p.s.) Australia's having CAD of 6% GDP at the moment

 

[Demandred]

Predicted to go down to 4% of GDP.

 

[gnrlies]

I have problems understanding CAD. I'll break this up into four parts.

1. What is net foreign liablilities? (Is it part of the Current Account?)
2. How bad is our CAD?
3. What are the economic effects of the CAD? ( In the answer, please make reference to inflation, deppreciation in $Aus and borrowing, employment, exports/imports.) I do know that out net incomes is negative and so is our balance of goods/services giving us a CAD.


This topic of CAD is pretty big and very hard for me to understand.

Thanks to all those who help.

Sparcod

1. The CAD is a "Flow" measure, not a "Stock" measure. Consider a balance sheet as opposed to a cash flow statement. A balance sheet is a "stock" measure, and a cash flow statement is a "flow" measure. Net Foreign Liabilities is a "Stock" measure, not a "Flow" measure.

In other words the CAD measures the increments in our foreign liabilities, not our total foreign liabilities. Our net foreign liabilities are formed from FDI, Loans from overseas, portfolio investment etc. Because if we sell an asset, or receive a loan from overseas we are bringing in money into australia, the actual investment or loan amount is recorded on the K&FA. This is measured in the CAD in terms of the incomes that they earn (i.e. interest or dividends).

2. Our CAD is Australias only significant economic problem at the moment (and most of the other problems are reflected in the poor performance of the CAD). It has traditionally (since 1983 - being the year of financial deregulation) been cyclical in nature between 3-6% and there has been much debate as to whether our CAD is a problem. In the late 80's and early 90's it was regarded as a problem (characterised by the famous "Bananna Republic" remarks made by paul keating). Howevor during the 1990's thinking turned to accept the CAD as an attribute of the australian economy. With low national savings, a higher CAD has been a cause of economic growth for us, and that it should not be seen as a problem. Dr Pitchford from the ANU suggested that a CAD was suitable for the Australian economy and the term "the pitchford hypothesis" reflects his work. The IMF has also abdicated that a CAD of up to 6% is sustainable (however anything greater should be of concern). This line of thinking has been adopted by the Australian government by virtually removing the CAD as an external balance policy objective.

Moving to more current CAD figures howevor, we have seen a slight tendency for the 3-6% cycle to be stretched. Current CAD figures are pushing 7% and there is talk that there is an underlining trend that our CAD's are increasing. Current figures have mostly been a result of high consumer spending (imports), and reduced international competitiveness due to a strengthened dollar. The biggest factor however has been due to the stellar profits of australian businesses (and hence increasing dividend payments overseas - noting that australian companies have been ranked third in the world for growth under the grant thornton super growth index). The net incomes account is typically seen as the structural component of the CAD, and growth in this component can account for the recent cyclical growth in the CAD.

In looking to the future, Australias CAD should see a reversing of this trend, at least in the short term. The australian dollar is expected to reach 66 cents by the end of the year which will help our BOGS in the medium to long term. Company growth under the same index saw us fall to 8th with company growth slowing, howevor with the ASX200 reaching 5000 points, it is yet to be seen how company profits will impact on the CAD.

3 - I cant be bothered to do 3. haha sorry I gotta get up at 6 to go to a workchoices seminar tommorow

 

[Sparcod]

Predicted to go down to 4% of GDP.

Says who?

 

[Demandred]

2007 CAB as % of GDP, forecast is -4.0

Page 85 of The Economist, Volume 379 Number 8471 (the one with a blind folded chicken on its cover).

 

[gibbo67]

2007 CAB as % of GDP, forecast is -4.0

Page 85 of The Economist, Volume 379 Number 8471 (the one with a blind folded chicken on its cover).

I'm curious as to who would proclaim that - department of treasury or the reserve bank maybe.....

 

[Dimorphic]

I have been having the exact same problem with the CAD as Sparcod, this has really helped me guys, Cheers!!

 

[Dragie]

mmmm I love CAD problems - they make me smile

 

[Mr. Sabuncuoglu]

mmmm I love CAD problems - they make me smile

thats makes the two of us

 

[Tess653]

according to my text book, 6% is the maximum limit on the CAD in any one year, but 3% is what they aim for on average in the long term.

more on the pitchford hypothesis: high net foreign debt becomes a problem when the government is borrowing money for day-to-day spending, on health or education or whatever. this is what happened in argentina and places like that.

on the other hand, 98% of australia's net foreign debt is caused by businesses. and since debt is basically an essential part of business, or at least business investment, this isn't really a problem, as long as businesses can service their debt

 

[Demandred]

6% is what OECD/IMF/World Bank considers as danger zone, a moderatley unhealthy CAD should be about 3%.

