Leigh Harkness on the RBA CAD perspective

Last week I discovered a recent speech by Guy Debelle on the RBA’s position on Australia’s current account deficit (CAD). I thought I would seek a response from Leigh Harkness as he has posted a number interesting articles about CADs over the last few months, and I have also noticed a number of discussion threads on MacroBusiness covering this topic lately.

Please find below Leigh’s response, and don’t forget to check out his website for some more thought provoking material.

In a recent address in Adelaide Guy Debelle, RBA Assistant Governor (Financial Markets) defended the Reserve Bank’s position of not managing Australia’s current account deficits. If the RBA was of the opinion that monetary policy affected the current account deficit and that reducing the current account deficit would improve the stability of the currency, the RBA Act would require the Bank to change monetary policy.

It is normal human behaviour to maintain the status, continue what you are doing and avoid change.  However, is this defensive human reaction clouding the RBA’s judgement?

In his speech, Debelle argues that Australian monetary policy does not affect the current account deficit and even suggests that large current account deficits could be a good outcome, and a zero balance a bad outcome.

The following is a synopsis of his main arguments:

1.       Summary of the global imbalance argument

Bad current account deficits are those which result from domestic distortions or excessive fiscal positions. Good ones are those which do not have such causes. . . . As long as current account positions are the result of savings and investment decisions by the private sector which are not affected by distortions, then there is no cause for concern.   . . . It is important to look beyond current accounts to the whole structure of the capital (financial) accounts [because]: 

  • . . . current accounts . . .  reflect the net outcome of a raft of savings and investment decisions . . . across the whole economy. The current account position is a symptom not the cause.
  • the capital (or financial) account, which is the mirror of the current account, is the net of a large array of gross capital flows. These flows reflect the financial decisions taken by both domestic and foreign investors.

 . . . it is often noted that Europe has a current account position that is close to zero. . . . there is nothing intrinsically optimal about zero. It may well be the case that the appropriate balance for Europe is not zero but distortions of one form or another have delivered such an outcome. If that were the case (and I am not arguing that it necessarily is), then Europe would be contributing to global ‘imbalances’ as much as those with large current account positions.

The US was able to earn relatively more on its stock of foreign assets than it paid on its foreign liabilities such that its net income position was often in surplus.  . . . focusing on the net balance of these flows, which is the current account position, is not particularly helpful relative to more scrutiny of the various components of the gross capital flows.

2.       A framework for the defence

a.       Within this country there are households that are at various stages of their lifecycle. . . . The young households have current account surpluses, the middle-aged households like me are in current account deficit. But these ‘imbalances’ are not generally cause for concern.

b.      Alternatively, we could consider the Australian states. At any point, there can be large current account positions between the Australian states.  . . .  imbalances across the Australian states are not a cause for concern.

 . . .  current account positions, even large ones, can exist that are benign and could not be classified as imbalances. The capital flows that are the counterpart to these current account positions are ‘good’, because they are associated with appropriate intergenerational transfers in the first case, and appropriate cross-border flows in an integrated economy in the second.

2.a Reasons to be concerned about capital flows:

  • the information asymmetry . . . For example,  . . . the US housing market.
  • the capacity to borrow in one’s own currency is important.

the economic adjustment that might ensue were they [current account deficits] to narrow precipitously.  . . . necessitating a sharp contraction of domestic demand so that the trade balance moves into surplus. Inevitably, this is associated with a domestic recession.

[But in] a world of floating exchange rates  . . . the main mechanism of adjustment is the exchange rate.  . . . Depreciation is stimulatory to the economy, whereas in the fixed exchange rate world, the adjustment is contractionary.

3.       Changes to Australia’s current account and capital flows

Over the past three years, there have been some quite sizeable changes in the size and composition of Australia’s current account and capital account.

From the early 1990s until 2007, Australia recorded a current account deficit which averaged around 4¼ per cent of GDP.  There were cycles around that level, with the current account narrowing to 2 per cent of GDP in 2001 . . . and widening to around 6 per cent of GDP in 2007. 

At the same time, there was reasonable stability in the major components of the capital account.

One of Guy Debelle’s propositions is that net foreign capital inflow caused current account deficit and that:

The capital flows that are the counterpart to these current account positions are ‘good’, because they are associated with appropriate intergenerational transfers in the first case, and appropriate cross-border flows in an integrated economy in the second.

It is worth noting the following chart before continuing.

