The document discusses the UK's current account deficit, which has widened primarily due to increased profits paid out abroad, despite improvements in trade balances. It argues that the current account deficit is not a reliable indicator of economic crises, as it historically has preceded both recessions and currency crashes. Global imbalances and the euro area's recovery challenges are presented as influencing factors for the UK's economic situation, rather than the current account alone.

1. The current
account deficit
that cried
“wolf!”
Rupert Seggins &
Marcus Wright
@RBS_Economics

2. A tale about the UK current account deficit
What is the current account, what has happened to it, why, and
what useful information does it give us about the economy?
1) The balance of money & credit going into and out of the UK.
2) The deficit has been large and recently got larger due mainly to
the UK paying out more in profits than it takes in.
3) Little by way of crisis warnings. But more by way of explaining
low interest rates and sluggish Euro Area recoveries.
2

3. What is the current account balance?
3
• It measures the difference
between money and credit
coming into the UK and
money and credit going out.
• This comes from buying and
selling goods and services
(exports & imports) and from
income paid on assets held by
foreigners here or UK assets
held abroad.
• It is affected both by
economic policies and
developments in the UK and
outside it.

4. What has happened? The long term story
4
• During the pre-war Gold
Standard & under the auspices
of the British Empire, the UK
ran persistently large current
account surpluses, entirely
due to net income from
abroad. After leaving the
dollar peg in 1972, that all
changed.
• The UK international
competitiveness issue is
nothing new. We have run a
trade deficit in 7 out of every
10 years since 1870.

5. What has happened more recently?
5
• The current account
deterioration is not down to
the trade deficit. That is
smaller than before the crisis.
• On the financial side, we have
been and continue to are
reduce our assets abroad. But
we are doing it slower than
foreigners are reducing their
assets in the UK.
• This has meant faster falls in
profits, dividends and interest
payments coming into the UK
than going out.

6. Why has the current account deficit got worse?
6
• The major reason for the
current account’s recent
deterioration is that our
income balance has changed
from a surplus to a deficit. In
particular, net income from
foreign direct investment
has seen the biggest plunge.
• There has also been some
evidence of a loss of
competitiveness with
Europe and Africa, even as
trade balances improved
with other regions.

7. A consequence of a weak Euro Area recovery
7
• A recent ONS study has
shown that the fall in net
income from enterprises
abroad has been driven by:
1) A fall in UK income from
non-G7 OECD countries
(mainly in Europe)
2) A fall in income going to
very large UK companies
3) A fall in UK income from oil
& gas and ICT with a rise in
income paid to foreign
wholesalers

8. The current account who cried “wolf!”
8
• The problem with the current
account as an indicator of
economic trouble is that in
the UK, it is always crying
“wolf!”
• Historically a deficit has
preceded some recessions,
but not others. It has
preceded more currency
crashes. But persistent post-
Bretton Woods deficits have
weakened any value it may
have had as an early warning
signal.

9. Exchange rates. Rules of thumb as opposed to current accounts
9
• Sterling is volatile, undergoing
both large appreciations and
depreciations. A rough rule of
thumb: a sterling slide of
more than 10% against the
dollar starts once every 4.5 to
5 years.
• A second rough rule of
thumb: a monthly rise in
sterling of more than 5%
against the dollar has
happened every 2 years since
1975. A 5% fall has happened
once every 1.5 years.

10. The current account tells us little about sovereign solvency
10
• One popular line of argument is
that the UK’s current account
deficit indicates that it is
vulnerable to a run on sovereign
debt, potentially risking default
as a result. This is unlikely.
• The UK government has little
foreign currency debt; the
average maturity of its debt is
16 years, providing a good
cushion against spikes in yields;
the UK has a good credit history;
and more QE is always an
option…

11. When the current account misleads…
11
• Current account deficits put
the focus on who the UK is
building up IOUs against. It’s
equally important to monitor
which countries have been
running up debts to the UK.
• The biggest deterioration in
the UK current account balance
was with Germany and other
European nations. Meanwhile
the biggest increase in UK
financial exposure has been
with China and other Asian
nations.

12. But global imbalances still matter for us
12
• Lower for longer interest rates
are in part a symptom of
global current account
imbalances as emerging
economies, in particular
China, export capital to
advanced economies.
• The problems in the Euro
Area, our largest trading
partner, are also being
compounded by current
account imbalances. In
particular, Germany’s larger
surpluses are hampering much
needed economic adjustment.

13. The bottom line
• The UK current account is a poor early warning indicator for
recessions and for big falls in exchange rates.
• It is more useful to note that exchange rates are volatile and
that large swings happen more frequently than you think,
regardless of the current account balance.
• Current accounts are important as part of the wider pattern
of global external imbalances that are exacerbating the
lower for longer interest rate environment & hampering the
Euro Area’s (and the UK’s) recovery.
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