Problem with Pitchford is that it assumes perfect information, or in other words, all investors have incredibly perfect forsight and never make a bad investment.

 

[MoonLiteDreamz]

Problem with Pitchford is that it assumes perfect information, or in other words, all investors have incredibly perfect forsight and never make a bad investment.

But didn't Pitchford state that it wouldn't matter if there's bad investment. because then the business can just call for bankrupcy. And then the CAD can even lower, because Australia doesn't have to pay that amount of money out overseas, thus no servicing cost?!.

 

[Demandred]

Domestically, what if a lot businesses went bankrupt?

 

[Tess653]

well, then that could downgrade our credit rating, so there is that risk with high foreign debt.

of course, for that to happen we'd probably have to have a serious recession, and then the credit rating would probably be the least of our worries.

and if we were heading towards a downturn, business investment would have probably slackened off a bit, and the RBA might have lowered interest rates, so we'd probably have a reduction in foreign debt anyway

 

[Demandred]

A recession isn't going to do any favours, even if foreign debt is reduced, the % of GDP as foreign debt will likely to increase. ANd if businesses can't pay back borrowed money (which doesn't really matter since its equity), credit rating is still going to plummet and that's only the beginning...

Oh btw, the RBA can only do so much in cushioning a recession, there is a point where monetary policy doesn't work at all - the liquidty trap and investor pessimism.

Come on Tess, if there's a way to reduce CAD, would you do it? Or would you do nothing at all?

I don't know about you, I prefer the former .

 

[MoonLiteDreamz]

High CAD is not a good thing. but Recession can boost eco growth. therefore recession isn't bad for the economy either.

Btw for my previous statement, I was just stating that Pitchford did put into account for 'bad business'. And stated it can good for CAD (for Short T. at least) Plus one or two business call for bankrupt wouldn't really decrease the national credit rating. so...

 

[gnrlies]

High CAD is not a good thing. but Recession can boost eco growth. therefore recession isn't bad for the economy either.

What have you been smokin? That sounds like something Paul Keating would say.

Btw for my previous statement, I was just stating that Pitchford did put into account for 'bad business'. And stated it can good for CAD (for Short T. at least) Plus one or two business call for bankrupt wouldn't really decrease the national credit rating. so...

The thing with the CAD and all those "The Sky Is Falling" naysayers is this:

Australia has always had a CAD. We've never not had a CAD.

Its always been in that range of between 3-6% (well, at least in a modern context since financial deregulation).

The difference between a CAD in 2006 and a CAD in the famous "Bananna Republic" days of the Keating and Hawke government is this:

Back where the CAD was a problem, a substantial amount of debt was incurred by the government. This was not necessarily for income generating activity. This is no longer the case. Hence a CAD only reflects the decisions made by individuals and businesses as per the price mechanisms within a market.

Business investment (FDI or Portfolio) holds absolutely no structural concern within the australian economy, and it is this component which everyone is getting so antsy about. Why are we worried if businesses are acquiring funds from overseas in order to facilitate income generating activities? So what if the returns are shipped off overseas (either directly in the form of dividends or indirectly in the form of interest or rent). It does not pose any real structural issue within the australian economy.

The problem with our CAD figures is represented by the goods deficit. This typically represents a non income generating deficit with the rest of the world. Whilst this is perhaps an undesireble outcome from a "numbers" perspective, the australian economy has historically shown resilliance to any real problem assosciated with the goods deficit. The goods deficit as we know ranges from around 0-4% of GDP, and this runs in cycles. It has done since god knows when.

As soon as all the journalists have put their final touches on their articles outlining how bad our record high trade deficit is, its time again to put pen to paper about how our exports are set to boom due to uranium sales to china, sustained resources boom, and falling aussie dollar.

Im sure the story gets tiring over and over and over, howevor it makes a good story to tell the people.

I think we do have a problem with the CAD, but only in that our export base needs to be diversified, and perhaps reduce our reliance on rocks n crops. Perhaps we should start focussing on some value added activities, and position ourselves appropriately to this wonderfull region of the world we live in: China, India, Japan, and south east asia all on our doorstep, and we are perfectly positioned to take advantage of it!