I can understand that there may be reasons for capital flows between developed and developing countries, say, from the USA to China.  But we are seeing the reverse.  Even if international capital flows were related to intergenerational transfers and appropriate cross border flows of an integrated international economy, it would not mean that those capital flows are causing Australia’s current account deficits.

International capital inflow could cause Australia’s current account deficits if it had a fixed exchange rate. The additional money from the foreign capital would enter the economy and raise national expenditure above income, causing current account deficits. Current account deficits generated by foreign capital inflow would be associated with stable or increasing foreign reserves.

But in a country with a floating exchange rate system, international capital flows do not increase the money supply.  Hence, they cannot stimulate national expenditure to rise above income and cause current account deficits.

If foreign capital were to drive up the exchange rate so that we shifted some of our expenditure from domestic products to buy additional imports, such transactions would maintain our national expenditure, but would reduce national income.  If that capital inflow flow were prolonged, national income would decline and we would experience a recession.  That has rarely been our experience in Australia.

In Japan, net private capital outflows have the effect of raising export income above the expenditure on imports.  That additional income would suggest that the economy should prosper.  It did while bank lending was growing rapidly.  However, in more recent years, the growth of bank lending has declined and the additional income from exports is spent on foreign capital rather than on domestic products.  Therefore, the additional income from exports is not stimulating the economy.  Consequently, the Japanese economy has been relatively stagnant in recent years.

Australia has a similar monetary system, but with current account deficits.  If foreign capital inflow were driving our current account deficit, then the only way we could sustain a situation where expenditure exceeded income and simultaneously achieve economic growth would be to create additional money to raise demand.

With the floating exchange rate monetary system, the only significant source of additional money is from the growth of bank credit.  As can be seen from the accompanying graph, except for a brief period around the year 2000, any loss of income due to foreign capital inflow driving the current account balance in New Zealand has been fully compensated by an equivalent if not greater increase in the addition expenditure generated by the growth of bank credit.

This credit growth has been very convenient for New Zealand, fully compensating income for the capital inflow in most years.

The close relationship between bank credit and the current account deficit raises the question as to whether it is the independent decisions of New Zealand investors that has been mainly responsible for driving the current account deficit.

In his speech Guy Debelle said:

Bad current account deficits are those which result from domestic distortions.

If a large number of us could print our own money, then the money we printed would enable each of us to buy more than we had produced.  When aggregated, those transactions would mean that the whole economy could buy more than it produced, resulting in current account deficits.

Debelle, and those of us who could not print their own money, would consider that those who were printing money were abusing the monetary system.  In their opinion, the current account deficits that were being financed by the printed money were the result of a domestic distortion in the monetary system.

We use money to distribute our goods and services.  The money we earn from selling goods and services enables us to buy goods and services of equivalent value.  From the macro-economic perspective, money constrains the nation’s expenditure to its income: its consumption to its production.  If people were to print their own money, they would be stealing products from those who had produced those products.  It is for this reason that our laws restrict the right of people to create money.

But would it be a distortion of the monetary system if the government were to create more money to finance its expenditure?  If it were not a distortion, we would not need to pay taxes.  The government could print all the money it needs to finance its expenditure.  Yet that money would have the same effect on the economy as the money we printed in the private sector.  It would cause the country to buy more than it produced, resulting in current account deficits.

It is for this reason that governments do impose taxes.  If they were to print money to finance expenditure, Debelle, as well as many of us, would consider that a great distortion of the monetary system and call upon the government to implement a more responsible fiscal policy.

What if banks could create additional money to finance investment, surely that would not be a distortion?  Guy Debelle’s speech indicates that it is the RBA’s view that investment and savings decisions are independent of each other so that if investment were greater than savings, that would not be a distortion of the monetary system.

In our world of floating exchange rates, when banks lend more than is repaid to them, it has the same effect on the economy as money printed by the private (non-bank) sector, or money created by the government to finance its expenditure: it results in national expenditure exceeding national income and current account deficits.

The reason for this is more evident when we examine bank lending in more detail.  Bank lending is a process whereby money: which represents a current entitlement to products; is created from debt: which represents a future obligation to supply products.  Essentially, it is the process that converts future obligations into current entitlements.  It is no wonder that it causes a shortage of goods in the current time, or a current account deficit.

The consequence of creating additional money from bank credit does not change if the money is lent for worthwhile investment projects.  Worthwhile investments may raise national income in the long term.  But that is irrelevant to its effect on the current account balance.

