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Should Australia be worried about its trade deficit?

If, like most property investors, you try to keep up with what’s happening in the economy it’s been another day and another screaming headline.

This time it is Australia’s trade deficit that we should be panicking about.

The trouble is that due to our habit of crying wolf often people begin to take little or no notice of the news, and find it impossibly difficult to differentiate between the important ‘big picture’ news and the peripheral or less consequential data which is whipped up in order to strike fear into us.

Let’s take a gentle stroll through what it all means and whether we actually should be worrying about our trade deficit.

The balance of payments

The balance of payments measures all of the trade flows both in and out of a country, and shows whether a country is borrowing to fund itself. The balance of payments consists of two accounts: the current account and the capital account.

The current account measures the flows of goods and services and determines whether a country is exporting more than it imports or vice-versa.

A country such as China has grown its exports very strongly and as a result is likely to have a more prosperous future.

The term “balance of payments” suggests that there is a balancing figure, and there is: the capital account.

Plenty of countries run a current account deficit. This is not necessarily seen to be a problem provided the deficit is moderate. Around the turn of the century the US began to record large current account deficits, which is a concern.

Where countries begin to run large deficits that cannot be funded by the capital account, a balance of payments crisis can ensue, such as was seen during the Asian financial crisis in 1997, where Thailand’s currency collapsed and its debts could not be funded.

Large current account deficits can eventually weaken a country’s currency. This in turn makes exports cheaper and can boost sales and eventually the deficit, in theory at least, should be corrected.

So what happened this week?

This week Australia recorded its largest trade deficit since 2008, before the financial crisis. The figures showed a trade deficit for November 2012 of $2.6 billion.

Trade deficits tend to go hand in hand with a current account deficit. Australia’s shortfall may seem large. In fact, it was the fourth largest ever in Australia’s history.

But why?

What are the causes?

In part, as I’ve touched on before, consumers are spending more money on imported goods because our dollar is so strong at present, still buying 105.5 US cents in spite of a raft of interest rate cuts. This week’s data showed a fair jump in imports in the month.

That’s not a good trend but it’s not necessarily going to be an enduring one. After all, if you’re bearish on Australia’s prospects then interest rates may fall further and the currency would therefore be likely to weaken at some point.

Is the trade deficit worrying?

In short, not particularly.

Although the numbers sound material, Australia’s trade deficit is, relatively speaking, fairly low.

Moreover, it is the future trend that is important, and as Australia moves from the capital investment stage of the mining boom to the production phase, exports will naturally begin to increase.

Over the short-term capital investment in mining construction leads to a deficit, but gradually this spending will start to generate growth in exports and in household incomes.

The key word here is investment.

The major dozen or so mega resources projects over the long haul will be the key to Australia’s prosperous future.

The 80% boom (effectively a recovery) in the iron ore price is a phenomenal turnaround and those who want Australia to have a bright future will hope that the price stays put rather than retracing.

Don’t forget that much of the increase in iron ore prices has only happened relatively recently so the full effect will not yet have flowed through to the reported trade data.

Interestingly Paul Bloxham of HSBC, the thoughts of whom are always worthy of note, believes that the Reserve Bank has reached the end of its interest rate easing cycle, and the next move in the cash rate will actually be up towards the end of 2013.

What next?

Expect Australia’s trade deficits to begin to fall through the year. Eventually as we move into the production phase of the mining boom Australia will begin to record healthy exports and the wealth of the country and average household incomes will increase.

Then, of course, we will be told to worry about something else.

I wonder what it will be next? (Hint: well, it will be the US reaching its debt ceiling next month).

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About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


'Should Australia be worried about its trade deficit?' have 2 comments

  1. Avatar for Property Update

    January 16, 2013 @ 12:30 pm jim wills

    Fair article, I’m confused though, I was thinking rates would be dropping lower. I hope they dont go up too much, kinda bankin on low rates for a year or two.

    Reply

  2. Avatar for Property Update

    January 16, 2013 @ 9:32 pm Pete Wargent

    Here’s what the futures markets imply: http://www.asx.com.au/data/trt/ib_expectation_curve_graph.pdf

    Reply


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