The relationship between bank credit and the current account deficit for Australia is shown in the accompanying chart.

It reveals that it is not the government’s fiscal deficit that is responsible for the current account deficit.  The only source of additional money that is related to the current account deficits is bank credit.

Bank lending did not always cause current account deficits.  In the days of fixed exchange rates, economies held national savings in the form of foreign reserves.  Those savings were created when growing export revenues were spent on domestic products, rather than imports.  While the domestic dollars were circulating around the domestic economy, the foreign reserves, or national savings, were left idle.  If banks were to lend that money for worthwhile investments, they could utilise those savings and enable the economy to accelerate its rate of economic growth.  Hence, bank lending could make a legitimate contribution to the economy without causing any imbalances.

Floating the dollar has prevented the economy from accumulating foreign reserves and national savings.  As a consequence, banks no longer have a legitimate source of savings to lend.  It has meant that any growth in bank lending constitutes a distortion of the monetary system.  It has the same effect as any distortion of the monetary system that would allow us to print money to finance expenditure.  It:

  • raises national expenditure above income;
  • raises spending above production;
  • raise imports above exports; and
  • results in current account deficits.


Latest posts by __ADAM__ (see all)


  1. Leigh

    Thanks, I’m learning. 1 question and 1 observation

    Q. So when does the accumulated deficit need to be repaid? I didn’t say it would be easy.

    O. I would argue that if banks properly assessed the risk against the money lent into Australia from offshore borrowings, and allocated the appropriate amount of capital, then this would apply a brake to unmanageable CADs ie no need to answer Q above

    • After a point foreign debts accumulated from persistent CADs do not get paid. For Australia we would have to go from 50 years of consuming more than we produce, to producing more than we spend for the next 50 years – is that a likely scenario?

      Countries are squeezed to make interest payments on foreign debts until they simply cannot even pay the interest.

      Then… well, things will not be pretty.

      • We are continuously financing our CAD by asset sales. That is the only reason why, after 50 years of continuous CAD’s, we are not totally bankrupt. As I’ve seen the 78% figure for Foreign ownership of our mining resources has been corroborated from several sources as now being between 80 and 83%. Our food chain outside the farm gate has been long-since been sold to Foreign companies..We are now busy selling inside the farm gate although this has been going on on a smaller scale for a very long time.
        We have just been fortunate we live in a land that has more abundant natural resources per head of population than anywhere else in the world. Unfortunately our good fortune has not made us prosperous guardians of our land so much as self-indulgent wastrels.

        The social cost of the CAD and asset sell-off is everywhere for us to see if we do have but eyes to see with. Unfortunately those who work for Government, or inhabit our academic halls, do not live in any areas where this impact is felt, where the communities have been destroyed.
        The economic costs are everywhere but I am particularly struck by in our requirement for massive city infrastructure to support a population now involved, not in any productive achievement, but in ‘taking in each other’s washing’

  2. Reading Leigh’s full article
    it seems that the only way to avoid a persistent CAD is to have restrict lending in a manner based on the level of foreign reserves.

    “government advised the bank to regulate its lending according to the level of foreign reserves. If there were plenty of foreign reserves, it could lend without restraint. But if foreign reserves were low, it was required to slow down or stop lending.”

    That seems like a reasonable point and one that has been used to explain the relationship between house price growth and CADs


    It seems that just a small tweak to the financial rules to tighten lending is all it takes to make housing more affordable and to limit that accumulation of foreign debts.

    • Yes, one would think that banning domestic ADI’s from accessing wholesale foreign funding to boost house prices is a prudent macro measure….

      It certainly provides a more robust system.

    • Reading your blog Cam, I think we are in total agreement. Lending standards are key to there being less requirement for offshore borrowing. Its not just lower LVRs that would create lower demand for offshore borrowings and higher actual domestic savings. Higher loan servicing standards provide the same sort of incentive to borrow less and retain more in the domestic economy through lower interest payments.

      Prince, I don’t think banning is the solution

      • As we can see from the GFC, foreign wholesale funding and the resultant CAD exposes our econonomy to huge external shocks. It so happens that taxpayers are called on to absorb these shocks
        So banks should be made to pick their poison – either a ban on foreign wholesale funding or an explicit repudiation of guarantee for banks by the Australian parliament.

    • Cam

      Lending is a process in which one party has something that it makes available to another.

      If the banks had money available that they had saved, and lent that, that would not be a problem. That is like someone at the Commonwealth Bank lending me their Qantas ticket to fly to London.

      The issue is whether the banks should be restricted from printing money.

      What banks are doing is converting your promise to repay a debt in twenty years time to a right to buy goods now.
      That is a very different problem.

      It is like the Commonwealth Bank issuing Qantas tickets to London, now, if I promise to give them a Qantas ticket to London in 20 years time.

      Qantas has issued all the tickets for its planes at this time. The additional tickets from the Commonwealth bank mean that it has a deficit of seats. To honor your ticket, it has to borrow seats from foreign airlines. That is, it has a current deficit of seats: a current account deficit, and is required to go into debt to honour the ticket.

        • Cam

          Great to see we agree.

          Banks are currently issuing about $1000 of tickets for every man, woman and child in the country and expecting the rest of the world to supply us goods (on credit) so that our economies can honor those tickets.

          The same thing is happening in Europe and the US. It is no wonder that confidence in the Western ticketing (monetary) system is declining.

      • Brilliant analogy Leigh thank you.

        Deep T – perhaps a restriction on size, but at least it has to be recognised that there is huge moral hazard in having half of your mortgage portfolio funded by foreigners.

        It also makes debt forgiveness (which is a likely, but unpalatable scenario for banksters) a lot harder to achieve….

  3. Graphed it looks like..an evil road to dire straights…Paved by highly paid saints

    Thanks Leigh ,DE…JR

  4. DE,

    You may like this recent paper by W. Max Corden (from Uni of Melb): “Global Imbalances and the Paradox of Thrift”:

    He presents a nice non-mathematical, neoclassical (NC) analysis of the international savings imbalances, then turns to Keynes, and presents Keynes’ anti-Says-Law argument against national/international savings – all in the context of the recent global financial kerfuffle. I am neither a NC or a Keynesian, but I part company with him and Keynes when they state that aggregate savings leads to dissavings – due to reduced aggregate demand. His solutions are also presented in the light of Keynes’ anti-savings argument.

  5. Weimar Republic

    But in a country with a floating exchange rate system, international capital flows do not increase the money supply.


    The only source of additional money that is related to the current account deficits is bank credit.

    I’m not sure if I understand your argument completely but if we accept that bank credit is the ultimate problem, and as a result banks seek money offshore, then servicing that borrowing can contribute to the current account deficit. So bank lending is the cause, which creates excessive foreign borrowing, which manifests as larger current account deficit.

    Is that what you are saying? If so I agree. If not can you clarify.


    • WR

      When we work, the money we earn represents our contribution to the economy. That money entitles us to buy products of an equivalent value.

      Therefore, money constrains our expenditure to our income; or constrains what we buy to what we have produced. If the only way we could have money was to work for it, then that economy could not have a current account deficit.

      If someone lends their money to someone else, that does not cause a current account deficit. The lender has reduced their spending to let the borrower increase their spending. It does not raise national expenditure above national income.

      The only way that people and businesses can buy more than they produce is if new money is created for them to spend.
      In a country with floating exchange rates, the only source of additional money is from domestic sources.

      International transactions are not allowed to affect the money supply. The government can create money, in the form of currency, and use that money to increase its expenditure. But it is a very limited source of money.

      Most money is created as bank credit. When banks lend, they add the debt to their assets and add deposits to their liabilities. Their balance sheets are balanced, yet the additional deposits are additional money. Banks do not need to borrow money from anywhere to create it.

      The additional money that the banks create enables people to buy more than they have produced. Everyone else in the economy with money has earned their money, and the amount of money they have enables them to buy the equivalent of what they have produced. The additional money enables the economy to buy additional products; that is, to buy more than has been produced.

      The only way a country can buy more than it has produces is to import more than it exports. The only way the country can pay for those additional exports is either to sell off capital goods (not income) such as land, or shares, or they can borrow offshore.

      The country does not consciously go out and borrow offshore to pay for the imports. There are a mass of exporters, speculators, investors and lenders on the foreign exchange market wanting to sell their foreign exchange to buy domestic currency. There are also a mass of importers, speculators, investors and lenders wanting to convert their domestic currency to foreign currency. Some of the transactions may result in foreigners holding deposits in banks. Those deposits are regarded as banks financing their lending (assets) with offshore funds (liabilities).

      When all these transactions are settled and netted out, the net supply of domestic currency is equal to imports. The net demand for domestic currency is equal to exports plus foreign capital inflow. The foreign capital inflow is equal to the difference between imports and exports which is equal to the growth of bank credit, as shown in the graphs.

      The foreign funds do not create additional bank lending. The banks do not need to borrow offshore to lend. The offshore funds can be quickly spent to buy capital assets or can be returned overseas. They are just one of the outcomes of the flow of funds.

      I hope this helps.

      • Weimar Republic

        sorry but no.

        banks lend and in doing so create a deposit. We all know this. I was outlining a series of steps.

        the foreign funds don’t create the lending, I agree, they follow as the step subsequent to the lending. also banks don’t need to source funds offshore but presumably they must be doing this because it is commercially better for them than domestic sourcing.

        So I am saying that a mechanism for loan creation to impact on the current account is when banks seek funds offshore subsequent to making loans and in them making interest payment on those foreign funds.

        It isn’t clear to me in either your article or your reply to me whether you agree that this is a mechanism (or perhaps the mechanism).

        • WR

          I think we may have to agree to differ.

          I understand that you are saying that the current account deficit is create only when banks seek funding offshore.

          My experience is that bank lending can create current account deficits without the banks seeking funding offshore. This can happen in countries with fixed exchange rates as well a country with floating exchange rates.

          It is the demand in excess of income that creates current account deficits and in countries with floating exchange rates, that demand predominantly comes from the growth of bank credit.

        • WR let me see if I can help out a bit. Maybe, Maybe not.

          >the foreign funds don’t create the lending, I agree, they follow as the step subsequent to the lending. also banks don’t need to source funds offshore but presumably they must be doing this because it is commercially better for them than domestic sourcing.So I am saying that a mechanism for loan creation to impact on the current account is when banks seek funds offshore subsequent to making loans and in them making interest payment on those foreign funds.

          What you are talking about is the way bank source funds to support their liquidity requirements. This could come from an internal or external source. If it was from overseas sources then yes the interest paid on these oversea sources would add to the CAD ( I think , it’s late maybe I will re-think that in the morning!). and yes we all know this is an after the fact exercise for banks, but for the purposes of this discussion that is irrelevant.

          What Leigh is saying is the credit itself ( not the liquidity sources ) creates demand for products above what is available in the local economy. It therefore drives demand for overseas goods which is what causes the CAD.

          He also notes that because we have a floating exchange rate the nation does not accumulate foreign reserves even in times of high ToT. This means that when we do have expanding bank credit we have no foreign reserves saved up to “pay” the foreign entities. Meaning that foreign sourced goods paid for on credit always add to the CAD. The fact that we do not accumulate foreign reserves also means that the only way additional money can be added to the local economy is via an expansion of credit in the local banking system.

          A question I have been asking myself is about the mechanics of government deficits and their effect on the CAD. Leigh’s research suggests there is limited or no effect. But I am still working through that one myself.. I think I am almost there.

          I hope that did Leigh justice.

          • Weimar Republic

            replied below. will be offline for a few days but will read your reply (if there is one when i am back)

          • DE

            A very good explanation.

            With regard to government borrowiing, if the government borrows from the banking system,then that can increase the money supply. That may be the case in the USA at this time where the current account deficit is greater than the growth of credit in the commercial banking system.

          • If every nation tried to restrict internal consumption based on their export earnings. Then every nation will out compete each other into a spiral of no global growth.

            There cant be a situation where every nation runs a Current Account Surplus.

          • Indo, but every country can endeavour to maintain a zero current account balance over the medium term, with cycles between deficit and surplus. In that kind of world countries would actually be spending approximately what they earn.

  6. For Australian to lives within its mean, “somebody” must limit the amount we can borrow to match what we produce. That means credit rationing. Unfortuantely, our banks are nothing but giant building societies now, and they will stop lending to businesses to maintain lending to housing.

    The only way to stop this malinvestent is to reform negative gearing and introduce a land tax. All of which are mentioned in the Henry review. All of which are political poison. We need bipartisanship in the political system to push this through, and I simply cannot see that happening with ‘faceless man’ controlling our political leaders right now.

  7. Weimar Republic


    this might be an apples and oranges conversation. Let’s see.

    I’m not sure why you would consider the overseas sourcing of funds irrelevant for a discussion about the current account deficit. And while they can choose to source locally, currently a lot is sourced overseas, why they choose to do so is irrelevant. Nevertheless if you check out the magnitude of this contribution to the current account it is pretty big, yes?

    In my comments I made it clear that I didn’t see this as a cause but rather an result coming from credit expansion. In other words it wouldn’t be occuring (at least to the level that it is) without the credit expansion. So for me this is a mechanism for transmission of a credit expansion into a larger current account deficit.

    I agree that intuitively if credit expands more imports will arise, but just as consumers might want to spend on imported goods, banks want to source funds for liquidity requirements (from overseas in this case). So why would one (consumer spending) be considered a valid method of transmission to a current account deficit and not the other (banks overseas sourcing)? They are both driven by the credit expansion. So as above, and in other comments, I have made lending the cause, but, apparently contrary to Leigh (stand corrected), I offer foreign sourcing as a mechanism for how to get from cause to effect (the CAD).

    Foreign payments are not the only source of the CAD of course, but as a % they are quite are are they not? Another way to present this is to work backwards and observe line items for foreign interest etc. in the CAD and ask how did they get there, what was the cause? Answer: foreign borrowing, but what was the cause of that? Answer: sourcing funds to support liquidity requirements but what was the need for that? Answer: credit expansion.

    Some other observations:

    The model has a degree of hysteresis. e.g. credit and CAD are highly correlated when credit is expanding but, for the USA at least, not so when credit is contracting. I guess we’d need to see some more data from other countries.

    It is possible to have credit expansion while having a current account surplus, is it not?

  8. Indo

    We have little growth now.

    Growth was much higher when we allowed the income from export growth to stimulate our economies, as China does today.

    In those circumstances, even without bank credit, our economies would grow more rapidly than they are now.

    • Thanks for the reply Leigh
      I am looking at a simplistic model where there is two countries X and Y . If both countries where waiting for the other to import so as to obtain export earnings then nothing would move ahead. Surely atleast one of countries should budge and stimulate internal demand either by government spending or by private sector credit creation by which there are imports.

  9. Weimar

    The Banks can simply create credit. I think we all agree that this is so and Steve Keen’s work seems to be pretty clear in this regard.
    The Banks rely on this crdeit ending up as deposits in their Bank. Again I think we all accept that (if I am wrong about our agreement then set me straight 🙂 )
    Now their problem arises because some of the population come to me and buy a tent, or to Gerry Harvey and buy a Flat screen, or buy a car. It is at that point that we need the Foreign Funding. We must pay for these goods not in A$ but generally in USD, or perhaps Euro, and maybe in the future Yuan.
    It is at that point the Banks borrow offshore.

    • flawse

      I doubt that foreign funding has much to do with payment for excess spending on imports.

      Money, or bank deposits are liabilities of the banks. Banks wish to pay as little as possible in interest on those liabilities.

      On the other hand, depositors want to earn as much as possible on their deposits. Therefore, many depositors may move their money into accounts with banks that offer higher interest.

      The banks who originally lent the money and from whom the deposits were moved now have to pay an interbank interest rate on its liabilities which are now shifted to the other bank. Alternatively, the other bank could ask for assets in exchange for those liabilities.

      To reduce their interest and retain their assets, banks may find that they can borrow off shore and pay lower interest rates on those liabilities than they would pay to other domestic banks.

      Hence, foreign funding may have nothing to do with the current account deficit. It may be just a mechanism for banks to avoid having to compete domestically for deposits.

      • Leigh
        In this case I cannot help but think you are confusing the macro situation with the micro…or alternately I am confusing the issue in the brief manner that I am writing and you are trying to answer the confusion I’ve created.

        On the national scale, there is only one way to fund the CAD and that is to borrow the money from some foreign source. We need to get USD from somewhere.
        From the Banks situation if they all wish to fund locally the process of funding excess consumption, will simply push up savings, and by definition, interest rates to a point where there is no longer a CAD. In this case the borrowing offshore allows interest rates to remain at a lower level and allows the CAD to continue.
        Alternately, we just keep on printing the good old bits of paper to try to keep interest rates down and desperately hope that our overseas suppliers take our paper in exchange for real goods. However unless they are able to buy something with our bits of paper they will pretty soon become exactly worth what they are…bits of paper.
        Our method of preventing this happening is to allow foreigners to buy almost any asset in Australia they take a liking to. If we did not allow this the A$ would deteriorate in value so far, again the CAD would correct itself.

        So I guess it is always something of a circular situation. My point always is, that if we inject some credit or money at some point, we need to follow that money right through the system to see where it goes. More to the point, the long term is 50 or 80 years not 10 years as most economists now define it.

      • >In this case I cannot help but think you are confusing the macro situation with the micro…or alternately I am confusing the issue in the brief manner that I am writing and you are trying to answer the confusion I’ve created.

        Actually I am completely confused. Surely foreign borrowing by banks effects the CAD.

        I think it would be helpful in regards to explaining the foreign source funding of banks is a step by step approach

        For example

        1. person goes to bank get loan
        2. bank deposit is created in the banks computer
        3. bank requires liquidity funding so sells bond to US fund denominated in $AU dollars.
        4. US fund buys AU dollars to purchase bond. ( exchange rate effect ) ( CAD effect ?)
        5. AU dollars transfered to bond issuing bank via interbank transfer at RBA.
        6. Person spends money. ( CAD effect ?)

        What happens to the Current Account when the bank pays interest on the bond ? the bond matures ?

        Would this be different if the banks were forced to use local funding sources? Is that even possible?

        Does the same sort of thing hold for mining investment?

        So many bloody questions 🙂

  10. Leigh Harkness
    August 11, 2011 at 9:54 pm


    For Australia to live within its means, it must limit its lending to its savings.

    We MUST HAVE positive real AFTER-TAX interest rates.
    Short term you can get savings with negative interest rates however the last 50 years have demonstrated that negative real after-tax interest rates lead to a lack of savings, over-consumption, mal-investment and a host of economic, environmental and social ills that follow these processes.

  11. Leigh
    I think I should say ‘I think the Asset sales allow this shambles to continue’ Cause and effect gets confused in the roundabout.

    Broken Model…at the risk of getting shot at here I think your Credit model is not how it works. Again Banks can create funding which returns to them. However in Aus case, with our very poorly structured economy’ the leakage into imports of any money injected into the economy is very high.
    So a good of it gets paid to me as an importer and I use it to pay for goods I import in say USD. It is at that point the Foreign currency becomes necessary.
    Again I stress the circular nature of the argument. It can be argued your way but in doing so I think we lose clarity about issues and how to fix the problems.
    The CAD is the result, in the first place, as Leigh says, the process of consuming more than we produce.

    • >Broken Model…at the risk of getting shot at here I think your Credit model is not how it works. Again Banks can create funding which returns to them.

      No banks create deposits in their own computers, but these are not reserves.

      In order to support the liquidity requirements of this newly issued loan includng interbank transactions then a bank need reserves. To get these they must either lend them off other banks (in the interbank market), get them directly from the RBA, or get them from the external sector.

      DE’s article on this


      The interbank market is manipulated by the RBA to maintain the current interest rate.

      Without understanding these fundamentals you cannot possibly understand how the creation of credit in the banking system creates a CAD. Which is why I asked for an example from Leigh.

    • flawse

      Sorry, I am slow to respond. I have been out fishing.
      My wife caught 4 salmon and I only caught one when I cast out her line and a fish bit before I had time to give it back to her.

      The shambles does continue quite smoothly until we run out of worthwhile assets, as Greece and a few other countries have found out. It does not need to be farms, mines or houses, it can be government securities, private secutities or bank securities.

      Bank deposits or securities (to fund the banks) are just some of the investments available to foreign capital.

      Note, for banks today, savings means loan repayments. Thus when banks lend the same amount as has been repaid, it does not affect the current account balance. Bank deposits are not savings.

  12. BrokenModel
    Would this be different if the banks were forced to use local funding sources? Is that even possible?

    The CAD would fix itself. Your scenario is not possible other than as a very short term.

  13. Weimar Republic

    Just returning to this after being away for a few days. Broken Model seems to be closest to my thoughts on this.

    Leigh said “I understand that you are saying that the current account deficit is create only when banks seek funding offshore.” I thought it was clear in my comments but it apparently not. My approach is not to develop a theory it is to look at the data and work backwards. On that basis it is impossible for the foreign sourcing to be the only cause of a CAD. I said it was a mechanism and perhaps the mechanism, meaning the main driver.

    Credit expansion has funded ponzi housing as well as imports on goods and services. The contribution to the CAD of foreign interest payments is significant, don’t have the data handy but I believe it has been 2-3% of GDP.

    Got no reply to be question/statement that it is possible to have credit expansion while having a current account surplus but to me this indicates that additional qualifiers are needed to the final paragraph of the article.